The decision of the Aam Aadmi Party to supply 20 kilolitres of water a month free to all metered households in Delhi has been met with a predictable reaction. Conventional wisdom has it that subsidies may be attractive politically but disastrous economically.

Any move towards subsidies is then to be treated with the contempt Indian politicians have now come to expect.

This two-dimensional approach completely misses the potential subsidies have to be an effective instrument of policy to promote not just equity but also growth. The approach has been rooted in the extremes between which Indian policy-making has tended to swing.

In the public sector era, subsidies were a symbol of the government’s commitment to bring about egalitarian growth.

Once that strategy led to a complete lack of control over how resources were utilised, economic policy makers moved to the other extreme arguing for a general reduction in subsidies. And, in this mood, the focus shifted from the overall levels of subsidy to the subsidy bill of individual service providers.

It was not just that the overall level of subsidy had to be kept down, but each service provider had to ensure that its service was not subsidised.

Case for cross subsidy



What the Aam Aadmi Party has now done is to move beyond this simple two-dimensional approach to consider other combinations.

Its water policy in Delhi provides a little less than 667 litres of water a day free to households but simultaneously raises the water rates for those who consume more than this limit.

The additional revenue generated from the higher rates is expected to pay for the subsidy to the less extravagant consumers. It is possible to find fault with the details of this policy.

Is, for instance, a single cut-off better than a lower initial cut-off with a graduated increase in price? But the basic case for a cross subsidy that will help the service provider remain financially prudent even as it meets social requirements, is well made.

The sustainability of this cross subsidy will depend on the specifics of each situation.

If the increased rates for the non-subsidised consumers pay for the subsidy to others, there will be no subsidy burden for the service provider as a whole. But if the increased rates lead to a decline in consumption by the non-subsidised consumers, there would be a decline in revenue. This in turn would hurt the economic health of the service provider.

It is in dealing with such a situation that the AAP would reveal whether its water initiative is a one-off election related measure or part of a larger and more nuanced understanding of the role of subsidies. If it is part of a broader understanding, it would have to differentiate between various kinds of subsidies.

There are basic facilities that any modern government should strive to provide every one of its citizens: access to food, water, and perhaps even clothing and shelter.

And subsidies are a much more effective way of ensuring this access than merely relying on legislations passed in Parliament.

In the case of this access to basic requirements, a case can be made for the level of subsidies to the disadvantaged to be maintained even if it means the service provider runs at a loss.

Labour paradox



At the next level are subsidies that can actually oil the wheels of the economy. Take the case of labour mobility.

Anyone who has the opportunity to interact both with unorganised workers and industrialists will be struck by an apparent paradox: even as workers complain about a lack of jobs, industrialists complain about a lack of labour.

One of the reasons for this paradox is that the no-subsidy regime has made public transport in several cities too expensive for workers in the unorganised sector to take every day. A subsidised transport system designed to move labour within cities and from villages to manufacturing towns has a growth effect which is not immediately visible.

In such cases, the specific subsidy would have to be offset by the macroeconomic growth it generates. The challenge here would be to ensure that this intervention is not converted into a subsidy for the transport sector as a whole.

Pushing for growth



A third kind of subsidy goes beyond merely oiling the economic machinery to actually pushing the economy onto a higher growth path.

These are the subsidies provided to industry in the form of infrastructure, surplus land and the like.

There is a case for such subsidies if they attract investment that fundamentally transforms the rate at which the economy is growing. These subsidies would have to be carefully monitored to ensure they are an effective investment, whose returns are in terms of a much higher growth of the economy.

If the Aam Aadmi Party really sees itself as a national alternative, it will have to demonstrate that its water initiative in Delhi is a part of a larger economic strategy that can correct the distortions liberalisation has generated without going back to the errors of the past.

And if it can come up with a nuanced and inclusive view of subsidies without being constrained by the conventional wisdom available on television, it would have taken an important step in that direction.

(The author is Professor, School of Social Science, National Institute of Advanced Studies, Bangalore.)