Although, by the 1990s India became more open to private sector, the remnants of the post-independence still continue. Successive governments find it hard to push pro-market legislations without being accused of colluding with the rich businesses. The increase in investments, jobs and GDP, brought about by the private sector, has not been able to turn the sentiments of people in favour of more pro-market policies. This has in turn made successive government struggle in-terms of their relationship wrt markets or the private sector.

We cannot do without the private sector. They bring jobs, taxes, innovation etc to the economy. But our government, and governments in general, needs to have a better relationship with markets. Karthik Muralidharan in his book, gives an interesting framework to look at the relationship between states and markets. Let’s discuss this framework below.

Let us look at the area of service delivery. This is where the private sector and public sector come head-to-head the most. All governments have 3 major roles in shaping the service delivery ecosystem. These are:

1. The role of Policymaker - Here the government makes laws regarding private sector participation. Makes commitments on public service delivery, allocates budgets etc.
   Government making laws regarding allowing private sector schools in the education sector is an example. Government also makes targets that it wants to achieve in terms of number of public schools started or literacy rate achieved.

2. The role of Regulator - Here the government makes rules and procedures related to how services can be delivered. These rules could be related to safety, quality standards, transparency, pricing etc.
   In education, government establishing standards on teacher quality, infrastructure etc in schools is an example of regulations.

3. The role of Provider - The government not only makes policies and rules, they are also a service provider themselves.
   Government runs public schools across the country, and in these cases it acts as a direct service provider.

As government takes on these different rules, it needs to have a different approach to the private sector. Let us look at each of these.

1. As Policymakers, government should views the private sector as an ally. Since private sector also contribute to service delivery, they play a role in bettering the lives of the citizens. Hence, the government should look at improving this by enhancing the ability of private sector to deliver services. As policymakers govt should implement policies that maximise the overall quality of services offered to all citizens.

2. As Regulators, government should look at private sector as an equal. Regulations should apply equally to all providers - among different private providers and between private and public providers. In India, government regulations often favour public sector providers over private sector. This is one of the reasons why public sector services providers end up as monopolies in some sectors and ultimately affect citizens choices. As regulators govt should ensure a level playing field across providers, address market failures, and make it easier for users to hold both public and private providers accountable.

3. As Providers, government should look at private sector as a competitor. In areas where private sector and public sector operates, governments should consistently ensure that public sector is competent enough to match the quality offered by private sector. Public sector provisions are usually sought by the poor. Making public sector services competent enough ensures that the poor receive quality services.

But unfortunately in India, government’s role as provider is usually given excessive focus. Because of this reason, government and private sector are often seen as competitors. This attitude even spills into government’s policymaker and regulator roles. This is often reflected in our policies and regulations, which instead of viewing the private sector as an ally and equal in service delivery, views it as a competitor to be defeated. But to improve it’s relationship with the markets and to improve access to services for citizens, the government needs to start looking at private sector as an ally, equal or competitor in different areas of it’s functioning.

1. Investments spending - These could include spending on infrastructure, law & order, public health etc. The purpose of this spending is to boost productivity and economic growth. The positive effects of such spending is expected in the long-term.

2. Welfare spending - These could include spending on subsidies, income support etc. The purpose of this is to enhance the quality of life of citizens, especially the poor, in the short-term.

(There is a third category of spending that has elements of both investment spending and welfare spending. MGNREGS, Public Schools etc are some examples.)

The quality of investment spending can be calculated through ‘Return on Investment’ calculations. But assessing the quality of welfare spending can often be difficult. Karthik Muralidharan proposes a three part metrics to assess this. The three components of the metrics are as follows:

1. Targeting:
   

   Here, it is important to consider who is excluded and who is included from a particular welfare policy. Welfare spending by nature is meant to support the poor. It addresses equity and poverty related concerns. But if the deserving are not getting benefits, this amounts to exclusion errors. This can be seen in the case of the Public Distribution System, where a considerable number of poor don’t receive the benefits because of issues like corruption, lack of documents etc.

   
   Similarly, when the rich are disproportionately benefiting from welfare policies, this amounts to inclusion errors. For example, the lion’s share of electricity subsidies goes to the rich farmers. This is because rich farmers have larger landholdings and hence use more electricity for farming. In these cases, scarce government resources are spent on the relatively better-off.
   
   Hence the essential question to ask here is: is welfare spending directed to the right beneficiaries?

2. Delivery:
   
   Even when the right beneficiaries are targeted, by correcting exclusion and inclusion errors, they may not receive the benefits. This could be due to leakages due to corruption - people misdirecting funds away from the beneficiaries. This could also be due to delays in payments - due to administrative hurdles.
   
   An example for this is the MGNREGS program. Several studies show how workers are not paid their salaries on time, how fake job cards are created, how workers are paid less than what the scheme mandates etc.
   
   Hence the essential question to ask here is: does the benefits actually reach the beneficiaries?

3. Design:

   
   Sometimes welfare policies are designed in such a way that they hurt the beneficiaries more than it benefits them. It gets trickier, when the hurt is not clearly visible but the benefits are. The hurt is usually caused by the market inefficiencies induced by the welfare policy.
   
   The public distribution system is an example of this. The PDS system creates two markets for food grains - one is the subsidised ration shops for the poor, another is the normal market where grains are sold at a higher rate. This leads PDS employees to redirect food grains from PDS shops, and sell them at a profit in the open market. This reduces the quality of food grains and the amount of food grains available at the PDS shops, hurting the poor. These issues could have been solved by government giving direct income support for the poor to buy food grains, instead of selling them through PDS shops. Direct income support do not distort markets and do not lead to leakages and corruption.
   
   Hence, all government welfare spending policies that try to support the poor by disrupting markets (by modifying prices or creating parallel markets) has a design flaw in them. They violate a core principle of economics: it is usually more effective to mitigate poverty by augmenting the incomes of the poor rather than subsidising specific goods and services.
   
   Hence the essential question to ask here is: how does the welfare spending affect the broader economy?

The state, market, and society are the three major institutions that impact an individual's life. When markets fail to allocate resources efficiently, we call it a market failure. When such market failures occur, the government is expected to intervene. 

Markets will and do fail. This is why we need the government. For example, the allocation of public goods is something markets can never do efficiently. Markets have no incentive to provide clean air (a public good) when they cannot charge people for accessing it or prevent non-payers from accessing it. 

In the same way, governments fail too. Governments are structurally flawed in certain areas, and policymakers need to be cognizant of the possibility of these failures while drafting policies. Government interventions to correct market failures or market inefficiencies can end up creating larger failures or inefficiencies when policymakers are not cognisant of governments' propensity to fail in certain areas. 

Government failures can be classified into six categories:

((This framework is borrowed from Takshashila Institution’s work).

1. Principal-agent problem

Government is structured in hierarchies: principals and agents. A principal is an entity that delegates authority or responsibility to another entity. An agent is an entity that is given the authority to act on behalf of the principal. For the agents' work, they receive their compensation. 

In a democracy, the citizens are the ultimate principals. We have put ministers and bureaucrats to work for us for the salary they receive from the taxes we pay. For example, citizens, as principles, appoint ministers to legislate laws for them. The ministers, in turn, acting as principals, appoint bureaucrats to implement these policies, and so on. 

