A project on

An Analysis of the Wagner’s Law

Suhrud Ka*randi*kar Akashi Shah

08HS2017 08HS2019

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Objectives

To test the Wagner’s Law in the Indian Context using six models

To break down government expenditure into components and analyze the effect of an increase in GDP on each of these factors

References

All data which has been used by us has been taken from the RBI website.

All graphs have been made by us using the data from the RBI website.

Research Papers we went through Competition, Market Structure and Market Power in

the Insurance Industry in Lesotho

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Statement of the Wagner’s LawThe percentage share of public expenditure increases with an increase in gross domestic product.

Sometimes also called the Law of Increasing State Activities.

Alternative statement The state activity in an economy increases as an economy develops.

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Understanding the Wagner’s Law

The fundamental idea behind this relationship is thatthe growth in public expenditure is a natural consequence of economic growth.The growth elasticity of public expenditure isgreater than one.Wagner’s law explains the complementarity between the growth of the industrial economy and the associated growth in demand for public services of an economic character such as transport and communication networks, waste disposal, and the like, undertaken ordinarily by the government agencies.

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Explaining the Wagner’s LawThere are three popular arguments to justify the

Wagner’s Law

Firstly, with economic growth industrialization and

modernization would take place which will increase

the role of the private sector. This continuous

diminishing share of the public sector in economic

activity leads to more government expenditure for

regulating the private sector.

Secondly, the rise in real income would lead to more

demand for basic infrastructure particularly education

and health facilities and, as Wagner asserts, it is the

government who provides these facilities more

efficiently than private sector.

Finally, to remove monopolistic tendencies in a

country and to enhance economic efficiency in that

sector where lumpy investment is required such as

railways, government should come forward and invest

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Trends in India

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Government Expenditure (G)

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GDP at Factor Cost at Constant Prices(Y)

Both GDP and Government Expenditure have shown increasing trendsOn an average GDP has increased by 5.16%On an average Government Expenditure has increased by 13.31%Government Expenditure has risen faster than GDP

Models to examine Wagner’s Law

1. Peacock Wiseman VersionLn(G)= a+bln(Y)+eb=1.01c=0.996c-correlation coefficient between G and YHence hypothesis is true.

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2. Peacock Wiseman Share Versionln (G/Y) = a+ bln(Y) +eb= 0.01Hence hypothesis is true

3. Musgrave’s Modelln (G/Y)= a+bln(Y/P) + eb= 0.016Hence hypothesis is true

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4. Gupta’s VersionLn(G/P)= a+bln(Y/P)+ eb= 1.016Hence hypothesis is true

5. Goffman’s Versionln(G)=a+bln(Y/P)+eb= 2.265Hence hypothesis is true

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6. Pryor Versionln(Gc)=a+bln(Y) + eb= 0.952Hypothesis is wrong

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Trends in Government Expenditure

Government Expenditure can broadly be classified into Revenue and Capital Account

The share of the revenue expenditure to the total expenditure of the Government of India has increased from 65.41 percent in 1950-51 to 83.41 percent in 2007-08.

Consequently, the share of the capital expenditure to total expenditure has decreased from 34.59 percent in 1950-51 to 16.59 percent in 2007-08.

It has also been observed that in the initial two decades (i.e. from 1950-1970)capital expenditure increases at a very fast rate than the revenue expenditure.

But from 1970 onward it has been declining continuously and its share in total expenditure has fallen from 44.35 percent to 16.59 percent, which is not a healthy trend for a developing country like India.

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revenue account

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Revisiting the arguments supporting Wagner’s Law

1st Reason – Growth of the private sector requires more regulation by the government to prevent exploitation.In India the number of regulatory bodies has steadily grown to 62*.Considering the disputes between different regulators, the government is now considering having a super regulator to resolve the differences between regulators.Naturally the expenditure on regulatory bodies is steadily increasing as the economy grows .

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Revenue Expenditure – An IndicatorA good estimate of the money spent on regulating the private sector is the revenue expenditure of the Indian Government.Let us see the trend in Revenue Expenditure of the government

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The Average rate of growth of the revenue expenditure over the past 40 years has been 14.94%

1 4 7 10 13 16 19 22 25 28 31 34 370

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1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 31 33 35 37 390

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0.3Revenue Expenditure as a ratio of GDP

1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 31 33 35 37 390

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Revenue Expenditure as a ratio of total expenditure

2nd Reason- The rise in real income would lead to more demand for basic infrastructure particularly education and health facilities and, as Wagner asserts, it is the government who provides these facilities more efficiently than private sector.The best indicator to assess this reason is the government expenditure on the capital account.

