Tag Archives | Social Welfare

Allocative Efficiency vs. Social welfare

If perfect competition always leads to allocative efficiency, does it also lead to increased social welfare? If so, why does the government intervene in the markets in the first place and why does it have monopolies of its own?

By Anupam Manur (@anupammanur)

 

Source: Cox and Forkum

Source: Cox and Forkum

Perfect competition, by definition, will produce the truest price of goods and services. Due to existence of a large number of buyers and sellers and the competition among them, the market forces of demand and supply alone will determine the price levels in the economy. And it is through the price mechanism that resources are allocated most efficiently: all those who are willing to produce and sell at a given price point and all those who are willing to buy the goods at the given price point can do so.

One of the reasons that governments intervene is to increase competition in the economy. Remember, perfect competition in reality is a rarity. Very few instances of markets that can be described as being perfectly competitive. Competition in the markets can be seen on a continuum with perfect competition at one end and pure monopoly at the other, both of which are ideal types. In reality, most markets fall somewhere in between and it should be the collective effort of society (including government) to push markets towards greater competition. Many government interventions can actually be seen in this light. Liberalising reforms undertaken by the government are usually made with the intention to reduce concentration of market power and increase competition. Privatisation of certain sectors or allowing FDI limits are examples of such reforms. It should be noted that the reason for the concentration of market power could be the government itself. In India, we have seen how the MRTP Act, FERA, etc heavily distorted the markets, which were then reformed in 1991.

Government intervention in markets in the form of actually producing goods and services should be carefully analysed. In some cases, the government can enter a market as one player to provide competition. When it is just one player in the market, it can act as a balancing force to the private player and thereby, increase efficiency due to the added competition (provided, it is a fair market player). The existence of BSNL in the telecom sector is perhaps the best example for this. However, many other instances in history have proved the opposite: that government owned public sector units usually lead to distortions in the economy. Examples range from when the government is the only player (eg. electricity distribution companies) or when the government is part of many players, but fail to produce efficiently (Air India). Bank nationalisation is one of the better examples of how government intervention has resulted in considerable inefficiencies. The reasons for nationalisation was to have greater control over this sensitive sector, to force banks to lend to priority sectors and to the government.

The government can also intervene in markets to correct other forms of market imperfections. Apart from concentration of market power discussed above, market imperfections can take other forms: under production of public goods and merit goods (goods with positive externalities), overproduction of demerit goods, etc. Government intervention in these aspects can lead to higher social welfare. It must be noted, however, that any form of government intervention, if it does increase social welfare in the short run, should be of a temporary and least intrusive form. It should aim to correct the market imperfections and withdraw as soon as possible. If not, in the long run, the intervention will eventually lead to a reduction in welfare.

While these interventions tend to increase economic efficiency, other interventions will be detrimental to it.  When the government intervenes in the market in order to meet its social objectives or for certain political reasons, it will lead to a reduction in economic efficiency and even reduces social welfare in the long run. These interventions are undertaken when the government believes that the economically efficient outcomes may not lead to social welfare or that the aggregate social welfare might not accrue proportionately to targeted sections of society. For example, imagine if the railways were completely privatised, then, at equilibrium, the tickets would shoot up by 4-5 times at least and this could make it unaffordable to the poor. This prompts the government to run the Indian railways itself, such that it can have better control over the price mechanism.

When the government uses the price mechanism to achieve political and social objectives, it will lead to a reduction in economic efficiency. High ‘sin taxes’ are used in order to curb activities such as smoking and drinking. Taxes are also used as a tool for redistribution of wealth: high tax on ‘luxury’ items in order to fund welfare schemes.

The gray areas in government intervention occurs when there is a clash between economic efficiency and social welfare. Sometimes, economically efficient outcomes may lead to a reduction of social welfare. Imagine the market for essential drugs. An economically efficient solution might price a life-saving drug too high and out of reach of most citizens, thereby reducing social welfare. Else, imagine if there is a sudden drought this year with the failure of monsoons and the prices of essential commodities soar. The markets might not price in the extreme consequences of such events, which might even be death. In each of these cases, it might be justifiable for the government to intervene. The challenge is to find the least distortionary method to do so.

Anupam Manur is a Policy Analyst at the Takshashila Institution.