There are three things to note in these principal-agent relationships. 
One, agency. Both principals and agents have the agency to interpret the policy or responsibility passed on to them. 
Two, interest. By oath, all agents are required to uphold the public interest. But all rational individuals also keep their self-interest under consideration. Often, their self-interest and the public interest can come into conflict with each other. 
Three, Information. Both the principal and the agent have incomplete information on many things; the principal knows some things that the agent does not, and vice versa. Based on the limited information at their disposal, individuals must decide what to do and how to behave. 

The combination of agency, interest, and information creates the government failure of the principal agent problem. As agency passes from principal to agent, the information passes through a chain of interpretations, where self-interest is often pitted against public interest and the original idea often gets distorted. 

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2. Rent Seeking

This is a fancy way to refer to corruption. This is an extreme case of principal-agent problem. Rent-seeking happens when an agent places self-interest over public interest. When considering how a policy might be actually implemented, it is important to keep in mind that this is the most prevalent type of failure in the government.

3. Regulatory Failures

Governments regulate to tweak what market players can or cannot do. Regulations try to correct market failures and provide a fair playing field for market players. When one market player accumulates market share through unfair means, it leads to the failure of market power. This is detrimental to efficiency in markets and the well-being of consumers. 

But sometimes regulatory institutions can be influenced by vested interests. This compromises the government's role as an unbiased umpire in the market. This leads to the emergence of a cartel or monopoly. 

Sometimes regulators may be unbiased. But they may introduce a lot of uncertainty in the market by their decisions, introducing many changes rapidly, or flip-flopping on important decisions. Regulatory stability is important for market players to establish businesses and make investments with long-term plans. But if regulators keep changing the tax structures and rules of the game regularly, this makes the lives of citizens and businesses very difficult. 

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4. Moral Hazard

In economics, a moral hazard is a situation where an economic actor has an incentive to increase its exposure to risk because it does not bear the full costs of that risk.

People respond to incentives. Realigning incentives makes people realign their preferences. But incentives could be perverse. There is always a risk with government actions creating ‘perverse incentives’. That is, making it easier or less costly to do something that is bad for the individual, society, or economy. The Indian education system is one example. Here, the government has created incentives to improve the teacher-student ratio, the infrastructure of schools, etc. Although these are done with good intentions, they have not translated into improving learning outcomes. In fact, the incentives are aligned in such a way that the machinery and personnel are more focused on input measures like infrastructure than educational outcomes. 

5. Market Distortions

Government actions can (and most often do) distort markets. Policies like price fixing, banning products, and making reservations all have market-distorting effects. These are not always bad if they're done to correct market failures. But governments usually go over and beyond addressing market failures. For example, putting minimum wage laws in place can reduce employment; instituting price ceilings can lead to a shortage of products; and banning products can drive these products into the underground. 

6. Lack of information

Making social-engineering decisions is always difficult. Introducing a new product into the market, hoping the customers will buy it, and then influencing them through advertisements is a gamble. People may or may not buy these products. In the same way, instituting a policy for building a road through a village would require taking a lot of people into confidence, like the residents, builders, maintenance workers, people who use the road, etc. These are complex negotiations. 

All such decisions face a failure of information. You never know how people will react to the new additions and incentives. You don't know if people really need what you're offering. In other words, there is no real-time feedback. 
But this failure is accentuated in the case of government, unlike markets, for two reasons. 
First, markets gauge people's preferences through prices. Prices act as a signaling information system for markets. In the case of government action, real-time data on how a program or policy is faring is minimal or sometimes missing, since government offerings usually don't involve prices or profits. 
Second, markets have strong incentives to seek and act on feedback since profits drive their decisions. But governments rarely have such incentives since they are monopolies in most of their areas of work. 

Markets and governments have different goals. For markets (private entities), maximizing profits is their primary goal. But the government's goals are different and more complex. It is important to define the goals of the government because this can be used as a yardstick against which government policies can be evaluated. There are different ways of looking at the government's goals, and this is just one of them. (This framework is borrowed from Takshashila Institution’s work).

1. Effectiveness

A public policy's effectiveness is determined by how well it is accomplishing the benefits it was designed to accomplish. Often, policies are doomed to fail from the get-go. This may be due to policies being assigned with too many goals, policies being designed without taking state capacity into consideration, etc. Policies can also fail due to implementation failures. The GST law in India is an example of an ineffective policy. Although reducing tax rates and improving ease of transactions through a tax policy, like GST, is a rational policy, the multiplicity of tax brackets and problems in implementation have reduced the effectiveness of this policy.

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2. Efficiency

Efficiency has to do with costs and benefits. If the costs incurred by a policy are greater than the benefits it achieves, it is inefficient, and vice versa. All policies have costs and trade-offs associated with them. For example, due to the birth defects among infants caused by a sleep aid called thalidomide, the U.S. Food and Drug Administration made the drug approval laws stringent. Although the policy led to reducing harmful drugs from reaching the medical market (benefits), it also delayed or prevented life-saving drugs from reaching the market (costs).

3. Equity

The goal of equity is to determine who bears the costs and who bears the benefits. Governments distribute cash/goods and provide services. All such policies will have winners and losers. Hence, practically, it is difficult for governments to ensure absolute equity. For example, reservation policy in India is envisioned to correct historical wrongs and ensure equity in the present. But when a community is given reservations, the other community feels like they have lost out. This leads to more and more communities asking for reservations.

Thumb Rule: Before evaluating government policies, the goals of the government need to be defined. One way of looking at the goals of the government is to look at them from the prism of effectiveness, efficiency, and equity.

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It is quite easy for anyone to answer any issue with a public policy solution. But through our discussions here in this newsletter we have come to know that not all issues need a policy response (read #2, #13, #15). So when asked to think about or draft a policy which responds to a particular issue, we need a framework to think through. The Three Steps framework helps you exactly with that. (This framework in from Shah and Kelkar’s In Service of the Republic)

So imagine you have an issue at hand. Whatever it might be. These are the three steps you should think through when drafting an appropriate policy response.

1. Is there a market failure?

If there is no market failure, then there is no role for the state. Different market failures need different approaches.

2. What kind of an intervention can I design to address this market failure?

The government only has a limited toolkit of interventions. The tools must be carefully chosen. Because, oftentimes proposed solutions do not address the problem. When a government is faced with Market Power, there is no need for government to setup a company of its own. This is what the Kerala government recently did by starting an OTT platform. But when public goods (like security or efficient justice delivery) are underdelivered by the market, the government needs to step in and deliver them.

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3. Is there enough state capacity to implement the proposed intervention?

Many times, despite having a good idea, the suggested intervention may not be implemented well due to state capacity limitations. For example, India’s maternity leave laws, as progressing as they are, have unintended consequences. Not only does it stretch the monitoring capacity of the state, it also impedes economic growth for a developing country like India where only a small percentage of women are in formal jobs. So maybe such ideas could be implemented at a future point, when we have the necessary context and capacity for it.

Thumb Rule: While drafting a policy to address an issues, ask yourself three questions: 1. Is there a market failure? 2. Does the intervention address the market failure? 3. Is there capacity to implement?

Time has flown by, and I’m thrilled to celebrate a significant milestone - 1 year of our newsletter journey together!

