MacroScan (Printable Version) - A Note on the Resources Needed for an Employment Guarantee Scheme

There has been much discussion of late on the resources needed for an Employment Guarantee Scheme. All of it however has been exclusively concerned with the question of financial resources. While financial resources can be a useful starting point, sooner or later we have to investigate the availability of real resources for such a scheme. This is so for two reasons: first, the assumption that raising the requisite amount of financial resources automatically releases the real resources needed for a Scheme is not always justified. This is particularly true in the present case, where, for instance, there would (and should) be a substantial additional demand for foodgrains arising from the implementation of the Scheme, while the real resources released through, say, taxes levied to finance the Scheme, are unlikely to consist of foodgrains. Such a mismatch can have serious inflationary implications. Secondly, if an economic system is demand- and not supply-constrained, then the magnitude of financial resources needed for financing such an Employment Guarantee Scheme would itself depend upon what instruments are used to raise these financial resources. In such a case in other words it is not as if a fixed sum has to be raised using this or that instrument; but the amount itself would vary depending on the instrument used. This is because if the government is to ensure that a certain amount of additional employment is to be generated in the economy, then, since taxation entails the release of resources and hence the creation of unemployment elsewhere, which government borrowing does not, the requisite effort by the government would have to be much larger if the programme is tax-financed. A tax-financed employment scheme in other words would require much larger government expenditure, and hence revenue, for creating a certain amount of additional employment than a borrowing-financed scheme, when unutilized resources are available in the economy (and when taxation does release resources elsewhere, i.e. does not fall entirely on savings).

The question of the financing of an Employment Guarantee Scheme therefore needs a closer examination than it has received. Let us, to start with, assume that there would be enough unutilized capacity and unsold foodgrain stocks available in the economy to meet the demands of such a scheme (the validity of this assumption will be examined later). Production in any sector requires as current inputs, materials and labour. The wages given to labour in turn are spent partly on food and partly on non-food consumption goods. The employment projects under this scheme then would be generating current demand for material inputs, for foodgrains and for non-food (mainly industrial) consumption goods. These sectors, for meeting this additional demand, would need to produce more, and hence would generate, in turn, current demand for their material inputs and for more labour, and hence for more foodgrains and non-food consumption goods, and so on. Let us assume that in all sectors directly or indirectly catering to the commodity requirements of the employment projects, the ratio of material inputs to value added is 1:2, the ratio of profits to value added is 1:5, and that all wages (amounting to four-fifths of value added) are consumed, half on foodgrains (where stock-decumulation by FCI meets additional demand) and half on non-food items (where production has to increase). This means that the total value of output in each of these sectors has the following components: materials 5/15, profits 2/15, foodgrains 4/15, and non-food consumption goods 4/15. On the employment projects themselves of course there would be no profit component, but let us treat the matter as if the profit component exists but is taken by the government, i.e. the funds it has to provide are lower by that amount. But subject to this, let us assume that the same ratios obtain on the employment projects themselves.

Now the exact number of labour-days per annum which needs to be generated under this scheme is not known. But a preliminary rough estimate can be arrived at as follows. Of the 20 crore households in the country, about 14 crore would be rural households. Let us say about 6 crore rural households would be in need of assured employment for 100 days and let us assume that each of them has to be provided with full 100 days of employment. This would mean 600 crore labour days, which, at Rs.60 per day, would generate a wage bill of Rs.36000 crore per annum. Not all this wage bill however needs to be provided on employment projects; some of it would be automatically generated as the multiplier effect of the employment schemes. Bearing in mind the fact that on the foodgrain component of expenditure there would be no multiplier effects, since output has already been produced and demand is met simply through stock decumulation, and likewise on the profit component (since we assume the marginal propensity to consume out of profits to be zero), let us estimate the value of this multiplier.

