The Flaw With Cash Transfers

One of the highlights of Prime Minister Modi’s policy is the implementation of the direct cash transfer scheme to replace the subsidy payments system.

At the outset this is not a bad idea because the subsidy system itself is distorted and has a lot of leakages. The subsidy bill is really high and the biggest people happens to be the targeting of these programmes.

The concerns of targeting stems from the fact that the beneficiaries of these subsidies ultimately end up with people who don’t require it. Targeting therefore is a very legitimate concern because this sort of leakage is one of its biggest criticisms.

Another concern is the misuse of the rations provided under the Public Distribution Scheme (PDS) where the fear is that the beneficiaries, especially the poor would just resell the food in the market and pocket the difference, which would defeat the system altogether.

That’s why the Modi government has rallied to make this happen and has laid the foundation with the Pradhan Mantri Jan Dhan Yojana for financial inclusion. With 10 crore bank accounts opened, the idea is to transfer a fixed amount to the bank account of the beneficiaries so that they can purchase goods at market rates.

While this will certainly fix price distortions, this leads to a host of other problems that is not being talked about.

To begin with, this is a policy that is being used to substitute the social sector spending with private sector intervention. In a country like India, state withdrawal from social sector is a near abandonment of the poor.

Secondly, in an effort to remove distortions in prices, this will lead to higher inflation because this is a classic case of too much money chasing too few goods. This puts the poor at the mercy of the market and their subsidy payments won’t be able to cover the essentials. The private sector is not interested in the eradication of poverty and this is would leave the poor worse off.

This is exacerbated by a statistical problem of periodic revision, something that India does badly in. Indian indices are notorious in their use of outdated data which brings the likelihood that these subsidy payments won’t be revised and ultimately become a pittance for the poor to live on in a few years.

Thirdly, cash transfers in its essence needs to be supplementary and should not become the mainstay of social sector spending. If India were to learn from the programmes of other countries such as the Bolsa Familia or Brazil, it would know that the cash transfers there would be conditional. Conditions would include immunisation of children, sending them to school and other desirable objectives.

For this, the state invests in the infrastructure such as hospitals and schools. The investments in these priority areas is essential for these programmes to work. In India, these payments could be excuses for the state to stop investing in things like healthcare and education because the assumption is that market forces would respond positively and build up the infrastructure required. This is a long shot and will mostly end up in market failure.


Ashwath Komath
An article by:
Ashwath Komath

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