When OPW started almost a year ago, my primary purpose was to help people willing to learn more about public policy an easy and accessible source of regular information. There have been times in this past year when I have not been very regular. But the encouraging words and support from all my subscribers helps me to write and develop more content every week. My heartfelt thanks to all you readers. This wouldn’t have been possible without you.

Highlights of the past 1 year:

1. Econ 101 - Articles to develop an economic way of looking at the world.

2. Frameworks - Ideas and models that could be applied to simplify policy puzzles.

3. Discussions - Applying Econ 101 and Frameworks to real-world policies.

4. Essential PolSc - Discussion of essential political science ideas.

5. Reading Links - Reading suggestions for policy enthusiasts.

Apart from this, we have a referral feature now, where you get some exciting gifts for sharing OPW with your friends.

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Thank you for being part of this journey.

I hope OPW has added something valuable to your public policy journey. Your feedback has definitely added a lot to mine.

At this juncture, I would like to take a small survey to understand more about you.

Please click the link below if you want to take the survey (it’ll take you around 5 minutes).

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What’s next?

Let’s make the next year even more enriching and inspiring. We will dive deeper into the world of policy, dissecting current public policy puzzles, and probing more about some of the concepts we have discussed so far.

Thank you,
Sonal Kuruvilla

Prisoner’s Dilemma

When I was a young boy, my elder brother and I used to get into physical fights. He was bigger and stronger than me, but I was more aggressive. There is this one fight that still stands out to me. My parents were not home, and we went at each other. The fight ended with a few visible scars on my face, courtesy of my brother's nails. 

Both of us were terrified. We knew the costs of our parents getting to know. But the scars needed an explanation. Our self-preservation instincts kicked in. We squashed our beef, started talking strategy, and came up with a lie. 

We both had something in it. I was always thought of as the troublemaker. So if my parents knew that there was a fight, I would be held accountable for causing fights. My brother knew that the scars on my face were sure to get him in real trouble. 

As expected, our parents came and questioned us. Soon, they smelled inconsistencies in our stories. We were good liars, but my mother happened to have this antenna to catch our lies (I have acquired the skills to beat it as I have grown older). So our parents decided to interrogate us individually. Now, here is a difficult situation. 

I didn't know what my brother would say. What if he succumbs under pressure? What if he makes up a story with me being the only villain? What if he breaks our agreement and tells the truth? In all these cases, I would lose out. Maybe he will stick to our agreement! What if he is also thinking about what I would say? So although sticking to our lie was a better strategy for both of us, telling the truth was the safest option. Finally, both of us told the truth, and I ended up with some marks on my thighs (courtesy of my mom) along with the scars on my face.

This is a perfect example of what economists call the prisoner’s dilemma. The prisoner's dilemma is a game theory concept that illustrates how rational individuals may not cooperate, even when it is in their best interest to do so. It is difficult for individuals to cooperate when they are separated and isolated, and when they are not sure if other individuals will cooperate too.

The Collective Action Problem

Something similar happens in collectives too. Think about this: prosperity cannot happen without peace. It only takes one person to create conflict and subvert peace in a community. So communities often develop codes and rules (call it culture) among themselves that everyone can abide by to ensure peace and, hence, prosperity for all. In such a community, everyone has an incentive to follow these codes, for the good of all. In a small group, like a hunter-gatherer band, each family obtains a significant share of benefits from the peaceful order, which outweighs the sacrifices they need to make. 

But establishing such an order in a larger group is difficult. This is because, in large groups, each individual bears the full costs or risks of abiding by the rules but receives only a share of the benefits. In larger groups people are separated from each other by virtue of the number of people in the group, and hence a scenario similar to the prisoner’s dilemma happens.

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For example, pooling your salary from your work with your family account is something you might do without a second thought. Because this money is to be divided between your family members and the places where it is used are seen by you, you get a satisfying proportion of that money for yourself. But what if your family has 100 members? In such a case, you may not be able to trace where all the expenses are going. You may get a lesser proportion than you give for various reasons (say, a hospitalized uncle has extra expenses). Cooperation to pool money is easier when the family is small and difficult when the family is big. Although cooperation is better in the long term, you don't have an incentive for it. You break away from the family, or you don't give your entire income to the pool.

This is the problem of collective action. Collective action problems exist when individuals, acting rationally in pursuit of their self-interest, have incentives to make decisions that are harmful to the interests of others as well as, ultimately, the individual themselves.

Hobbes, Locke, Rousseau

When groups are large, people tend not to cooperate. People get pushed into prisoner's dilemma situations. The system descends into a 'better fraud takes all' kind of scenario. Thinkers like Thomas Hobbes, John Locke, and Jean-Jacques Rousseau thought about this question and arrived at the social contract theory to propose a solution. 

Now, here is the problem they tried to address: 
1. Cooperation is better than competition for the good of all. 
2. People don't have an incentive to cooperate when groups are large, like a city-state or country. 
3. How do we ensure people cooperate in such a way that everyone benefits? 

They used this line of thinking to explain the emergence and necessity of the state. Although they disagreed on certain aspects and had varying views on the state and human nature, all three of them agreed on the need for a legitimate authority. They proposed that such a legitimate authority can only evolve through a contract between people in society. 

Think about this, when there is no authority, a time without the state ('state of nature'), people tend to do what they please. Hobbes viewed individuals in the state of nature as brutes who are always seeking more. Rousseau thought of individuals in the state of nature as inherently good but corrupted by society. Nonetheless, they stressed on the importance of order in society for peace and prosperity. Hence, people come together and make an agreement or contract. They surrender some of their freedoms to a sovereign authority in exchange for security and protection. The authority is given monopoly of violence for the purpose of preventing excesses by one individual over another. Such an authority allows people to cooperate, because they know that the authority will ensure cooperation from others as well.

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Social Contract

Modern conceptions of states are fundamentally rooted in social contract theory. The state’s role is to enable cooperation among different individuals and groups so that peace and order can prevail and hence result in prosperity. 

It is important to note that the state stands to serve the people, who established it in the first place. Society existed before the state and can exist without the state. But to enhance efficiency, peace, and prosperity, a state was formed with the consent of members of society. Today, the overarching nature of the state—with taxes, rules on morality, curtailing of freedoms, surveillance, and policing—can sometimes confuse us as to who the real sovereign is. In this context, is good to remember Locke’s conception of the state. For Locke, sovereignty ultimately rests with people and they transfer some of it to the state. He said:

The state exists to safeguard the rights and liberties of citizens who are ultimately the best judges of their own interests; and that accordingly the state must be restricted in scope and constrained in practice in order to ensure the maximum possible freedom of every citizen.

Not all countries have had such an explicit gathering of individuals to sign this contract. But at the end of the day, it is important to develop an awareness and definition of this contract to ensure we don't fall prey to the prisoner’s dilemma. 

Homework:

1. Read this brief article on social contract in the context of India.

In democratic countries, the executive is the branch of the government that implements policies. We often call the people in the executive as bureaucrats. The quality of the executive is very important to ensure that the policies made by the legislature reap the benefits. Francis Fukuyama calls this activity using the term ‘governance’. According to him:

(Governance is the) government's ability to make and enforce rules, and to deliver services.

In simple words, governance quality is a measure of how good the executive (bureaucrats) do their job. Fukuyama gives a framework to assess the quality of governance.

According to this framework, quality of governance is the result of an interaction between capacity and autonomy.

