Go for performance-based funding | Opinion
The dilemma is that states which need resources most are the least efficient. There’s a way outUpdated: Oct 09, 2019 18:30 IST
The upcoming recommendations of the 15th Finance Commission will deeply affect policy and governance across India in the next five years. Public attention on the Commission’s report usually focuses on the allocation to the central versus state governments, and on the size of the divisible pool of resources. These are important issues, but a potentially much more important component in the Commission’s Terms of Reference (TOR) is the directive to devise methods of performance-based funding to states — especially for health and education.
This is critical, because high-quality research on service delivery in the last two decades has documented massive variation in the cost-effectiveness of policies to improve social sector outcomes. For instance, an unconditional doubling of teacher salaries (accounting for the majority of education spending) had zero impact on student learning outcomes. In contrast, linking even modest amounts of teacher pay to performance have been found to generate large increases in learning outcomes at a much lower cost. More recent evidence shows that performance-based incentives increase the effectiveness of resources and inputs. Cross-country evidence also shows that additional financial assistance has a positive impact on growth in countries with better governance, but no impact otherwise.
In the Indian context, there is robust evidence that the quality of governance is weaker in poorer states. For instance, teacher and doctor absence rates are consistently higher in poorer states. The fiscal cost of teacher absence alone is over ~10,000 crore per year. This creates a vexing challenge for the Finance Commission, because states that are most in need of additional resources to provide basic services like education and health are also those that are likely to be the least efficient at converting additional spending into improved outcomes.
One practical way of solving this challenge is to earmark funds for a performance-based pool that will be allocated to states based on improvements in a few critical measures of human development. It is wonderful that this idea is already in the Commission’s Terms of Reference. The rest of this column provides guidance on how best to implement it. There are three key principles to apply: Pick a few critical indicators; invest in high-quality independent measurement; and tie funding to improvements in indicators.
First, the number of indicators should be small to enable prioritisation and focus. They should also be based on outcomes, and not inputs or implementation of schemes. Even focusing on four key outcome indicators will enable substantial progress relative to the status quo.
For health, these indicators should be: Infant mortality rate below age one, and child malnutrition rate at age two. These are critical determinants of long-term human development, and also excellent summary statistics of the quality of health systems.
For education, these indicators should be: Foundational literacy and numeracy, and girls’ secondary education completion rates. India’s greatest education challenge is the learning crisis where tens of millions of children do not have foundational skills, and nothing matters more for Indian education than ensuring universal foundational literacy and numeracy. Similarly, girls’ secondary education is a critical determinant of female empowerment, age of marriage, total fertility, and child health and nutrition.
Second, performance-based financing is only viable with credible and independent measurement (as also noted by the 13th Finance Commission). It is also critical that measurement be done through independent representative household surveys, because facility-based surveys do not capture those who do not use them, and also have significant data integrity concerns. This will require the Finance Commission to fund the independent data collection, and locate the effort in an “institutional home” such as the NITI Aayog’s Development Monitoring and Evaluation Organisation (DMEO). This will ensure that the measurement is both legitimate (by being overseen by a part of the government), and independent of the individual states and line departments being assessed.
Third, the funding provided as performance-based grants should be based on improvements in outcomes and be on a per-child basis to adequately account for variation in states’ initial conditions and population. Ideally, these additional funds can be used at more localised levels like districts and blocks as part of an innovation fund to be deployed for locally-appropriate interventions and innovations. This will provide a direct reward for localised efforts to improve outcomes and also encourage district- and block-level innovation.
Given the reduction in growth projections and strained public finances, it may be tempting for the Commission to de-prioritise the allocations for performance-based financing. This would be both a mistake and a missed opportunity. Efficiency in expenditure is even more important in times of fiscal strain. Evidence shows that even modest amounts of performance-based funding can have a large multiplier effect on the efficiency of the much larger amounts of spending on inputs. The Finance Commission has a historic opportunity to implement such a pivot, and thereby improve the quality of public spending.
Karthik Muralidharan is Tata Chancellor’s Professor of Economics at UC San Diego
The views expressed are personal