Suppose Re.1 is spent on an employment project. This directly generates Rs. 8/15 of wage-bill. But it indirectly brings forth production worth Rs.9/15 (excluding from Re.1 the profit and foodgrain component), which in turn brings forth 9/15.9/15 worth of production in the feeder activities, and so on. Since each of these activities has 8/15 of its output value constituted by the wage bill, it follows that Re.1 spent on an employment scheme would give rise a total wage-bill of [8/15 {1+ 9/15 +(9/15)2 + (9/15)3+…}], which comes to Rs.4/3. It follows then that to generate a wage-bill of Rs.36000 crores, the required employment projects should cost Rs.27000 cr. But since 2/15ths of this consist of profits which come back to the government, i.e. resources for them need not be found, the actual expenditure which the government has to incur is only Rs.23400 cr.

In working out the value of the multiplier we have assumed no effects of taxes. In a demand-constrained system if the idea is to maximize employment per unit of government expenditure then raising tax revenue to finance this expenditure is likely to be counterproductive. There is however only one kind of taxation which in no way lowers the value of the multiplier effects of government expenditure, viz. taxation which impinges entirely on savings and hence has the effect merely of transferring savings from private hands to the government. Since such taxation has the additional beneficial effect of keeping wealth inequalities in check, apart from keeping down government debt to an equivalent extent, there is every reason for garnering through additional taxation at least the additional profits that would be generated as a consequence of the employment scheme (the bulk of which is likely to accrue to the private sector). The amount according to the above calculations comes to Rs.5400 crores (Rs.36000 cr. wage-bill times profit-wage ratio of ¼ less the fictitious ''profits'' of Rs.3600 cr. on the employment schemes). This taxation does not have to be directly levied on those who actually get the additional profits. If it is levied on the capitalists in any way, that still keeps the total magnitude of profits unchanged in the economy despite the introduction of the employment scheme. (Of course I am not suggesting that the total profits should remain unchanged and not be reduced in the economy through taxation. They should be, but that is a separate matter having nothing to with the employment scheme as such).

Of the total resource need of Rs.23400 cr., if Rs.5400 is raised through taxation of the capitalists (which would still leave them exactly as well off as they were before the introduction of the scheme, since it would take away only the additional profits), then the remainder, Rs.18000 cr. should be raised by borrowing, since this is exactly the amount that would accrue to the FCI on account of its decumulation of foodgrain stocks. The government can borrow this amount from the banking system; but since it would accrue to the FCI, which itself is a part of the government, the net indebtedness of the government would not have increased at all. In short the employment scheme can be financed entirely in a manner which does not impinge on anyone’s current economic position. This is because of the assumption of a demand-constrained system.

The question arises: how valid is this assumption? There is at present substantial unutilized capacity in a host of industrial sectors, with the exception of steel. And in steel there is a world-wide shortage arising from heavy demand from the People’s Republic of China. It is unlikely that the state of unutilized capacity in sectors other than steel would disappear; indeed Indian industry has been afflicted by unutilized capacity for several years now. And even in steel, with China taking steps to ''cool down'' her ''overheated'' economy, the current tightness in the market is unlikely to last long. Besides, in many of these sectors, even if there were no actual unutilized capacity, the generation of demand would call forth additional capacity creation fairly easily and fairly soon (the government would have to be alert to this possibility and instruct nationalized banks to provide the requisite credit), a proposition which had been advanced by P.C.Mahalanobis in the context of his famous four-sector model developed for the Second Plan. The Mahalanobis assumption, if I may call it so, has much substance in it, provided the government creates the right environment for its realization.

That leaves foodgrains, where approximately 18 million tonnes (equivalent roughly to Rs.18000 crores) would be required to be held by the FCI and decumulated when the need arose. These would have to be excess stocks, i.e. over and above the ''normal'' stock-holding. Until July 2002 the country systematically had substantial excess stocks; the magnitude as on July 1, 2002 being 37.6 million (63 million tonnes of actual stocks compared to 24.3 million tonnes of ''normal'' stocks). Since then the stocks have come down because of some drought relief expenditure and also because of the government’s policy of dumping foodgrains in the international market at ''throwaway'' prices (reportedly even below the prices charged to the BPL population). But stocks are building up again, the excess stocks as on July 1, 2004, amounting to 6 million tonnes; this figure is likely to climb steeply in November-December. A figure of 18 million tonnes of excess stocks therefore is unlikely to pose any problems: indeed for the entire decade 1992-2002 the economy was systematically saddled with excess stocks. What is needed however is that the government must not dismantle the machinery of procurement and public distribution it has built up over the years in a misguided burst of neo-liberalism.

