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An unending money illusion

An unending money illusion
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First Published: Mon, Jan 10 2011. 09 47 PM IST
Updated: Mon, Jan 10 2011. 09 47 PM IST
The Union government recently indexed the wages of workers under the Mahatma Gandhi National Rural Employment Guarantee Scheme (MGNREGS) to the consumer price index for agricultural labour (CPI-AL). The step, aimed at boosting the purchasing power of workers, came in the midst of a controversy over the government not linking wages under MGNREGS to the minimum wage under the Minimum Wages Act, 1948.
The wage hike, ranging from 17-30%, is likely to prove illusory. Perhaps it already is. For, in a time of spiralling inflation, even frequent wage revisions are no good as a policy measure. The only thing these do is to make poor workers the victim of what economists call “money illusion”: A rise in nominal wages is seen as something satisfying while real wages get constantly eroded by inflation. Taming inflation would be a much better policy response. That, however, is beyond the government’s powers as recent statements by home minister P. Chidambaram and finance minister Pranab Mukherjee indicate.
In a low-inflation environment, the gap between what workers earn in wages and their productivity is either low or is within manageable proportions. In the case of MGNREGS, this link is broken. While government economists blame supply constraints for inflation and underplay the role of rising rural incomes for adding fuel to fire, the situation is more complex and may remain so in the years to come. Thanks to MGNREGS many workers have been diverted from farm labour into purely Keynesian “digging ditches” type of jobs. The result is that, in relative terms, the cost of hiring farm labour is rising and is often reflected in demands for higher minimum support prices by farmers. Anecdotal evidence from states such as Punjab, West Bengal and Andhra Pradesh suggests that such processes are already at work.
It is this “gap”, caused by the divorce between production on farms and rising inflation that the government is trying to bridge. There is a “moral” argument for doing this, as pointed out by Pronob Sen, a principal adviser to the Planning Commission. But morality often makes for bad policy choices. Purely in economic terms, this cannot be done for long: A wage-price spiral is already on. The remedy lies in a different direction. Either the government dramatically improves the supply situation, which is difficult as it is spending little money on increasing agricultural productivity; or it will, sooner or later, have to do some demand management. This is likely to be expensive, politically that is. There is no escaping the cleft stick it is caught in.
What is causing inflation: rising rural incomes or supply constraints? Tell us at views@livemint.com
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First Published: Mon, Jan 10 2011. 09 47 PM IST