What do we mean by that?

1. Capacity

Capacity is the ability of the executive to get a work done. The most commonly used measure of capacity is the ability to extract taxes. Ability to collect taxes signifies both the capacity to collect taxes and it also gives the state the resources to operate in other domains. Another measure of capacity is the level of education and professionalisation of government officials.

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2. Autonomy

Autonomy refers to the manner in which politicians issue mandates to the bureaucrats. Often, bureaucrats can receive contradictory mandates from different politicians. Politicians can issue mandates on who should be recruited into the executive, and politicians can issue mandates on how to do a task. Hence, in Fukuyama’s words:

Autonomy therefore is inversely related to the number and nature of the mandates issued by the principal. The fewer and more general the mandates, the greater autonomy the bureaucracy possesses.

Ensuring good governance is a careful dance between capacity and autonomy. That is, depending on how much underlying capacity a bureaucracy has, having more or less autonomy might be advantageous or disadvantageous. One would wish to restrict the discretion of an agency and impose explicit regulations upon it if it were staffed by inept, self-serving political appointees. In contrast, if the same agency were full of professionals with high education and values, one would not just feel safer granting them considerable autonomy, but would actually want to reduce rule-boundedness in hopes of encouraging innovative behaviour.

Fukuyama classifies a few states based on autonomy and capacity as shown in the following graph:

The graph shows where the countries are at and where they need to move. According to Fukuyama, India is a complex example. India evidently has low state capacity. But higher autonomy may not be good right now given corruption and clientelism in the executive.

Thumb Rule: Quality of governance is the result of an interaction between capacity and autonomy. When the capacity of the state is high, it should give more autonomy to it’s personnel and vice versa.

Let us assume you have a car. You fill it with a full tank of fuel, get it washed in a nice car spa, change the seat covers, and air the tires. But if the car engine is not working or if it is not working efficiently, all those other things you do won't really help you get from point A to point B. Karthik Muralidharan, in his book, compares the Indian state to a 1950s car. According to him:

The 1950s were the last time we made systematic investments in the institutional foundations of the Indian state. Since then, we have continuously added expectations to the state without commensurate investments in the state itself.

As far as a state is concerned, in order to meet citizens' expectations, it must possess the necessary capacity. But how do we think of state capacity? Karthik Muralidharan, in his book, provides a framework to think about this.

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When we think about state capacity, it is important to differentiate between the scope of a state and the strength of a state.

1. Scope of a state

This refers to the range of goals that a state takes on. Traditionally, states were expected to do only a few tasks. According to Adam Smith: 

It is the role of the state to provide for the defence of the country, to enforce contracts, to provide for public works and infrastructure, and to protect society from the injustice or oppression of other individuals.

But after the second wave of democracy, the idea of a welfare state became popular. More and more states, like India, took on more tasks like promoting economic growth, regulating firms and economic activity, delivering public services, improving human development, etc. But a state can only meet the requirements within its scope if it has the strength to do so. 

2. Strength of a state

This refers to the ability of a state to achieve its goals. The strength of a state is not just about the amount of money spent on each of its goals. It is mainly about how efficiently a state can convert its expenditure into desired outcomes. 

Sometimes states define the scope of their institutions ambitiously without being cognisant of their strengths. 

Let us take an example. 
The per-capita number of government workers (no. of government workers per person) in India is one-fifth that of the United States of America. The number of police officers per capita, for example, is only 135 per 100,000, one of the lowest rates in the world and far below the median (318) or mean (333) of police officers per 100,000 capita in the rest of the world. 

Although India has such limitations in terms of personnel (the strength of the state), it doesn't reflect in the regulatory burden imposed on them (the scope of the state). In a paper written by Rajagopalan and Tabarrock, they say this: 

India has essentially all the inspections, regulations, and laws a developed country such as the United States has, but at approximately $235 of federal spending per capita, the Indian government simply cannot accomplish all the tasks it has assumed. Consider: U.S. federal government spending per capita was five times higher in 1902 than Indian federal government spending per capita in 2006. Yet the Indian government circa 2006 was attempting to do much more than the U.S. government did in 1902.

State capacity is not just about the scope of a state and the things the state aspires to do. It is also about the strength of a state and the things the state can do. 

In his book, Karthik Muralidharan also gives six key systematic elements of state capacity. These include the systems and processes for:

1. Collecting, Analysing and acting on data

2. Recruiting, training and managing personnel

3. Ensuring quality of public expenditure

4. Collecting adequate revenue and doing so efficiently

5. Optimising tasks across layers of our federal governance structure

6. Effectively leveraging non-state actors, including the private sector and civil society

Thumb rule: It is important to consider both the strength and scope of a state while thinking about state capacity. Think about the 6 key elements of state capacity when you think about the strength of a state.

Once Upon a Time

It is the 1400s. I wake up early in the morning. I barely had any sleep during the night. Recently, I bought two cows. All night, my ears were scouting for any unfamiliar sounds. I am worried these groups of bandits (think of Westerns like Django Unchained) would come and take my cattle away. 

The first thing I do in the morning is go out and look for the cows. I let out a sigh of relief. They are still there. I grab a tumbler, milk them, and feed them some grass. I go for a long walk to this person's house, who told me he would buy milk from me for a few shovels of millets. I walk as fast as I can and reach my destination. I am glad I was not stopped en route by anybody. If those bandits they talk about get to know I had milk in my hand, I know I will lose it. I exchange the milk for the millets. Takes the walk back. Lo and behold, I hear the clip-clop of horse hooves. They have seen me. The millets in my hand are taken away. I am asked to give them milk the next day onwards at a designated time and location.

From the next day onwards, when I sleep, I don't scout for any sounds. If someone steals my cows, so be it. The milk is of no use to me anymore. In fact, I wish the cows were dead—so I don't have to feed and milk them just so that it can be taken away from me. 

Well, it is not the 1400s anymore. But if it were, my life wouldn't look much different from this. Those with power and wealth plundered whoever they pleased. If you had to earn and save for yourself and your family, you had to do so in hiding. 

But gladly, times have changed. But how?

Roving Bandits vs Stationary Bandits

Mancur Olson explores the wonders of economic growth over the last 200 years and the evolution of democracies in his work. He does this thought experiment with bandits. 

Back in the day, bandits used to travel and plunder what they saw fit. Olson calls these traveling plunderers 'roving bandits’. But some of these bandits will settle down in a location—’stationary bandits’. Historically, people preferred stationary bandits over roving bandits. 

Why would people prefer a stationary bandit who plundered through taxes regularly to a roving bandit who plundered once in a while? 

This is because when a society has anarchic violence, people not only lose what they have, but they also don't have any incentive to produce. A roving bandit walks into a village whenever he chooses, plunders all he can find, and then moves. People have no incentive to increase their productivity in such a society. Why take care of the cows, when I can’t consume its milk?

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But a stationary bandit (or an autocrat) monopolises plunder, because of which people only have one person to worry about. Moreover, the autocrat has an incentive to provide public goods, as long as this leads to an increase in his own income. Additionally, the autocrat doesn't tax so much that it discourages people from working because, again, it will affect his own income. In Olson’s words:

History until relatively recent times has been mostly a story of the gradual progress of civilisation under stationary bandits interrupted by occasional episodes of roving banditry. From about the time that Sargon's conquests created the empire of Akkad until, say, the time of Louis XVI and Voltaire, there was an impressive development of civilization that occurred in large part under stationary banditry.