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On an average capital expenditure of the government has grown by 11.52%

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Capital Expenditure as a ratio of GDP

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Capital Expenditure as a ratio of Total Expenditure

Is the falling capital expenditure a cause of concern?If we look at the private investment in our economy over the past 40 years it has increased from a very small value in the 1970s to over 30% most recently.This more than makes up for the fall in percentage of the capital expenditure. It makes sense now that more of government expenditure should got to regulating the private sector

191 3 5 7 9 11 13 15 17 19 21 23 25 27 29 31 33 35 37 39

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An Interesting ObservationIn the paper “Investment led Growth in India:

Fact or Mythology” by Peter E Robertson, the author has made an interesting observation.

He has debated the widely accepted notion that a rise in the investment is the main reason for India’s impressive growth.

He says that a more important reason for this growth has been the rise in per capita productivity of the Indian population.

Since the private investment has reached about 35%(which is the level of private investment countries like China and Japan reached during their respective economics miracles)

A further rise in the capital formation will not contribute as much to India’s Growth. Further growth will have to be triggered by human capital formation and an increase in per capita productivity.

What has been the cause of this rise in per capita productivity?

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Social Sector ExpenditureWe feel that one of the major causes for the rise in per capita productivity.

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Social Sector Expenditure has risen by 16.17% in the last 30 years The rise has been more pronounced in the recent years

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Social Sector Expenditure as a ratio of Total Expenditure

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Social Sector Expenditure as a ratio of GDP

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Observations from the previous slide

Though the absolute sales of LIC, with respect to both policies and premium, have shown a general upward trend, the market share of LIC has been steadily declining. With respect to policies the market share has fallen from 94% in 2003 to 66% in 2008.

LIC has underperformed in the years 2006-08 with not only the market share but even the overall premium having declined.

During the 2008-09 period the sales of LIC have shown a general upward trend. Even its market share with respect to both policies and premium has increased. This can be attributed to recession which hit around the same time hurting private players and working out in the favor of LIC.

The market share of LIC wrt policies has always been higher than that wrt premium. This indicates that LIC targets the small investors while private players target the bigger fish.

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1 2 3 4 5 6 7 8 90

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Private PlayersPremium

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The Private Players

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Private Players-Market Share

Premium

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Private Players-Market Share

Policies

Observations from the previous slide

The private sector has shown a very steady growth as can be seen from the graphs. The CAGR (Compound Annual Growth Rate) of the private sector has been 153% as opposed to the 21% CAGR of LIC.

The market share with respect to policies has always been lesser than that with respect to premium. This indicates that the private players have targeted the upper class of the Indian population.

There has been a fall in both absolute sales and market share in the period 2008-09. This can be attributed to the recession of 2008.

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Analyzing the Market

After the IRDA Act of 1999, 16 firms entered the market in 2000-01.

By 2009 this number increased to 20.

So the market, now, consisted of 21 firms. 20 private and LIC.

Let us view how the market power has changed over this period and where the market is heading.

The major factors that impinge on market structure and market power existing in a particular industry are:

the levels of seller/buyer concentration levels of product differentiation prevailing in a particular market and the entry and/or exit conditions in the prevailing market.

The entry and exit conditions shall be covered in the regulation section. As for product differentiation the products offered by the various firms are more or less similar. Here, we’ll mainly consider the seller concentration aspect of the market.

Herfindahl- Hirschman Index

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1 2 3 4 5 6 7 8 90

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HHI

Observations• We see that the value of HHI is falling as we go from 2003-09• It has stayed almost constant from 2008 to 2009• The market is slowly but surely getting more competitive

Year HHI

2003 0.89

2004 0.83

2005 0.77

2006 0.70

2007 0.66

2008 0.59

2009 0.58

4 Firm Concentration Ratio

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1 2 3 4 5 6 7 8 90

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4 Firm Concentration RatioYear Ratio

2003 0.9707

2004 0.9501

2005 0.9335

2006 0.9091

2007 0.8997

2008 0.8133

2009 0.8091

Observations• The four firm concentration ratio shows us the same trend as

HHI• Since the Four Firm Concentration Ratio is not a weighted

average, it does not give as smooth a graph as HHI

Determining the market form

The number of firms in the market is 20. Though this is neither necessary nor sufficient indicator of any market form, the number of firms can be viewed as ‘few’.

