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Economy Facing Stagflation: Need to Improve Supplies and Keep Up Demand
Arun Kumar
The Government, worried about the inflation rapidly inching up month after month, has finally become pro-active. The steps announced are designed to lower the prices of basics like diesel, steel, cement and plastics. Wholesale Price Index (‘WPI’) has risen at more than ten per cent for more than a year, and in April 2022, it was at 15.08 per cent – a level not seen in more than a decade. Consumer Price Index (‘CPI’) has risen 7.8 per cent, well above the Reserve Bank of India (‘RBI’)’s target of four per cent plus minus two per cent for the fourth consecutive month.
Accelerating inflation
Inflation is high whichever measure we take. The CPI reflects the impact of inflation on the citizen’s budget. If it is higher than the increase in incomes, wages and salaries of people, then their standard of living declines. The WPI is what the producers take into account in their cost of production. That in turn determines the price of their product and the profits they earn. Rising WPI sooner or later translates to higher consumer prices, which have been moderated of late by the decline in the wage bill and interest costs. That is why the CPI has lagged considerably behind the WPI for some time.
The April 2022 data shows that the increase in CPI is accelerating. It is much higher (7.8 per cent) than its level in April 2021 (4.2 per cent). Also, it is substantially above March 2022, at about 20 per cent at an annualized rate. This has given momentum to the rising rate of inflation measured by CPI, and it is likely to continue to rise in the coming months. The government is trying to check this.
The situation is aggravated by the slowing down of the world economy due to the war in Ukraine and lockdowns in China. They are causing increased supply disruptions and shortages of various critical inputs like energy, fertilizer, metals, computer chips, manufactured products, wheat and soybean. Consequently, prices are not only rising; India’s current account deficit has rapidly increased, thereby weakening the rupee against the dollar, though not against other major currencies. Since trade is denominated in dollars, it has meant that all imported items, including energy, become more expensive in India and inflation kicks up.
Faltering growth
The most recent data is available for the third quarter of 2021-22, that is, for the quarter ending December 2021 and the second advance estimate for the year 2021-22. Both these are provisional. Also, this period is prior to the third COVID wave in January- February 2022.
The Gross Domestic Product (‘GDP’) data shows a sharp increase of 8.95 per cent over 2020-21. This was expected because of the low base in 2020-21 (due to the pandemic). But when compared to the pre-pandemic year 2019-20, the GDP is higher by 1.7 per cent only. So, growth over the pre-pandemic level is negligible, which implies a stagnant economy.
The real growth is even less. The data used for quarterly estimation of GDP and for the second advance estimate does not independently measure the growth of the unorganized sectors, except for the agriculture sector. It is mostly assumed that the unorganized sector can be proxied by the organized sector. This is not a valid assumption. The unorganized sector literally collapsed due to the lockdown and the subsequent difficulties due to slow opening up of the economy. So, it has been in decline rather than growing. This has been the case since demonetization in 2016.
Further, demand has shifted from the unorganized to the organized sectors for many components of the economy. Hindustan Unilever recently reported that its market share has increased due to the decline of its competitors from the small sectors. This is also true of trade where demand has shifted from the neighbourhood small stores to e-commerce and big chains. The unorganized sector, working with a small amount of capital, exhausts it even during brief closures and is then unable to revive. Even if it restarts after borrowing from informal money markets, its costs rise and it struggles to survive.
Thus, if the decline of the unorganized sectors could be accounted for, the GDP would be below the 2019-20 level. This is corroborated by the RBI data on consumer confidence. It is at 72 per cent currently, while it was at 104 per cent in January 2020, just before the pandemic. This data is also mostly fro ken into account. The implication is that consumption is well below the pre-pandemic levels. Then how can the GDP have crossed the pre pandemic level?
Some sectors are, of course, doing well, such as FMCG (fast-moving consumer goods), pharmaceuticals, technology and telecom. Sectors like metals and petroleum benefited due to the rise in global prices even before the war in Ukraine. After the start of the war, all these sectors have been doing even better due to disruption in supplies. But many components of the organized sectors, like contract services and mass consumption items are still not back to pre-pandemic levels. So overall, even the organized sector has not fully recovered.
Economy is in stagflation
In brief, including the unorganized sectors, production, employment and investment have not recovered to the pre-pandemic levels. The economy has recouped only a part of the pandemic hit production in 2020-21.