Autocracy to Democracy

An autocrat establishes order and gives people incentive to work. This wouldn't have been possible in an anarchic system. But here is the problem with an autocrat. The autocrat taxes not just to provide public goods to people. He taxes much more than what is spent on people, because he is taxing to invest in his luxuries, increase his prestige and to maximise his net surplus. For example, Calgue and Rausser says this about Stalin:

He (Stalin)…….had an interest in the productivity of his domain similar to the interest an owner of a firm has in maximising the value of the firm's output. Stalin and some of his successors could use a large portion of any increase in Soviet output to increase their military power, international influence, and personal prestige.

This is where democracies come in. Now, let’s be real. Democracies are not perfect. It’s not a system where people vote who they like to power and the people in power do good to all (although it should ideally be)! A democratic government only needs a majority to win and can end up only to catering to this group.

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Let’s assume it’s a majority that controls the democratic government. Even in that case, the government has no incentive to increase taxes beyond a certain point. Because a high amount of taxes can distort the incomes of the majority too. So the majority will influence the government not to increase the taxes too much.

But there is more to a democracy. It is the the rule of law. Investing in public goods, enforcing contracts, ensuring property rights, etc. are all very important to ensuring productivity and growth in an economy. These important steps, when they are taken, reap benefits in the long term. But most autocracies have their fair share of succession battles, doubts about legitimacy, and continuous shifts in power. Hence, prioritizing the long term is difficult for an autocrat. Olson says:

We have seen that whenever a dictator has a sufficiently short time horizon, it is in his interest to confiscate the property of his subjects, to abrogate any contracts he has signed in borrowing money from them, and generally to ignore the long-run economic consequences of his choices.

But the rule of law ensure continuity in a democracy. People know what to except. Most importantly, there are mechanisms to check the violations, both by the state and citizens, through courts. This enables economic growth.

We Need a State

Anarchy creates chaos and takes away incentives to be productive. Nobody wants to sleep scouting for noises, worried someone is going to take away their cattle. Nobody wants to walk the road, afraid of bandits. But it is hard for a large group of people to come together, and create conducive conditions for all to thrive. This is why we need a state. The state provides the necessary incentives to bring people together for everyone’s benefit. Provide public goods that otherwise wouldn’t exist.

The modern state has its problems. But let’s face it, we need a state—preferably a democratic one.

Why do we need a democracy? Do you think it is a better form of government than the alternatives? When we think about the alternatives, we need to think about the alternatives that existed before. If you have thought about these questions, Mancur Olson has a brilliant thought experiment for you. Where he helps his readers think from plundering bandits and towards the idea of democracy.

Read this seminal paper written by Olson. Here is the notes I have taken from reading the paper; if you want to get a gist of his ideas.

The Constitution of India enshrines principles of social justice, equality, and welfare. Fundamental rights and directive principles of state policy lay down the framework for promoting social, economic, and political justice. In other words, India is a welfare state. By virtue of this, the government, both at the center and the states, spends a considerable amount of money on various developmental initiatives. For example, social sector expenditure as a share of total expenditure for the years 2023–24 is 18% of the union budget (around $100 billion). This is a considerable amount, and it is important to ensure it is efficiently spent. How do we think about public sector expenditure efficiency?

(This framework is derived from M. Govinda Rao’s book Studies in Indian Public Finance.).

Input vs Output

First of all, it is important to separate between input, output, and outcome. We often come across articles and commentaries on how much money the government sets aside for different sectors. For example, after every union budget, there is a guaranteed op-ed criticising the outlays for the education sector, which is usually around 2% of the GDP. Remember, as far as public expenditure efficiency is concerned, this is only level 1, i.e., input. The money the government spends on a particular scheme or intervention is the input. If the government sets up 2 lakh schools in the country, it doesn’t mean that the students studying in these schools will be educated. Although inputs get considerable attention in the media, and although governments play up inputs as the end all be all, inputs are only level 1.

Level 2 is output. When the government spends money on setting up schools, the expected outputs are: school infrastructure, teachers, textbooks, etc. Outputs are the most immediate results that we see when money is spent on a particular intervention.

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Inputs to Outputs

The transition from inputs to outputs depends on two factors:

1. Allocative Efficiency

Prioritizing which goods and services to spend on determines allocative efficiency. Not all areas where there are gaps need government interventions. Some of these gaps are better addressed by markets; some of these gaps can be addressed later. For example, capital expenditures help in capital formation and creation of positive externalities. But subsidies tend to distort prices and should be employed only when other less distorting approaches are unavailable. Although such decisions - where to allocate funds - need considerable economic thought behind them, fundamentally, it is a political decision.

2. Technical Efficiency

This is achieved when different inputs are used in an optimal combination. For example, Direct Benefit Transfers have reduced leakages in subsidies, and including members of society to monitor teachers has increased teacher attendance. Factors like “targeting expenditures to intended groups, choosing appropriate technology to deliver services, assigning the task of delivery to appropriate levels of government,” etc. influence technical efficiency.

Outcome

There is one more level: outcome. Outcome simply refers to the impact the input and output have had on the lives of people who are beneficiaries of the particular policy intervention. In various sectors in India, government expenditure efficiency is measured against input and output alone. This is not enough, since outputs without outcomes do not bring about any real change or solutions. For example, even if we ensure adequate teacher salaries (input) and optimal teacher attendance (output) in a school, as long as students don’t get educated, the intervention has directly achieved almost nothing of value for the citizens.

But outcomes are not easy to achieve. Efficiency in public expenditure may result in better output, but not necessarily outcomes. M. Govinda Rao has this to say about outcomes:

Efficiency in outcomes is determined by a number of exogenous factors in addition to efficient outputs. While it may not be possible for the governments to control the exogenous factors determining the outcomes in the short term, the best they can do is to ensure output efficiency and put in place the policies changing the structure of incentives and accountability towards outcome targets.

In the education sector, although it is impossible for government to absolutely ensure outcomes, it can at least monitor outcomes at regular intervals and change inputs accordingly.

Thumb Rule: Allocative efficiency and technical efficiency need to be considered when inputs and outputs of a policy intervention are drawn. Based on periodic review of outcomes, adequate changes need to brought in the way inputs are planned and outputs are defined.

C-SPACE

There is a new business in Kerala-Town. It's called C-SPACE. A government-run OTT platform. The platform "aims to deliver a unique blend of informative and entertaining content tailored for the masses." The chairman of the platform says that the platform will try to address growing imbalances in the OTT sector. 

This comes at a time when the state is grappling with a staggering amount of debt. The state's debt amounts to around 35% of its GDP, and the interest payment burden is 20%. Salaries for government employees were delayed in the month of March for reasons unknown. Not to mention that the share of salaries and pensions in government expenditure is around a whopping 50%. 

Kerala has the largest number of pubic sector undertakings in India, with most of them making losses year-on-year, even with the government pumping in tax payer’s money at large scale to these companies.