We will mainly determine the market form from the HHI and Four Firm Concentration Ratio.

In 2003 both HHI and FFCR were close to 1, 0.89 and 0.97 respectively. The initially monopoly existed with LIC as the dominant firm.

However, the situation was rather different in 2009, the HHI and FFCR fell to 0.58 and 0.80 respectively.

We give more weight age to HHI since it is a weighted ratio. The indices of 2009 indicate that the market is OLIGOPOLISTIC. Since the products are fairly similar we can call this PURE

OLIGOPOLY.

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Regulation in the Insurance Industry

Let us analyze the various aspects of regulation. The main issues we shall consider are

Protection of Policy Holders interest Solvency Ratio Regulations of Investments

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Solvency Ratio One of many ratios used to measure a company's ability to meet

long-term obligations.

The solvency ratio measures the size of a company's after-tax income, excluding non-cash depreciation expenses, as compared to the firm's total debt obligations.

It provides a measurement of how likely a company will be to continue meeting its debt obligations.

Generally speaking, the lower a company's solvency ratio, the greater the probability that the company will default on its debt obligations.

‘Available Solvency Margin’ means the excess of value of assets over the value of life insurance liabilities and other liabilities of policyholders’ fund and shareholders’ funds.

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Solvency (continued)

Prescribing solvency requirements is a balancing act:

low requirements will not allow the Regulator enough time to intervene

high margin requirements will require high capital with higher costs to consumers without any additional significant protection.

The control level solvency margin requirements may be reviewed from time to time in this perspective. This is entirely within the domain of IRDA.

All life insurance companies are expected to maintain a solvency ratio of 150%.

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Protection of policy holders interestInsurance regulatory authority of India has taken strict measures to keep the customer informed of the policy that he/she will be buying.The guidelines framed by IRDA are to ensure best possible service to the policyholders:-

Maximum of 15 days for enquiry or demand of additional document by the insurer.

Maximum of 30 days after date of receipt of all relevant documents for payment of claim.

If payment cannot be made due to proper identification of the payee then interest to be paid upon the claim amount as per savings bank account of any scheduled bank.

If payment cannot be made due to any other reason, then interest rate is to be 2% higher than bank’s interest rate.

For any matter the insurer has to respond within 10 days of receipt of any communication by the policyholder.

Process of distribution of surplus in case of with-profit policy

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Obligations.--- Every insurer, who begins to carry on insurance business after the commencement of the Insurance Regulatory and Development Authority Act, 1999 (41 of 1999), shall, for the purposes of sections 32B and 32C of the Act, ensure that he undertakes the following obligations, during the first five financial years, pertaining to the persons in---

(a) rural sector, (I) seven per cent in the first financial year; (II) nine per cent in the second financial year; (III) Twelve per cent in the third financial year; (IV)Fourteen per cent in the fourth financial year; (V)Sixteen per cent in the fifth year;

of total policies written direct in that year; (b) social sector, in respect of all insurers, -- (I) five thousand lives in the first financial year; (II) seven thousand five hundred lives in the second

financial year; (III) ten thousand lives in the third financial year; (IV) fifteen thousand lives in the fourth financial year; (V) twenty thousand lives in the fifth year.

Regulation of Investments

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Conclusion

The insurance industry in India can be said to be under OLIGOPOLY. It can also be viewed as a transition from Monopoly to Competition with both indices showing steadily declining trends.

After the recession in 2008, LIC has performed better than the private players. This reflects the general psyche of the Indian population. People look at LIC for ‘safety’ and ‘guarantee’ while they look at private players for better returns.

This also implies that even though the market share of LIC is steadily declining, it will never completely go out of business as investors will always look to LIC for safety purposes and for minimizing risk.

LIC targets the mass population of the country while the private players target the upper class.

IRDA which is the regulatory authority for insurance industry in India maintains a strict vigilance over the firms for safeguard of policyholders’ interests.

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A part of the premium accumulated by the insurers have to be diverted towards the rural and social sector under the current regulations

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