A different view to Inflation!

Food inflation hits 18.3% (Economic Times dated 7th Jan 2011) says one headline. It certainly is not healthy and sustainable. And a side headline on the front page shows inflation linked NREGA wages now applicable. We are experiencing painful increase in inflation and particularly food inflation – representing shortage of supply, more money in people’s hand, less productivity, lots of exports that it causes scarcity, fewer imports than necessary, etc. The reasons can be any or combination of any of them.

The first thing notable in all this is, people now have more money in their hands – thanks to schemes like NREGA which pushed up the wage bar. Linking it with inflation will further add to the increase in inflation. If we look at the past one decade, in particular, there has been a tremendous increase in salaries in real terms, thanks to the IT revolution and service driven economy. The MNCs and Indian companies too do not mind shelling big bucks for the right talent. This is quite evident from the number of ‘commoner millionaires’ in cities. Increase in the number of companies, increase in the amount of business coming to India, increase in skills of employees, inelasticity of supply of talented human resources in the short term, etc are some of the factors responsible for ever increasing salaries.

The market forces of demand and supply play a very big role in increase of salaries in urban India. Increased salaries, in turn, result in easy availability of finance. Burgeoning salaries are security enough for banks to give loans for home, automobiles, university education, land, etc. Increase in demand of all such commodities by such large section of people in turn causes surge in the prices to the extent that they seem unreasonable and ridiculous. Look at any urban market, the salaried are in the race to buy homes and have their salaries are tied up for two decades (typically) in EMIs to banks.

Government is playing a big role in putting more money in hands of rural folks, particularly keeping vote bank in mind. Agriculture loan waivers, various subsidies, NREGA schemes, etc puts a lot of money in hands of a very large section of people, causing increase in demand for goods and services in rural India – particularly food items and low end services. While market forces are involved in urban areas, in rural areas government intervention is just too conspicuous. Whatever the reason for increased supply of money, its value always decreases when there aren’t corresponding goods and services to support it. Simply put, we are experiencing more demand for goods and services than are available. To add to it, monetary measures – the ones adopted by the RBI relating to interest rates, etc. – are of little use. We have supply constraints which cannot be resolved in the short term.

Of course, there is no way we can immediately increase the productivity of pulses, for example. In fact, there is no short term solution to this. Few steps to address food inflation are – to increase the productivity in agriculture, revamping the supply chain, providing adequate marketing, financing, elimination of middlemen, etc. Whatever progress we make in IT, we lag behind in agriculture. Let’s put our best minds to it. The country needs it.

Let’s view things a little differently. Why increase in salaries and wages increase inflation so much? Using no official or unofficial estimate – supposing for every 1000 salaried persons there is but one entrepreneur. The assumption seems realistic. Very few would venture out in the hectic and not-so- easy world of entrepreneurship.

Now increase in the income from business will not give as much push to demand as increase in salaries would give. Firstly, entrepreneurs are fewer than salaried persons. Secondly, entrepreneurs would like to reinvest the income depending upon the phase of growth the organization is experiencing. Thirdly, increase in salary is a wider phenomenon. Increase in salary for same services creates an industry wide increase. As a result, there is more money now in the hands of very large number of people. On the other hand, increase in income of an entrepreneur is due to his special efforts like – negotiations, contracts, contacts, after sales, etc. Notably, increase in macroeconomic factors like taxation, prices of raw materials, etc. have industry wide influence even in case of enterprises. Having said all that, salaries increase only when the businesses prosper. There is a time lag between boom in business and increase in salaries. If we look at IT companies, the most important resource is Human Resource. Given the kind of enviable operating margins IT companies have, it is quite natural that the business profits trickle down to the salary level quite fast indeed.

Let’s summarize. In case income from business increases, a very less base of population experiences increase in income in hand. But as businesses continues to prosper, salaries increase eventually, putting money in the hands of a very wide base of population.

As a result of the latter, you would see ridiculous real estate prices that you now see. Similarly, increase in demand for food items, hence the unsustainable food inflation; increased demand for automobiles; increased demand for fine dining; increased capacity to ‘waste away’ things

Who suffers the most as a result of all this? The answer is simple -- the one whose income is not linked to inflation. On the lighter side, auto rickshaw drivers in Delhi generally benefit from an increase in prices of the fuel that goes into their vehicle. Their fare, most of the time, increase more than proportionately.

The author does not argue whether increase in income of salaried is good or bad but tries to examine its effect.

Total population of India and China form 37% of world population, according to 2009 World Bank's World Development Indicators. Increase in affluence of such huge population puts huge pressure on limited resources of the planet; whether it is sustainable or not, is debatable and beyond the scope of this write up.