Indeed from the point of view of managing the foodgrain economy, an employment guarantee scheme is positively beneficial. Since the FCI’s abnormal stock-holding pushes up interest costs, and hence food subsidies, providing an excuse for demands for dismantling the entire procurement and distribution system, the utilization of these stocks in employment schemes would actually ease fiscal pressures on account of reduced food subsidies. It would also tone up the efficacy of the public procurement-cum-distribution programme by preventing its getting clogged with excess stocks on account of reduced purchasing power in the hands of the rural poor (a fall-out of the neo-liberal penchant for deflation through cuts in government expenditure). The reduced food subsidy bill on this score would perhaps suffice to pay the interest costs on government borrowing for the employment guarantee scheme; but even if there is some shortfall, the amounts involved would be small. Since banks are flush with funds the government may in fact arrange to borrow from them at low rates of interest for the employment guarantee programme. It could even print money to finance the programme in which case the question of interest payments would cease to matter.

To sum up, once we take account of multiplier effects, then given the fact that the Indian economy is nowhere near being supply-constrained, financing an employment guarantee programme need not impinge on the pre-existing level of well-being of any particular class. If a minuscule sum of Rs.5400 cr. is taxed from capitalists (who would have got this exact amount as additional profits), and Rs.18000 cr. is borrowed (and a low or zero interest rate on such loans can always be arranged institutionally), then we can provide employment guarantee, and thereby achieve a major breakthrough in eradicating rural poverty.



