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SPHINX WITHOUT A SECRET - The UPA's inflation is crucially linked to subsidies

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By Ashok Sanjay Guha The author is Professor Emeritus, JNU
  • Published 22.05.14

As the United Progressive Alliance regime breathed its last, postmortems began on its economic policies and performance. It was cogently argued that its performance on almost all economic parameters was excellent, certainly better than the National Democratic Alliance’s as well as that of Narendra Modi’s Gujarat. Its failures were a by-product of its success: rapid economic expansion meant massive infrastructural investment and opening up of huge natural resource sectors in telecommunications, mining and so on, all of which generated opportunities for large-scale corruption, environmental degradation, displacement of farmers and exploitation of tribal communities. Certainly, these were factors responsible for the UPA’s bad press. But can they explain the total collapse of its popular support? Environment, for one, has not been an issue in this election (except for the ‘environment tax’ allegedly extracted by Ms Jayanthi Natarajan) and, while marginalized tribals were certainly crucial in Naxalite-affected areas and displaced farmers in West Bengal, they have had no impact on electoral outcomes elsewhere. Corruption certainly has been a key talking point in 2014, but had it been pivotal, the main beneficiary would surely have been the Aam Aadmi Party, not the Bharatiya Janata Party.

So, what accounts for the UPA’s electoral catastrophe? If its economic stewardship has been as masterly as traditional indices suggest, is this a case of the operation being successful but the patient expiring? Or was hoi polloi so dazzled by Modi’s media blitz that it completely lost sight of a reality that was transparently clear to us economists?

Perhaps, it is time for our tribe to abandon its multiplicity of performance indices and focus instead on the stated concerns of the common voter. Throughout this campaign, voters have been vocal, indeed vociferous, about their distress on two major economic issues — inflation and unemployment. Indeed, inflation rates are the one set of numbers that even the most enthusiastic supporters of the UPA bemoan and, in this article, we concentrate exclusively on them. A later article will focus on the unemployment issue. Since 2008, the UPA’s inflation rate has galloped far ahead, not only of the NDA’s, but also of the rest of the world’s. Prices have risen so much faster in India than anywhere else (with the possible exceptions of Brazil, Indonesia, Russia, South Africa and Turkey) that we cannot possibly blame them on global factors. India’s inflation is very much a home-made product. But how did we manage to conjure up this djinn? The UPA’s fiscal deficits were not much worse than the NDA’s — though the latter almost achieved price stability. At this point, economists might well throw up their hands and proclaim that Indian inflation — like the capricious Indian voter — is an unsolvable puzzle, a riddle, as Churchill might have put it, wrapped in a mystery inside an enigma.

We have a simpler explanation.

The UPA’s inflation in our opinion represents a sphinx without a secret. It is crucially linked to the UPA’s subsidies — not, as sometimes argued, through their effects on money income and demand, but through their adverse repercussions on incentives and the consequent supply effects. The most substantial of these subsidies are of course those associated with NREGA and with the Right to Food Act. NREGA guaranteed every rural family 100 days of employment at the government’s expense at or above the legal minimum wage. The work done was supposed to create rural infrastructure — but the focus was entirely on employment rather than productivity: the most labour-intensive of techniques was employed and machinery effectively banned so that the public works, even when completed (which they generally were not), did not survive the next monsoon. Meanwhile, the incentives of labour were distorted: after all, which Bihari worker would prefer to migrate to an alien and hostile environment of hard work in the fields of Punjab or the factories of Maharashtra when given the option of staying home and tinkering with essentially symbolic work at reasonable wages? NREGA created little or no productive capacity but seduced an army of rural labour away from productive work. It was a massive exercise in the creation of what was once called “disguised unemployment” by the government. Ever since its roll-out on a national scale in 2008, NREGA has withdrawn labour from actual into symbolic employment with the inevitable negative consequences for output. Even if NREGA had been fully paid for out of taxes, even if it had not contributed a rupee to the budgetary deficit, it generated inflation by reducing the supply of goods on the market. And, indeed, the acceleration of inflation from 2008 is quite palpable.

The foodgrain subsidies, whether in states like Andhra Pradesh, Tamil Nadu, Gujarat and Chhattisgarh or through the RTF, deflected the inflationary pressure away from cereals on to higher quality food (vegetables, fruits, pulses, oil, meat, fish and eggs) and to manufactures. Assuming, again for argument’s sake, that there were no leakages in the long chain from the farmer to the consumer and no increase in deficits on their account, the subsidies to consumers and the minimum support prices that made them possible distorted the pattern of production (and consumption) away from the optimal, thus reducing total output and fuelling inflation.

We do not deny that NREGA or food security may have made the rural poor better off. Obviously, an income subsidy, whether in the form of reasonable wages for little or no work or of free foodgrains, is very welcome to the beneficiaries — even if its benefits are subsequently neutralized through inflation. But the same redistributive effects could have been achieved through direct cash transfers without diverting labour away from real work or distorting prices and production patterns and thereby reducing output levels.

All other subsidies — on irrigation, power, diesel, fertilizers, cooking gas or anything else — have had similar distortionary effects. They have, for example, encouraged the use of water and fertilizer-intensive crops and techniques, thereby not only depleting soil-fertility and long-term productivity but also discouraging production that would have used our scarce resources more efficiently, thus adding to aggregate output even in the immediate present.

Of course, we have assumed away the demand effects of subsidies purely for argument’s sake. In fact, the subsidies exerted strong pressures on the budget, widened our deficits and added substantially to inflationary pressure.

The proliferation of subsidies also gradually eroded one of the most durable assets of the UPA regime — the image of Manmohan Singh as a committed reformer. This reputation survived well into UPA II, but by 2011, as subsidy followed subsidy, the prime minister was increasingly unmasked as a figurehead designed to shield the real decision-makers from accountability. When Pranab Mukherjee was appointed finance minister over his objections and forced by budgetary pressures down the path of retrospective tax legislation, the confidence of foreign, and indeed Indian, investors evaporated, the rupee sank to historic low levels and import prices (especially of oil) shot up, adding yet another component to our inflation. This was the external component of our swadeshi inflation — but even this was a self-inflicted wound.

Indian inflation over the last few years has been directly linked to India’s subsidy regime. The patrons of this regime in the Gandhi family and the National Advisory Council have much to answer for in accounting for UPA’s electoral implosion. So does a prime minister who abandoned his economics to genuflect before royalty.