Home / Opinion / Online Views /  The economic reason for middle-class discontent

If the Congress wants to know why it has alienated the Indian middle class, it should take a look at a remarkable piece of research, India Market Strategy: Penny Rich, Pound Poor, by Credit Suisse analysts Neelkanth Mishra and Ravi Shankar. The report looks at the impact of government spending and welfare payments on the poor and the middle class. Their basic argument: while wages and consumption at the bottom of the pyramid will continue to increase because of government redistribution policies, incomes of middle class are being squeezed because of lower growth and a slowdown in the pace of increase of government wages.

This column had pointed out last August (The High Cost of a Free Lunch) that the free lunch for the masses has resulted not only in higher inflation but also in lower growth. The Reserve Bank of India has been unable to reduce interest rates because of high inflation, which, in turn, has led to high cost of capital, thus slowing growth. Also, the money spent on subsidies has led to less funds being available for capital expenditure, which again has led to supply bottlenecks, adversely affecting growth. What the Credit Suisse report analyses is the different impact this has had on different classes. While the poorer classes have benefited from the government largesse—seen clearly in the rise in rural wages—the slower growth as a result of the populist measures has hurt the middle class.

The authors say that the National Rural Employment Guarantee Scheme, which has been blamed for the rise in wages and for inflation, accounts for merely 6% of government spending on rural India. What is far more important is the increase in welfare spending and government expenditure on rural infrastructure.

The numbers bear out the authors’ conclusions. Expenditure on social services in the combined budgets of the states increased by 125% between 2008 and 2012. Total development expenditure by the states has gone up by 108% over the same period, while central government spending on food subsidies increased by 130%. Farm procurement prices have been increased substantially. The upshot: a substantial rise in rural wages and in rural consumption, while it has also led to higher inflation.

Wages for the middle class had also risen, thanks to the Sixth Pay Commission. The analysts say that, “Wages for government employees increased 85% from 2008 to 2010; the 1.5 trillion increase being 2.4% of gross domestic product (GDP) over two years." But that impact is now finished and the pace of increase has slowed down.

Looking ahead, the report says that the 12th Five-Year Plan has planned a large increase in spending on rural roads, rural housing and rural electrification. Spending on welfare schemes, too, is unlikely to slow—the Food Security Bill is an example. Moreover, state finances are mostly in decent shape and they can afford to increase spending. In other words, consumption at the bottom of the pyramid will continue to grow.

The authors are analysts with a brokerage and their intention is to assess which sectors and which companies would benefit from this trend. But the report can also be viewed from a broader social perspective. What it lays bare is a clash of interests between the poorer and the middle classes.

The slowdown in growth has affected middle class wages while jobs are hard to get. Many young people who came into the job market during the boom years expected 9% GDP growth to last forever. Annual salary increments of 20% were taken for granted, job-hopping for even higher pay raises was easy. The media churned out article after article about the great India story, adding fuel to the optimism. Now that growth has slowed to 5.5% or thereabouts and they’re lucky if they can hold on to their jobs, their high expectations have been dashed. No wonder they feel the government doesn’t care about their concerns and is interested only in trying to get re-elected by populist programmes. There have been growing demands for pruning the fiscal deficit by a roll-back of ‘entitlements’.

It’s not only the middle class that suffers from low growth. One of the main sources of employment for the masses has been the construction sector. But construction activity has slowed, seen from the fact that bank credit to the sector at the end of November 2012 was lower than at the end of March 2012. That will make it difficult to find jobs for the masses.

The only way out is to increase growth. The Chinese authorities discovered long back that higher growth can paper over the conflicts in a society. It is time the Congress, too, realizes this.

The Prime Minister understands this very well, as does the finance minister. In recent months, they have taken a series of small steps to improve sentiment in the markets, whet the appetite of foreign investors and boost investment. As many economists have pointed out, reviving investment demand, along with boosting spending on infrastructure, is the key to higher growth.

True, the days of 9% growth have gone and the Prime Minister has said that even 8% average growth during the 12th Five-Year Plan is ‘ambitious’. But we need, at the very least, to get back to 7% growth soon. That would be a necessary, if not sufficient, condition for regaining the support of the urban middle class.

Manas Chakravarty looks at trends and issues in the financial markets. Your comments are welcome at capitalaccount@livemint.com.

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