Themes > Features	04.12.2004


A Note on the Resources Needed for an Employment Guarantee Scheme

Prabhat Patnaik

There has been much discussion of late on the resources needed for an Employment Guarantee Scheme. All of it however has been exclusively concerned with the question of financial resources. While financial resources can be a useful starting point, sooner or later we have to investigate the availability of real resources for such a scheme. This is so for two reasons: first, the assumption that raising the requisite amount of financial resources automatically releases the real resources needed for a Scheme is not always justified. This is particularly true in the present case, where, for instance, there would (and should) be a substantial additional demand for foodgrains arising from the implementation of the Scheme, while the real resources released through, say, taxes levied to finance the Scheme, are unlikely to consist of foodgrains. Such a mismatch can have serious inflationary implications. Secondly, if an economic system is demand- and not supply-constrained, then the magnitude of financial resources needed for financing such an Employment Guarantee Scheme would itself depend upon what instruments are used to raise these financial resources. In such a case in other words it is not as if a fixed sum has to be raised using this or that instrument; but the amount itself would vary depending on the instrument used. This is because if the government is to ensure that a certain amount of additional employment is to be generated in the economy, then, since taxation entails the release of resources and hence the creation of unemployment elsewhere, which government borrowing does not, the requisite effort by the government would have to be much larger if the programme is tax-financed. A tax-financed employment scheme in other words would require much larger government expenditure, and hence revenue, for creating a certain amount of additional employment than a borrowing-financed scheme, when unutilized resources are available in the economy (and when taxation does release resources elsewhere, i.e. does not fall entirely on savings). The question of the financing of an Employment Guarantee Scheme therefore needs a closer examination than it has received. Let us, to start with, assume that there would be enough unutilized capacity and unsold foodgrain stocks available in the economy to meet the demands of such a scheme (the validity of this assumption will be examined later). Production in any sector requires as current inputs, materials and labour. The wages given to labour in turn are spent partly on food and partly on non-food consumption goods. The employment projects under this scheme then would be generating current demand for material inputs, for foodgrains and for non-food (mainly industrial) consumption goods. These sectors, for meeting this additional demand, would need to produce more, and hence would generate, in turn, current demand for their material inputs and for more labour, and hence for more foodgrains and non-food consumption goods, and so on. Let us assume that in all sectors directly or indirectly catering to the commodity requirements of the employment projects, the ratio of material inputs to value added is 1:2, the ratio of profits to value added is 1:5, and that all wages (amounting to four-fifths of value added) are consumed, half on foodgrains (where stock-decumulation by FCI meets additional demand) and half on non-food items (where production has to increase). This means that the total value of output in each of these sectors has the following components: materials 5/15, profits 2/15, foodgrains 4/15, and non-food consumption goods 4/15. On the employment projects themselves of course there would be no profit component, but let us treat the matter as if the profit component exists but is taken by the government, i.e. the funds it has to provide are lower by that amount. But subject to this, let us assume that the same ratios obtain on the employment projects themselves. Now the exact number of labour-days per annum which needs to be generated under this scheme is not known. But a preliminary rough estimate can be arrived at as follows. Of the 20 crore households in the country, about 14 crore would be rural households. Let us say about 6 crore rural households would be in need of assured employment for 100 days and let us assume that each of them has to be provided with full 100 days of employment. This would mean 600 crore labour days, which, at Rs.60 per day, would generate a wage bill of Rs.36000 crore per annum. Not all this wage bill however needs to be provided on employment projects; some of it would be automatically generated as the multiplier effect of the employment schemes. Bearing in mind the fact that on the foodgrain component of expenditure there would be no multiplier effects, since output has already been produced and demand is met simply through stock decumulation, and likewise on the profit component (since we assume the marginal propensity to consume out of profits to be zero), let us estimate the value of this multiplier. Suppose Re.1 is spent on an employment project. This directly generates Rs. 8/15 of wage-bill. But it indirectly brings forth production worth Rs.9/15 (excluding from Re.1 the profit and foodgrain component), which in turn brings forth 9/15.9/15 worth of production in the feeder activities, and so on. Since each of these activities has 8/15 of its output value constituted by the wage bill, it follows that Re.1 spent on an employment scheme would give rise a total wage-bill of [8/15 {1+ 9/15 +(9/15)2 + (9/15)3+…}], which comes to Rs.4/3. It follows then that to generate a wage-bill of Rs.36000 crores, the required employment projects should cost Rs.27000 cr. But since 2/15ths of this consist of profits which come back to the government, i.e. resources for them need not be found, the actual expenditure which the government has to incur is only Rs.23400 cr. In working out the value of the multiplier we have assumed no effects of taxes. In a demand-constrained system if the idea is to maximize employment per unit of government expenditure then raising tax revenue to finance this expenditure is likely to be counterproductive. There is however only one kind of taxation which in no way lowers the value of the multiplier effects of government expenditure, viz. taxation