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India on an inflation treadmill

India on an inflation treadmill
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First Published: Tue, Jun 14 2011. 04 31 PM IST
Updated: Sat, Jul 02 2011. 12 21 PM IST
Wages are rising. Input costs are hurting. Reforms have stalled. This is not just a description of what Indian industry is going through right now. It also captures the situation on the farm. Curiously, both farmers and businessmen have the same litany of woes.
First, let’s see what is happening to rural wages. The Mahatma Gandhi National Rural Employment Guarantee Scheme was initially introduced with the decent intention of providing wage employment to unskilled rural workers for 100 days a year—sort of income support scheme when outside work is not available. It is also a classic example of how good intentions do not necessarily make for good policy.
The massive rural jobs scheme has distorted rural labour markets. One way to figure this out is to see what has happened to rural wages. The Hindu Business Line reported on 15 May that data collected by the Labour Bureau showed how rural wages had shot up in 2008 and 2009 in most states. Other than a few states, such as Gujarat and Himachal Pradesh, rural wages in most states have increased far faster than the inflation rate. Farm wages in Andhra Pradesh nearly doubled in the two years.
Higher wages for the desperately poor are welcome in case rural productivity is growing equally fast. A farmer pays his workers twice as much because their output per head has increased by the same amount, or more. Otherwise, the rise in wages without at least an equivalent rise in productivity is a clear recipe for inflation—which hurts the poor the most.
Farmers have been hit by a further problem: the rise in fertilizer prices, thanks to higher global crude oil prices. The simultaneous rise in labour and input costs is squeezing farmers. “The Labour Bureau figures are an eye-opener, though they conform to what farmers themselves say. And if you add soaring energy costs as well, protecting the margins of farmers becomes a real challenge,” Ashok Gulati, chairman of the Commission for Agricultural Costs and Prices, told the newspaper.
What can happen next is a sobering tale. The government is then under pressure to bolster the profit margins of farmers—an important voter bloc—by raising the minimum support price for farm produce. The price at which the government agencies buy food from farmers tends to act as a floor on food prices around the country. So a higher guaranteed price will most likely push up food prices across the country. Consumers need to brace up for higher food inflation.
But that’s not the end of the story. High food prices hurt the poor, who spend most of their money to buy food. So the government has now decided to link the wages it pays, for work done on the rural jobs scheme, to inflation. The aim is to protect the purchasing power of the people who work under its employment guarantee scheme.
Thus higher food inflation leads to higher rural wages—and the cycle begins all over again.
The United Progressive Alliance government seems to have put India on an inflation treadmill that it now tries to explain away by saying that high inflation is the inevitable result of high growth. Ministers and government economists have been busy offering this explanation, even though China has grown faster since the beginning of this century with a lower inflation rate.
What next? Here’s one possibility. Farmers will eventually have the incentive to cut their dependence on unskilled labour. They will get machines to do the job of men. Data on tractor sales in 2009 was an advance indication. Tractor sales were at a record despite the worst drought in many decades. One possible reason is that farmers were ready to buy machines even in a drought year because they were worried about the trend on rising wages amid stagnant productivity. What began as a well-intentioned scheme to help rural labourers may perversely end up cutting demand for them.
To be sure, higher guaranteed prices do act as an incentive for farmers to produce more. This year’s record food harvest can be at least partly explained by the government decision to offer higher purchase prices to farmers. But the costs of such a policy are ever-growing food subsidy bills and upward pressure on food prices.
The only long-term solution to the current tangle is to promote policies that shift the supply curve to the right. Higher demand for food will not be inflationary only if supply of food also moves up significantly. But that will require reforms in agricultural markets, greater public investment in rural roads and irrigation projects, encouraging modern retail chains to build cold chains to connect farmers with urban consumers, and promotion of new farming techniques.
In contrast, the current set of policies resembles an inflation treadmill that could leave the Indian economy gasping for breath.
Niranjan Rajadhyaksha is executive editor of Mint. Your comments are welcome at cafeeconomics@livemint.com
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First Published: Tue, Jun 14 2011. 04 31 PM IST