Saturday, November 10, 2007


(On the economics of the heart vs. the economics of the brain)

In a poor, developing country (which, by the way, India still is) a problem the government faces is how to spend the limited money it raises by way of taxes and other sources. The means are modest and the claims on resources are many. In such a situation, how should the government prioritise its expenditure.

Here is an experiment that gives an ample hint. Imagine you are the top government official in a poverty-stricken village with the mandate of improving the lot of the people there. You have at your disposal a very modest grant from the state budget but full freedom and authority to decide how it should be spent. Since this is only a ‘thought’ experiment, and since you are the government official, we shall assume that your intentions are noble and that corruption is not part of the equation (somewhat divorced from reality but acceptable for an experiment under ‘controlled conditions’ as they say in science.) In the course of your duties, you come across the following cases where the money you get from the government can be well spent.

There is an elderly gentleman living alone, in failing health and badly in need of unaffordable medical care. Next, there is a tragic case of a pregnant young widow with no means of support whose husband had recently died in an accident. The third case is that of a family with a young kid in school where the husband has recently lost a job in a city textile mill. He now survives on menial jobs and feels he must pull his son out of school. And lastly, there is an ambitious young man who works in the city as a petrol pump attendant and would like a loan to get started with his own grocery store in the village. The funds with you are sufficient to support only one of the above claimants and no more. Who would you support with the government’s funds at your disposal? Take your time and think over it. In the meantime, here is my conclusion.

Societies where the prevailing value system mandates the flow of scarce resources towards any of the first three claimants (does not really matter which one) are those likely to remain poor and backward for extended periods of time. The society which makes it easier for the ambitious petrol pump attendant to have a first claim on the funds would be in the forefront of countries breaking free from the confining shackles of poverty and underdevelopment.

The logic may be explained thus. Government expenditure is most effective in promoting the long term and sustainable welfare of its people when there is a multiplier involved. In other words it must do good and that good in turn must lead to other good things coming out of it. More precisely, government expenditure should head in that direction where the multiplier is the greatest among the competing alternatives. In the example I have given above, there is clearly no multiplier at work in aiding the elderly gentleman. There is some long term multiplier in the case of the young pregnant widow and that of the family with the school going child. But not to the extent as in the case of the petrol pump attendant who wants to invest in a village store, with all its potential for fulfilling a real need of the villagers and of kick-starting the local economy.

The funds given away to the first three cases would essentially constitute charity and would necessarily entail more of such spending in the coming years with little visible difference to the village economy at large. The petrol pump attendant, on the other hand, would require money only for this one year, to get started. Not only are you free to fund other projects or cases in the coming years, the likely repayment of the loan would allow you to double your future outlay. Incidentally, the choice of occupation for the young man was no accident. Dhirubhai Ambani began his career as a petrol pump attendant.

In a sense, what I have outlined here is an example of the perennial clash between the economics of the heart versus the economics of the brain. One is all about feelings and emotions, and those essentially fuzzy notions of justice and equity. An extreme and distorted form of this is what we would call populism, where rather than merely ignoring the long term benefits, you actually go about doing harm to it to secure your short term compulsions. The other side of it, which may aptly be called ‘economics of the brain,’ appears heartless and cruel, but over the long term works wonders for its citizens.

In India, improbable as it may sound, something like this actually happened and with remarkable success. Back in the mid-sixties, during the early phase of the Green Revolution when the country was reeling from food shortages and from the ignominy of the PL-480, it was consciously decided that the target group for spreading awareness about the use of High Yielding Varieties of seeds would be not the poor marginal farmer but the relatively better off farmers with larger land holdings and better education. It was reasoned (and quite correctly too) that these farmers would be in a better position to assimilate the new techniques and deliver results. In the event, one of the criticisms against the green revolution is that it increased rural inequality. But considering that it freed us from both the food crisis and the PL-480, few of us would care to deny that the exercise was well worth it. Indeed, to this day it remains one of independent India's greatest achievements.

This is a critical lesson people in India are yet to fully understand. The matter of economic policy has to be guided by reason accompanied by a sense of detachment. When you bring in the heart, what you get is a palliative and never the bitter medicine that actually cures the disease.

A government that defines its purpose as the business of attending to sob stories, is never out of business.