Governments spend money on a variety of areas. But generally, these areas could be divided into two:
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.
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:
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?
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?
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?