The debate on fiscal crisis of Punjab economy initiated by Hindustan Times is timely and deserves appreciation for bringing in the issue in public domain. The fiscal policy, the only dynamic instrument of economic development in the hands of the state government, has been dysfunctional for nearly three decades. This has resulted in halting economic progress of the state and pushing it from number one to number seven in terms of per capita income among the major Indian states.
The dramatic change in the status of Punjab economy from the most prosperous to a laggard one has affected the pride and prestige of Punjabis. The dismal economic performance of Punjab economy has wider consequences for the otherwise widely recognised entrepreneurial skills of the industrious Punjabis. In fact, the crisis is multidimensional and the consequences are widespread which is a cause of worry and needs explorations.
Fiscal policy of the state is composed of three components -- state's own tax and non-tax revenue, revenue transfers from the Centre and the borrowings. To understand the worsening of financial position of Punjab, one has to take recourse to history. Punjab witnessed fiscal deficit of 5.3% during 1985-1990, the highest among 14 major states. In the same period, the overall fiscal deficit of the 14 major states was 3.3% and the fiscal deficit of Haryana and Maharashtra was 2.7 and 3.1% of the gross state domestic product, respectively. One fundamental reason for running a high fiscal deficit of Punjab was the relatively low revenue receipts as a percentage of gross state domestic product. This was the peak period of militancy in Punjab.
Militancy disrupted the normal functioning of almost all institutions in the 1980s, including the tax collection machinery, which is yet to be made fully functional even after two decades of democratic rule. Tax evasion is still rampant. Given the central government transfers, the state government resorted to borrowings to fulfil its committed expenditure needs. Therefore, the result of this policy was accumulation of debt burden.
Centre's new policy
When the Centre adopted new economic policy in July 1991, several changes such as dismantling internal and external controls, reduction of tariff barriers and change in the tax structure reduced the revenue collection of the Centre. It is evident from the finance commission reports that the proceeds of the shareable taxes transferred to the states declined. During the 1990s, the state governments, on the one hand, faced the reduced supply of funds from the Centre, and on the other hand, due to change in tax structure their own tax revenue collection declined.
This double shock impinged heavily some of the states like Punjab which had already accumulated high debt burden. In 1994-95, the Centre further made amendments in the policy of lending to the states and states had to shift to commercial borrowings. The market interest rate charged on borrowings multiplied debt burden of the states in general and Punjab in particular. When the changed tax structure started giving dividends to states, some states recovered quickly from the fiscal stress but Punjab could not recover due to accumulated high debt burden on the one hand and its inability to raise its own tax revenue on the other because of near-breakdown of tax collection machinery in the state.
Long financial constraint
Further, the two-decade-long financial constraint led to collapse of investment-GSDP ratio (social overhead capital), which amounted to reduction in the future capability to produce higher level of output. The state plan documents testify this when we compare low level of plan outlay of Punjab compared with neighbouring Haryana. The cut in expenditure of Punjab adversely affected the developmental and human capital (health and education) expenditures. The liberalisation strategy of economic development provided ideological support to downsizing the public sector along with minimalist state intervention in economic activities.
The emphasis of the state was shifted to promoting business interest without any regulations on it. The payments made to the employees in the government sector have been regarded as burdensome activity without realising that social returns of expenditure on social overhead capital are very high without which the private investment cannot thrive. The decline of social overhead capital increased cost of doing private business multiple times and symptoms have been reflected in farmers committing suicides and some of industrial activities/towns such as Batala disappearing from the industrial map of Punjab. In addition, a large amount of new investment opportunities such as information and communication technology revolution has also bypassed Punjab.
Why has the financial crisis of Punjab continued to deepen over a long period of time? The probable answer is that it gives dividends to political leadership of Punjab. The political leadership is intelligent enough to observe the changes in social fabric of society and devise suitable strategy that allowed them to remain in power along with enhancing newly developed business interests. Competitive populism alternative to developmental agenda paid high dividends to political leadership since the late 1990s and in the first decade of the 21st century.
Liberalisation, privatisation and globalisation world order provided rationale for adopting populism as a strategy over the developmental agenda by the state. The populist strategy based on doling out freebies helped in engaging the common man on the one hand and engaging a large number of prominent political personalities in governmental positions that had earlier been occupied by professionals on the other hand -- all this at the expense of the state exchequer. This strategy, in fact, has eliminated virtually the opposition which is the backbone of a functional democracy. In a lighter vein, some economists, however, are unable to understand that not only their otherwise legitimate professional positions have been occupied by the politicians and bureaucrats but the political leadership is averse to their advice rendered in public interest. Simply because it does not suit the ongoing dominant strategy called profligacy.
The way out
Is there a way out? There are several ways through which the state finances can be fixed and economic development process can be restored. Democracy gives ultimate power to people and if people are well informed and enlightened, they can use their wisdom and power to participate in the political process to restore the order. There should be removal of restrictive fiscal rules. The major responsibility lies with the state government to make corrections in the fiscal policy that can increase revenue based on the principles of progression. The borrowings can be done only for those investments where the social rate of return is higher than the cost of borrowings. Controlling tax evasion which will be helpful in raising own tax revenue is one of the most legitimate options with the state government.