Why did we need an OTT platform during such times? Spending based on borrowing looks good for political showmanship but incurs a huge cost to future generations. Instead of cutting losses and streamlining spending for necessary reforms, why is the Kerala government starting one more business venture? "Imbalances" are there in various sectors. Markets are never perfect. But the question that governments need to ask when venturing into areas like this is this: Will there be a considerable amount of benefit to society through this intervention compared to the costs, as opposed to leaving it to markets? There seems to be no such thinking behind this move. In a country with a high marginal cost to public funds and in a sector where there are already many decentralised players, it is only rational to question the wisdom behind C-SPACE. 

Government and Business

But there is a larger issue here. Government’s role is not to run businesses unless absolutely necessary. There is a growing consensus on this issue across the democratic world, at least in talk. But our state and our politicians don't seem to be privy to these vital policy discussions. 

Why is it problematic for the government to run businesses?

1. Government has never been good at running businesses.

At the heart of this is the incentive problem. Businesses sustain themselves only when they make profits. Profits are only made when the people running it stand to earn a part of the profits. For a bureaucrat running a government-owned business, there is no incentive to make the business profitable. He is getting paid his salary, no matter what! He has no incentive to turn this company profitable because he stands to gain nothing from it. (Forget the fact that he will have no previous experience or specialisation in this field.) If the company makes profits year-on-year, the money goes to the Treasury and gets distributed to a large number of people through other schemes. If the company makes losses, they are incurred from the Treasury, and the costs are borne by millions of tax-paying citizens. So when the company makes profits and when it makes losses, it is so small an amount incurred by each citizen that nobody notices it in the short term (dispersed costs and dispersed benefits). 

We have previously discussed Milton Friedman's framework for spending money at OPW. According to this framework, government spending falls into the least efficient category, where someone else's money is spent on someone else. So for the people who spend, they neither have the incentive to economise (spend as little as possible) nor make the most out of it (get the maximum output or profits). 

2. Once the government starts something, it is difficult to stop.

Can you think of any brands that have enjoyed monopoly status on a product for, say, more than 3 decades? I can't think of any. Markets have a way of reinventing themselves over and over. No company can continue to enjoy market power (without illegal means) for a long time. They will be destroyed by competition (where is BPL now?) and replaced by newer innovations (where are the STD-ISD booths?). This process is called creative destruction. But there is an exception to this. Government-run monopolies continue with impunity for decades. Not because they reinvent themselves or because they outperform their competitors. IRCTC and KSEB were, are, and will be, because they are monopolies by law. The state doesn't allow competitors in these markets. 

There are usually special interests that surround these businesses. Employees, unions, vendors, suppliers, allied businesses, middlemen, manufacturers, advertisers. So it doesn't matter if this company logs losses every year in government budget books; they bring votes and play optics. Do you know that the Kerala government still runs a department dedicated to Coir? Coir is largely replaced by its alternatives in the market, but the government just can't stop it because of the interests surrounding this market. Government capture by special interests is a common phenomenon in any democracy, and increasing the bandwidth of government activities is one way you can make this issue deeper.

OTT is the trend now. It was not so 10 years ago, and it probably won't be in the next few years. Markets will bring in better alternatives that we cannot possibly predict now. When that happens, C-SPACE will become a liability that profits a few people and their interests, but the costs will be borne by all Keralites. Creative destruction rarely happens with government run firms.

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3. The government's job is not to compete with the market.

There are platforms that already promote independent cinema, like Mubi. There are OTT platforms, like Netflix and Amazon, for commercial releases. Moreover, there is YouTube, which is free for all creators to upload their work. Why is the government competing with these markets? Obviously, the government is more powerful than any of these companies, with its deep purses and, most importantly, its monopoly in violence. 

Instead, the government should play the role of enabling these market players and others. Why not promote a more start-up-friendly atmosphere in Kerala, where start-ups can attempt to start alternative OTT platforms like C-SPACE (if they think there are profits in this area)? 

Entrenched Statism

I struggle to understand what problems the government is trying to solve through this initiative. 

• There is no market failure. One can make the case that C-SPACE brings positive externalities by promoting independent creation. Then what is stopping the government from running a music platform, an art studio, a reading club, and a reality show? We already have markets for all this, which run fairly well. 

• There are no missing markets. We already have independent cinema platforms. 

• There is no 'redistribution of incomes' angle here. 

• If imbalances do exist in the OTT market, isn’t it better to address it through regulation?

From what I understand, the idea behind this initiative is just plain old statist thinking that goes like this: "If Netflix and Amazon can do this cool thing that is trending now, the state can do this too." No, the state can't. The state has better things to do with its limited capacity.

This statist thinking was the same idea behind government-run app-taxi services and government-run wifi services. There is a reason why these fail, and unfortunately, we don't seem to learn a lesson from it. On the one hand, the government is trying to privatise and disinvest (KSEB and KSRTC being a few examples), and on the other hand, the government is getting its hands deep into more businesses. Maybe the Kerala government is trying to give future politicians something to disinvest.

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Some policy solutions are relatively easier to achieve than others. The ‘Policy Complexity’ framework helps us to look at all policies and predict their relative success. This can assist us in making policy solutions that are easier to implement and hence have higher chances of attaining their objectives. (Ajay Shah and Vijay Kelkar discuss this framework in their book, In Service of the Republic.)

The framework contains 4 elements.

1. Number of transactions: When the number of transactions are high, it is difficult to achieve the expected outcomes. When the number of people who need to do their work for the success of the policy increases, the policy is less likely to succeed. For example, when subsidies were passed through government bureaucratic channels, the leakage of money was higher. When the number of transactions were reduced through direct benefit transfers, the leakages were largely cut down.

2. Discretion: When discretion at various levels of the policy process is higher, the policy is less likely to achieve its objectives. When the outcome of a policy is dependent on the discretion of various individuals, it can move away from its established outcomes and start surfing in the waters of uncertainty. The election process in India is a good example. The process is on the scale of the population. But the activities to be done by each individual are clearly earmarked, and there is no room for improvisation. As a result, every officer who implements the policy works to achieve a common outcome, hence ensuring success.

3. Stakes: When there is more at stake due to a policy decision, it is less likely to be implemented efficiently. Individuals will be greatly impacted by the decisions made by state agents in situations where the stakes are high. Due to this, private citizens will make a significant effort to sway the result. For example, the criminal justice system in India is highly inefficient due to the extent to which people are willing to go to bribe officers, taint evidence, etc. due to what’s at stake.

4. Secrecy: When the work of an institution that is part of the policy process is secretive, it is less likely to be efficient. When an institution is open in terms of its data, its working policies, etc., there is more scrutiny. This leads to more accountability and, hence, efficiency. The judiciary in India, especially wrt the appointment of judges, is an institution with a lot of secrecy. The pendency of cases, inconsistency in judgment, executive-judiciary standoffs, etc. can largely be attributed to this.

Thumb rule: When the number of transactions are lower, discretion is lower, stakes are lower, and secrecy is minimal, a policy is more likely to achieve its desired outcomes.

You must have heard the word ‘Governance’ thrown around quite a lot. But what does it mean exactly? How do we measure governance?

Francis Fukuyama talks about governance and a new way of looking at it, and measuring it, in this paper.

In philosophy, Occam’s razor is the idea that you choose the easiest theory when two different theories are trying to explain the same phenomenon.

When we translate this idea to public policy, we get the following principle: When two alternative policy tools yield the same outcome, we should prefer the one which uses the least coercion.