Not only is the economy below the pre-pandemic level: if undisturbed by the pandemic, it would have continued to grow at about four per cent; thereby in 2021-22, it would have been higher than its level in 2019-20 by more than eight per cent (not the official 1.7 per cent). So, at best, one can say the economy is stagnant. Combined with the accelerating inflation, the implication is that the economy is in stagflation. This has serious implications for the economy and especially for the marginalized sections. For them, a reduction in the rate of inflation is not enough, given their stagnant or declining incomes.
It puts policy makers in a fix. If, to control inflation, they try to reduce demand, then the economy slows down. If they try to boost growth, then inflation may rise. The delicate solution lies in eliminating supply bottlenecks without curtailing demand.
The RBI raised the cash reserve ratio to reduce liquidity, and raised interest rates to reduce demand. However, these do not address the reasons for rising inflation, which are: supply bottlenecks in India and abroad, the war in Ukraine and consequent shortages, the lockdown in China, the increased pricing power of corporates, closure of units in small and micro sectors in India, and increase in global freight charges. Presently, when consumption has not yet recovered and demand is short, an increase in interest rates will only reduce investment, employment and incomes – worsening stagflation.
What needs to be done?
It is for government to address supply bottlenecks, check speculation and reduce indirect taxes to lower inflation. Units that have closed down need to be helped to revive. Direct tax collections have to be increased so that the indirect taxes can be cut without driving up the fiscal deficit in the budget. Specific steps for doing this have been suggested many times recently. The budget needs to be redrawn since expenditures will rise with inflation (through, for instance, the subsidy bill) while revenue buoyancy will decline due to slowdown in the economy.
In brief, the economy faces stagflation, to tackle which government, rather than the RBI, needed to act; the steps announced are a start. More needs to be done to eliminate supply bottlenecks without curtailing demand.
(Dr. Arun Kumar is Malcolm Adiseshiah Chair Professor, Institute of Social Sciences. Article courtesy: The Leaflet. The Leaflet, founded by advocates Indira Jaising and Anand Grover, is an independent platform for cutting-edge, progressive, legal & political opinion.)
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The Indian Economy Is Heading for a Stationary State
Prabhat Patnaik
Adam Smith and David Ricardo had been haunted by the idea of capitalism ending up in a “stationary state”, by which they meant a stable state of zero growth. Marx used the term “simple reproduction” to describe such a state, where there is no net addition to production capacity and the economy just reproduces itself at the same level period after period. The Indian economy appears headed for such a state.
The Modi government’s propaganda machine, as usual, is working overtime to paint a rosy picture of the economy; but the reality is the very opposite. This propaganda uses a simple arithmetical trick. If output falls, say, from 100 to 90, then the fall is 10 per cent; and then if it recovers next year to 100, then the increase is 11.1 per cent (because of the lower base). The rate of increase (11.1 per cent) being higher than the rate of fall (10 per cent) allows the false claim that the economy has resumed its growth trajectory; in fact it has shown no growth at all over the two year period. Such a false claim is precisely what the government is resorting to.
Let us completely forget 2020-21, the year when the pandemic was acute, and just take the preceding and the succeeding year. Between 2019-20 and 2021-22, the gross domestic product in real terms increased by just 1.5 per cent, which was lower than the population increase (2 per cent) between these two years; per capita real GDP was thus lower in 2021-22 compared to 2019-20.
The ingredients that went into the making of this stagnation are worth examining. Consumption (namely, private final consumption expenditure in real terms) was about 1.5 per cent higher in 2021-22 compared to 2019-20, while gross fixed capital formation in real terms (that is, gross investment in real terms other than changes inventories) was 3.75 per cent higher. The somewhat higher rate of growth of investment than of consumption was because of a bunching of investment projects that had been postponed from the days of the lockdown; it could also perhaps have been because of replacement and modernisation expenditure in some sectors. In either case this higher rate cannot be maintained for long. As the rate of growth of investment comes down, the rate of growth of consumption will come down too (because of what economists call the “multiplier” effect, namely because the lower investment will reduce output and hence employment and consumption demand), which will push the economy even more emphatically towards a stationary state or simple reproduction. The economy, already virtually stagnating (and retrogressing in per capita terms) is thus moving firmly into a state of absolute stagnation (and hence even greater retrogression in per capita terms).