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Bringing efficiency to social welfare

The linking of the Atal Pension Yojna to other welfare schemes is a positive step towards greater operational efficacy

Women_in_Deogarh_morning,_Orissa,_India

In order to be successful, social schemes in India need more efficient design structures and easier and more effective implementation procedures. The first step towards achieving this would be to streamline the existing structure of the implementing agencies as this would reduce the economic cost incurred. Thankfully, the current government has already realised the benefits of optimising implementation and has begun to link various schemes to each other. The latest pension scheme in India, the Atal Pension Yojana (APY), will utilise the organisation architecture of the National Pension Scheme (NPS) launched in 2004 and will also be using the accounts created under the Pradhan Mantri Jan-Dhan Yojana (PMJDY) to broaden its provision.

Linking with the NPS

The biggest advantage of linking the APY to the NPS is the number of benefits availed by utilising the NPS’s established structure. For example, the Union Budget 2014-15 made the NPS more lucrative by granting an extra tax deduction for investments in the NPS. The Finance Minister announced that a separate tax deduction of Rs 50,000 will be allowed over and above the limit of Rs 1.5 lakh set by Section 80C of the Income Tax Act, 1961. This was done to increase the demand for the NPS.

Another bonus to the APY is that it can piggyback on the subscriber base already accumulated by the NPS. In a period of 6 years, the NPS has managed to accumulate 38 lakh subscribers. However, this number could still increase; 38 lakh subscribers still only form a small percentage of the total population. One of the reasons for this is the low commission rate for NPS agents. They consequently do not have sufficient incentive to promote the scheme and the net result is that people are comparatively unaware about the scheme. Keeping this in mind, the Finance Ministry has announced that pension schemes for the unorganised sector would be linked to the PMJDY .

Linking to the PMJDY

The PMJDY is a scheme to improve financial inclusiveness amongst low income groups and was launched in August, 2014 in two phases. The first phase will end on August 14, 2015 and its target is to provide bank accounts to all families that don’t already have one. The aim of the second phase will be to provide micro finance and unorganised sector pension schemes though ‘business correspondents’. The PMJDY utilises the Aadhar framework as a delivery mechanism. The Aadhaar is the ID number issued by the Unique Identification Authority of India. It was introduced with the primary objective of providing identification to Indian citizens who did not have government issued identification documents. As of January, 2015, the PMJDY scheme had managed to open 115 million accounts. However, only 28% of these were active while the rest had zero balance.

The Finance Ministry has been trying to activate these zero balance accounts by linking them to various Direct Benefit Transfers such as the APY. This approach is very similar to the various methods used by the government to incentivise Aadhaar cards. One such method was to use Aadhaar to create the subscriber database of beneficiaries for schemes such as Mahatma Gandhi National Rural Employment Guarantee. Another was to make the Aadhaar sufficient proof for “Date of Birth” to obtain a Permanent Account Number (PAN card), an identification for Indian citizens who pay income tax. Linking PMJDY accounts to such schemes would not only increase financial inclusiveness in the country but also help ingrain a habit of long term saving among individuals.

Such a move would benefit the APY too as it would allow the scheme to access the Aadhar database to help identify beneficiaries.  Despite having a voluntary enrollment process, Aadhar has managed to cover 80.46 crore people. As per an affidavit by the government, “16.25 crore bank accounts have been linked to it enabling the public to get direct benefit transfer (DBT), over 37 crore LPG subsidy transfer transactions amounting to a total of over Rs. 11,500 crore and a total of Rs. 61.04 lakh payment transactions have been done through DBT across the country for 34 schemes amounting to Rs. 681.14 crore.”  The 16.25 crore accounts created include those bank accounts created under the PMJDY.

Outcomes

This step taken to link various authorities will help in efficiently and effectively delivering social welfare schemes to Indian citizens. Reducing the level of compartmentalisation across the various social welfare schemes would streamline the process for both government and citizens. Clustering various social schemes together will help in directing the energies of the various governments authorities involved and will reduce the transaction costs faced by subscribers who have to deal with cumbersome processes in multiple government offices to avail of these schemes. For instance, the potential of Aadhar as a common database for all social benefit schemes would make identification of beneficiaries much easier as well as reduce the amount of paper work and documentation necessary for beneficiaries to avail these benefits.

However, there is still a vast scope for improving the operational efficiency of social welfare schemes such as the APY. A greater use of innovative processes and technologies will probably be the next major step, though awareness and finances may initially be a burden in achieving this. Most government authorities have already using mobile phones as a platform to interact with subscribers to their schemes. The next innovation would be to use electronic payments via mobiles for directing cash transfers. Vodafone has tried to bring mobile cash transfer services to India through M-Pesa but a lack of digital and financial education has restricted its growth in India. There may still be a long way to go, but the linking of schemes is certainly a positive first step.

Devika Kher is a Research Associate at Takshashila Institution. Her twitter handle is @DevikaKher

Image credits: Ekta Parishad

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