When policymakers face a policy issue, they have various options for action. Suppose all these options lead to the same outcome. In this case, one way to choose between them is by opting for the least coercive approach. Coercion means measures like taxation, imprisonment, fines, bans, restriction etc.

Why is it better to choose the least coercive approach? Because, simply put, freedom tends to work best in most situations. In other words, less coercion usually leads to better outcomes. But often times, there are market failures because of which the government has to intervene. But even in those scenarios, when we go to the source, with well understood causal claims about the source of the market failure, we will find ways to address the market failure using the smallest use of the coercive power of the State.

Another reason why the Occam’s Razor approach makes sense in public policy is because public policy is a complex field which involves no certain answers and quick hacks. What do I mean? The information available to policymakers is limited, many wrong decisions are taken, and many decisions are poorly implemented. Governments do not know the preferences of citizens. Politicians and officials are self-interested actors and work for themselves. Many government actions fail to achieve the desired outcome, but they always have unintended consequences. At best, governments work ‘okay’! Hence, it's good to be humble, and swing the smallest knife to get the job done.

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Ajay Shah explains Occam’s Razor in public policy through an interesting example. Here it is:

When we want to drive the incidence of a certain crime to the desired rate, we want to find out the lowest possible punishment that gets the job done. You can reduce theft to desired levels by promising to cut off the hand of the thief. We would much rather achieve the objective using a reduced use of the coercive power of the State, with mere imprisonment.

The purpose of punishment is deterrence, not vengeance. And, in the class of deterrents, we seek to find the smallest possible use of the coercive power of the State that gets the job done.

Suppose 4 years of imprisonment and 2 years of imprisonment are equally able to get the incidence of a particular crime down to the desired level. Suppose a person says: I am not a liberal; I am not squeamish about using the coercive power of the State; I hate the people who commit such crimes; I don't care whether they get 2 years or 4 years in jail. But a large fraction of all convictions are in error. In these cases, we are inflicting the punishment upon an innocent. The harm is minimised when we have deployed the lowest possible punishment.

Thumb Rule: When two alternative policy tools yield the same outcome, use the one which uses the least coercion.

I once took a policy-related exam. Most of the questions were multiple-choice, except one. In this one question, it was asked to explain a policy that according to us was well-designed.

I picked the mid-day meal scheme. At the time, I didn't know much about the scheme, and I didn't know anything about good policy design. I spoke at length about the qualities of the scheme. The brilliance in the design of this policy, I explained, was the fact that it achieved multiple outcomes. Through this one policy, we could improve student attendance, reduce malnutrition, fortify food to target health outcomes, improve grain procurement from farms, etc. Well, to my luck, the examiner probably didn’t know much about policy design either, or he/she appreciated my attempt. I aced the exam. From then on, for any policy-related exam or interview, the mid-day meal scheme became my go-to example with guaranteed impressing powers.

But this was years before I had met Mr. Jan Tinbergen (No, I didn’t meet him in person, it’s just an expression!). Tinbergen rule is for those good-hearted, yet ignorant, policymakers or aspiring policymakers like me, who wants to do everything through one policy.

This is what the rule says: at least 'n' independent policy instruments are required to successfully achieve 'n' independent policy targets.

Shooting multiple targets with one arrow is impossible. (Image generated in Nightcafe)

Policy targets are those indicators that policy makers want to achieve for their economy (country). GDP, employment level, greater production, improved competitiveness are all examples of targets. Policy instruments are those tools available at the behest of policymakers to achieve these targets.

According to Tinbergen rule, one of the reasons why policies fail is because they are laden with many policy objectives. For example, the mid-day meal scheme is a policy instrument used to achieve multiple objectives/targets. Improving school attendance and improving nutrition are two objectives to name a few. Providing mid-day meals to students is the policy instrument in this case.

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All systems become complex when the design constraints are increased. This is due to the fact that objectives frequently clash, and attempting to optimize for one results in a decline in the other. For example, in the case of the mid-day meal scheme, school attendance is under the ambit of the ministry of education, while nutritional outcomes are managed by the ministry of health. Complexity level 1: inter-departmental coordination. Complexity level 2: clash of objectives. One possible way in which mid-day meal scheme objectives could clash with each other is this: Even the kids who don’t come to school need to be given nutritious food. So the focus on mid-day meals could take away attention from kids who are genuinely not able to attend school.

Another area where policies are laden with several objectives in India is in taxation. Our tax structure tries to achieve multiple policies and ends up achieving none effectively. Dr M. Govinda Rao summarises this condition best when he says:

Although many countries’ tax policy is used as an instrument to accelerate investment, encourage savings, increase exports and pursue some other objectives, Indian’s obsession is perhaps unique. In addition to the above, India’s tax policy is loaded with objectives such as industrialisation of backward regions, encouraging infrastructure ventures, promotion of small scale industries, generation of employment, encouragement to charitable activities and scientific research, and promotion of enclave-type development through Special Economic Zones (SEZs). These objectives are pursued through various exemptions, differentiation in rates and preferences which enormously complicate the tax structure and open up avenues for evasion and avoidance of tax and create rent-seeking opportunities.

To adhere to the Tinbergen rule in policy space, policymakers must make institutions and policies that attempt to address only focused and specific objectives. Moreover, there must be an understanding among policymakers that not all objectives can be achieved through government policy, and hence, some of them are best left for the markets and society to handle.

Thumb Rule: Design separate policy instruments to achieve each independent policy target/objective.

Living in Fear

I use a bike for all of my local travels. On most of these short trips, and sometimes long ones, I travel solo. So, for the longest time, I have only owned one helmet. On rare occasions, when I have someone with me, the pillion has to travel without a helmet. But when I have a pillion, I am extra careful at the turns, just to make sure the police are not waiting to catch people travelling without helmets. But the Kerala government has come up with a curveball recently: AI cameras. God, I hate those things! Now, every time I travel with a pillion, I have to be on the lookout for cameras too. (Buying a helmet is way easier, I know. But dragging myself to the helmet shop is really hard! I hope at least a few of you can empathize!)

But why am I so afraid? Who am I afraid of? After all, it's my bike, my life, and my money!

The simple answer is: I am afraid of the fine that the police or the AI cameras might charge me. What if I don't pay? If I don't pay, the fine might increase. What if I still don't pay? I guess I may be summoned to court. What if I don't show up? Now we are talking! If I don't show up, the state, through its personnel, aka police dudes, will unleash violence on me. They might probably come to my house, drag me out, and put me in a cell. That is what I am afraid of.

Let's admit it; we are all afraid of this 'daddy state.' That is why we all obey traffic rules, pay taxes, and maintain peace—or at least try to. We don't want the state to get angry. But it is not just when we disobey or harm the state that it gets violent. It can get violent even when we harm someone else. If I break the windows of my friend's apartment, it is not just a feud between me and him. The state comes to the scene and settles the case between us, and most of us comply because we don't want the state to get violent. My friend is not allowed to get violent on me, even though it was his windows that I broke. If my friend gets violent and breaks my legs, I'm not supposed to retaliate, even though it was my legs that were broken. The state is the only actor allowed to use violence. It is as if the state has a monopoly on violence.

State Monopoly of Violence

In political science, the state monopoly on violence is a very important concept. It signifies that the state possesses exclusive authority over the legitimate use of physical force within a specific territory. Essentially, the state is considered the sole entity with the right to maintain law and order, enforce laws, and utilize force when necessary. States create conditions where nobody is permitted to engage in violence, while the state retains the ability to inflict violence.