When the economy is in such a state of absolute stagnation, it becomes very difficult for it to get out of this state. The reason is simple. The total GDP is necessarily equal to private final consumption expenditure, plus gross investment, plus net exports (namely exports minus imports of goods and services), plus government consumption. Let us for the moment ignore the last two items; let us also ignore that part of investment which is meant for producing goods and services for the export market. Then, if the economy is experiencing stagnation, there is no reason for consumption to increase as it basically depends on the level of income; it would therefore continue to experience stagnation. Investment too will not increase because there is no reason for firms to enlarge capacity, as the economy, and by inference the home market, has been stagnant. Unless therefore at least one of the three expenditure items that we have ignored so far, shows an autonomous spurt, namely a spurt autonomous of the home market, the economy will continue to remain mired in a state of stagnation (or even negative growth until a state of stagnation is reached).
Now, net exports will not suddenly show an upward spurt, as the world economy itself is stuck in stagnation, so that the external demand for Indian goods has no reason suddenly to increase; and under the neo-liberal regime the government will not suddenly impose high tariffs or other protectionist measures in order to reduce India’s imports. Precisely for the same reason investment for the export market or for import substitution will not show any upward spurt. And as for government expenditure, since the government is committed to keeping the fiscal deficit in check, as a proportion of GDP, unless tax revenue as a proportion of GDP increases suddenly, government expenditure can hardly show a trend different from the GDP. Even here if tax revenue as a proportion of GDP rises because of indirect taxation which largely impinges on private consumption, there will be no net addition to demand: the rise in government consumption as a proportion of GDP in this case will be largely offset by a fall in private consumption as a proportion of GDP. Exactly the same holds for government expenditure financed by larger direct taxes imposed on that segment of the population which consumes the bulk of its income.
Only that increase in government expenditure therefore can have the effect of overcoming the state of stagnation which is financed either through a larger fiscal deficit relative to GDP, or through an increase in the rates of direct taxes on the rich. The latter course includes either larger taxes on corporate incomes or larger taxes on private wealth. But these ways are precisely what the government has steadfastly refused to follow. It has remained more or less committed to the fiscal deficit limit; and, far from larger taxes on the rich, it has been giving tax-concessions to the corporate sector in the utterly mistaken belief that such concessions will revive the economy by increasing investment.
This belief is mistaken for two reasons. First, even assuming, for argument’s sake, that corporate investment increases through such tax concessions, this will be offset by the reduction in government expenditure owing to reduced government revenue, thereby preventing any net increase in aggregate demand and hence thwarting any revival of the economy. Secondly, corporate investment depends on the growth of demand in the economy and not on tax concessions; if demand in the economy is not increasing, then tax concessions given to capitalists are simply pocketed by them without their undertaking any additional investment.
It follows that if the economy is caught in the grip of simple reproduction, then it becomes extremely difficult for it to come out of it within the confines of a neo-liberal regime. This is not a specifically Left argument; it is an argument that would be accepted by anyone not interested in ideological obfuscations. Not surprisingly, even some honest liberal economists have been making this very point.
It may be thought that since the output of the agricultural sector is not determined by demand-side considerations, but is autonomously determined, with government stock-holding picking up the excess of output over demand, a rise in agricultural output can introduce an autonomous source of growth into the economy as a whole; and that this will prevent it from settling down at simple reproduction. This is certainly a logical possibility, but the figures of GDP growth between 2019-20 and 2021-22 that we have given already include the agricultural sector’s growth rate. Hence unless there is a sudden acceleration in the growth rate of the agricultural sector, nothing will break the stagnation. And within a neo-liberal regime, one of whose main characteristics is to squeeze peasant agriculture, there is no reason to expect an autonomous acceleration in agricultural growth rate. The tendency for the economy to settle down at a state of simple reproduction therefore remains unimpaired.
If for some reason there is an adverse movement in income distribution while the economy is in simple reproduction, then that, far from lifting the economy from simple reproduction, would cause a recession, namely a negative rate of growth, which ultimately would take the economy to another, new, state of simple reproduction, with a higher level of the unemployment rate. This would be because such an adverse shift in income distribution would have the effect of lowering the level of aggregate demand through a lowering of consumption, as the poor have a higher consumption per unit of income than the rich.
The tendency towards simple reproduction in the Indian economy under neo-liberalism, is indicative of the fact that neo-liberalism has reached a dead end, not just in India but in the world as a whole.
(Prabhat Patnaik is Professor Emeritus at the Centre for Economic Studies and Planning, Jawaharlal Nehru University, New Delhi. Courtesy: Author’s blog at networkideas.org.)