which impinges entirely on savings and hence has the effect merely of transferring savings from private hands to the government. Since such taxation has the additional beneficial effect of keeping wealth inequalities in check, apart from keeping down government debt to an equivalent extent, there is every reason for garnering through additional taxation at least the additional profits that would be generated as a consequence of the employment scheme (the bulk of which is likely to accrue to the private sector). The amount according to the above calculations comes to Rs.5400 crores (Rs.36000 cr. wage-bill times profit-wage ratio of ¼ less the fictitious ''profits'' of Rs.3600 cr. on the employment schemes). This taxation does not have to be directly levied on those who actually get the additional profits. If it is levied on the capitalists in any way, that still keeps the total magnitude of profits unchanged in the economy despite the introduction of the employment scheme. (Of course I am not suggesting that the total profits should remain unchanged and not be reduced in the economy through taxation. They should be, but that is a separate matter having nothing to with the employment scheme as such). Of the total resource need of Rs.23400 cr., if Rs.5400 is raised through taxation of the capitalists (which would still leave them exactly as well off as they were before the introduction of the scheme, since it would take away only the additional profits), then the remainder, Rs.18000 cr. should be raised by borrowing, since this is exactly the amount that would accrue to the FCI on account of its decumulation of foodgrain stocks. The government can borrow this amount from the banking system; but since it would accrue to the FCI, which itself is a part of the government, the net indebtedness of the government would not have increased at all. In short the employment scheme can be financed entirely in a manner which does not impinge on anyone’s current economic position. This is because of the assumption of a demand-constrained system. The question arises: how valid is this assumption? There is at present substantial unutilized capacity in a host of industrial sectors, with the exception of steel. And in steel there is a world-wide shortage arising from heavy demand from the People’s Republic of China. It is unlikely that the state of unutilized capacity in sectors other than steel would disappear; indeed Indian industry has been afflicted by unutilized capacity for several years now. And even in steel, with China taking steps to ''cool down'' her ''overheated'' economy, the current tightness in the market is unlikely to last long. Besides, in many of these sectors, even if there were no actual unutilized capacity, the generation of demand would call forth additional capacity creation fairly easily and fairly soon (the government would have to be alert to this possibility and instruct nationalized banks to provide the requisite credit), a proposition which had been advanced by P.C.Mahalanobis in the context of his famous four-sector model developed for the Second Plan. The Mahalanobis assumption, if I may call it so, has much substance in it, provided the government creates the right environment for its realization. That leaves foodgrains, where approximately 18 million tonnes (equivalent roughly to Rs.18000 crores) would be required to be held by the FCI and decumulated when the need arose. These would have to be excess stocks, i.e. over and above the ''normal'' stock-holding. Until July 2002 the country systematically had substantial excess stocks; the magnitude as on July 1, 2002 being 37.6 million (63 million tonnes of actual stocks compared to 24.3 million tonnes of ''normal'' stocks). Since then the stocks have come down because of some drought relief expenditure and also because of the government’s policy of dumping foodgrains in the international market at ''throwaway'' prices (reportedly even below the prices charged to the BPL population). But stocks are building up again, the excess stocks as on July 1, 2004, amounting to 6 million tonnes; this figure is likely to climb steeply in November-December. A figure of 18 million tonnes of excess stocks therefore is unlikely to pose any problems: indeed for the entire decade 1992-2002 the economy was systematically saddled with excess stocks. What is needed however is that the government must not dismantle the machinery of procurement and public distribution it has built up over the years in a misguided burst of neo-liberalism. Indeed from the point of view of managing the foodgrain economy, an employment guarantee scheme is positively beneficial. Since the FCI’s abnormal stock-holding pushes up interest costs, and hence food subsidies, providing an excuse for demands for dismantling the entire procurement and distribution system, the utilization of these stocks in employment schemes would actually ease fiscal pressures on account of reduced food subsidies. It would also tone up the efficacy of the public procurement-cum-distribution programme by preventing its getting clogged with excess stocks on account of reduced purchasing power in the hands of the rural poor (a fall-out of the neo-liberal penchant for deflation through cuts in government expenditure). The reduced food subsidy bill on this score would perhaps suffice to pay the interest costs on government borrowing for the employment guarantee scheme; but even if there is some shortfall, the amounts involved would be small. Since banks are flush with funds the government may in fact arrange to borrow from them at low rates of interest for the employment guarantee programme. It could even print money to finance the programme in which case the question of interest payments would cease to matter. To sum up, once we take account of multiplier effects, then given the fact that the Indian economy is nowhere near being supply-constrained, financing an employment guarantee programme need not impinge on the pre-existing level of well-being of any particular class. If a minuscule sum of Rs.5400 cr. is taxed from capitalists (who would have got this exact amount as additional profits), and Rs.18000 cr. is borrowed (and a low or zero interest rate on such loans can always be arranged institutionally), then we can provide employment guarantee, and thereby achieve a major breakthrough in eradicating rural poverty.



© MACROSCAN 2004