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Why does the state need this monopoly, you might ask? In simple terms, the state uses the threat of violence to secure obedience regarding taxation and behaviour. Thomas Hobbes, in his classic work, Leviathan, articulates this perspective:

"For the laws of nature, as justice, equity, modesty, mercy, and, in sum, doing to others as we would be done to, of themselves, without the terror of some power to cause them to be observed, are contrary to our natural passions, that carry us to partiality, pride, revenge, and the like. And covenants, without the sword, are but words and of no strength to secure a man at all."

Without the fear of the sword, all promises, laws, and regulations become ineffectual. So in theory, all of us have surrendered our agency to wield the sword to this entity called the state, trusting that the state will act wisely. This concept is central to the idea of the social contract (a topic for later).

The Cost of State Monopoly of Violence

Now, the state is comprised of human beings - like the elected ones we have in a democracy. What stops them from doing whatever they want with this incredible power to use violence? Well, the early political scientists were also worried of this. So they came up with the idea of the rule of law - a set of rules the state needs to follow while exercising its monopoly over violence. In other words, the state can't use violence whenever they want; it has to adhere to certain limits and directions. However, when the checks and balances surrounding the state are imperfect, state violence can be applied in unjust ways. This begs the question: should we be fundamentally suspicious of the state or be trusting of it? It's worth pondering, and I'll reserve my opinion on this for later.

For now, let us assume that the checks and balances surrounding a state are nearly perfect. The justice system is efficient, the policing of citizens is not discriminatory, and the laws and rules are followed by the state machinery. Even then, we have a problem!

This is the problem: since the state has a monopoly on violence, coercion is at its heart. In other words, there is no action that the state can undertake that doesn't have an element of violence (or the threat of violence) in it. Coercion of any kind hinders human freedoms and doesn't bode well for society. When human beings are free and untethered, their ingenuity brings forth good and prosperity for all. But when they are coerced, even if the intentions are pure, it creates unintended consequences that are not always pleasant. Hence, all state action involves an element of violence/coercion; coercion curtails human freedoms; this slows down progress.

For example, all state spending is done through taxes. Taxes, of all kinds, are a form of coercion. When earning people are taxed, it discourages them from working, in one way or another. This reduces the overall output in the economy. So the money taxed to be spent on something good causes poverty in some other area by reducing overall economic output.

This is why in public policy, we have frameworks for government spending. Market Failure is one such framework we have discussed in the past. It talks about those instances where human freedoms don't produce optimal results, and hence there is a case for the government to intervene. When the government intervenes, through coercive means at times of market failure, the benefits generally outweigh the costs.

For an aspiring policy professional, the concept of monopoly on violence should evoke a sense of caution. Because all your policy suggestions are grounded in the state's capacity to inflict violence on its citizens. So tread carefully. If you believe violence is not the answer to the issues around us, then the state isn't either. Because at the heart of the state is violence.

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Homework:

1. Watch this documentary that talks about the idea of monopoly on violence through historic examples.

This is what Goodhart’s law states: When a measure becomes a target, it ceases to be a good measure.

This simple statement has significant consequences in the world of policy. But first let us talk about the difference between a measure and a target.

Measures are indicators used to assess various aspects of a policy. They provide data and insights into the performance and outcomes of policies. Measures can be quantitative, like literacy rate, teacher-student ratio, or GDP rate. Measures can be qualitative too, like teacher quality, patient satisfaction, or customer service quality.

Targets, on the other hand, are specific goals or benchmarks set by policymakers or authorities to achieve desired outcomes. For instance, a target might be to reduce the unemployment rate from 8% to 5% within a certain time frame. Another example of a target is to increase the high school graduation rate from 80% to 90% within the next five years.

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But what happens when a measure becomes a target? It creates perverse incentives.

Let me explain. Take the case of the healthcare system in India. Across academic and policy literature, the number of beds per hospital is emphasised as the most important metric in healthcare. The number of beds per hospital is a measure. Based on this measure, policymakers set targets like adding 100 more beds to each hospital within three years. This incentivizes politicians and bureaucrats to meet this bed-addition target at any cost. This leads to unintended consequences, such as overcrowding hospitals with low-quality or insufficiently staffed beds to meet the numerical goal. The focus on quantity (adding beds) might overshadow the more important goal of providing quality healthcare. In an effort to meet the target, hospitals might engage in behaviour that does not necessarily improve healthcare outcomes.

Because of such conflation of measure with target, hospitals become overcrowded, attention given per patient reduces, and health outcomes deteriorate. The solution to this problem is not to make more measures and then translate them into even bigger targets. The solution is to stop letting measures become targets. How?

Instead of setting targets solely based on numerical measures like the number of beds, policymakers should consider more comprehensive targets that focus on improving healthcare outcomes and quality. For example, a target could be "to reduce patient waiting times for critical care by 20% within three years." This target places emphasis on quality and patient experience rather than just quantity.

One other area in India where Goodhart’s is in full swing is the education sector. Measures like teacher-student ratio, literacy rate, and school infrastructure specifications have translated into targets and have done nothing to improve the educational system in the country. We have a good infrastructure with no students. We have attained perfect student-teacher ratios, with teaching being sub-standard.

It is important to measure the outcomes, and it is important to have targets for policy interventions. But it is also important to understand that when measures become targets, they create perverse incentives and unintended consequences.

Thumb rule: When a measure becomes a target, it ceases to be a good measure.

Previously, we spoke about market failures. Market failures are certain situations in which people and their free ingenuity fail to achieve solutions to problems that occur during market transactions. Market failures call for the government to intervene. But how does the government intervene? What are the options that the government have?

There is only a limited toolkit of interventions that the government can utilise to address a market failure. (This framework is from the book In Service of the Republic, by Shah & Kelkar.)

It is to be noted that all these options are coercive in nature. Hence, it is fundamentally undesirable. They curtail freedoms and will have unintended consequences. But nonetheless, they are sometimes required to bring long-term good by correcting current shortfalls.

It is to be noted that when we talk about policy levers, we refer to laws passed by the legislature. Because in a constitutional democracy, only an elected legislature is allowed to coerce private individuals.

So here are the levers that the government has that they could move when they encounter a market failure. All policies are, in one way or another, a modification of these.

1. Coercion that modifies behaviour: These include government rules like bans, limits, prohibitions, etc. The government uses its monopoly of violence and threatens people with complicity. For example, drunk-driving is banned in India. This ban is accompanied by jail terms and/or a fine.

2. Coercion to pay taxes: Here, the government uses its monopoly of violence to force people to pay taxes. The government can link modifying behaviour and raising taxes. Higher taxes can be charged to discourage certain behaviors. (Eg: Cigarettes). Just like this, subsidies can also be provided to encourage some behaviour.

3. Spend Money: The state can choose to spend tax revenue in two ways:

a. Running Public Services: For example, police or RBI.

b. Giving out subsidies to private persons: Usually subsidies are given out to
produce externalities, which justifies their existence. But sometimes subsidies are given out unconnected to externalities, as pure redistribution.

Thumb Rule: There are only 3 ways in which the government can intervene when facing a market failure: modify behaviour through laws, collect taxes, and spend money.