Will Government Steps Tame Runaway Inflation?

WPI rising at 15.08% in April 2022 has set alarm bells ringing in the government. Not only has the WPI been rising at above 10% per annum for over 13 months, it has been rising faster since February 2022. In other words, it has accelerated. Of course, the war in Ukraine has impacted it but it had been rising rapidly prior to that. In November 2021 it had risen by 14.87%. It moderated a little till January 2022 and then again rose.

In November 2021 the government had cut taxes on petro goods to bring down their prices. Now the government has again cut these taxes in the hope of moderating inflation. By restricting the exports of wheat and sugar it seeks to lower their prices. Additionally, it has acted to lower prices of basics like, steel, cement and plastics. These steps should help moderate inflation. The issue is how much and whether it will benefit the citizens, especially the marginalized ones?

Acceleration and Generalization to all Commodities.

When indirect taxes are levied on basic items of production, they feed into the price of all other products. For instance, if price of energy rises, since it is used in all production, price of all products rise – there is a generalized price rise. If tax on diesel is raised, transport costs, cost of running pumps in the fields and electricity generated using diesel rise. Similar is the case with coal, cement, steel and plastics. So, one way of lowering the rate of inflation is to reduce taxes on these basics.

Further, if there is profiteering in these basics then another way of lowering their prices is to reduce the customs duties so that import of these goods becomes cheaper. The domestic producers are then forced to lower their prices. This is the plan in the case of steel where excessive profits are being earned and oilseeds.

Similarly, if some goods are being exported since the price abroad is higher than in the domestic market, then their export can be banned or a duty levied on their export. This increases supplies in the domestic market and the price declines. This is the plan behind restricting export of wheat and now sugar. Shortage of wheat in the global markets led to its prices rising and that spurred increase in exports from India and caused its price to rise in the domestic market. However, these steps need to be well thought through and not taken as knee jerk reactions, as has happened in the case of wheat exports. One day a team went abroad to explore exports and the next day exports were banned. Sugar production is at a record high so why a sudden restriction of exports of this commodity.

A constant increase in prices raises expectations that they will continue to rise. In anticipation, all prices start rising and it becomes difficult to reverse this trend. The pricing power of the organized sector has risen due to increase in its market share consequent to the decline of the unorganized and small sectors. Their profits have been zooming as per RBI report, in spite of economic decline and stagnation. Once such expectations set in, traders also take advantage and raise prices further. Considering this, the government should have acted much earlier to prevent buildup of expectations about price rise.

The international factors – war in Ukraine, severe lockdown in China, supply bottlenecks, sanctions on Russia, rise in shipping charges, etc. – are not in the control of the government. Given the uncertainty, these factors will continue to operate for the foreseeable future. So, the government needs to act more urgently on the internal factors.

What does inflation mean for the citizens?

It is prices in relation to the wages that determine the purchasing power of the citizens. If the wages rise as prices rise then the purchasing power is not impacted. This is called indexation to prices and determines the Dearness Allowance.

Inflation measures the rate of rise in prices. So, a decrease in the rate of inflation does not mean that prices are declining. It only means that they are rising less. It is like a train slowing down to halt at the next station. The speed is decreasing but the train is moving ahead. In most advanced countries and even middle income countries the wages are mostly indexed to prices. So, even a high rate of inflation does not pinch the pockets of the citizens. But in India, that is not the case since there is a substantial unorganized sector.

In the unorganized sector, by definition, workers cannot bargain for higher wages as prices rise. Since there are large numbers of them seeking work, they are forced to accept the wage being offered. Being unemployed is not an option for these marginalized sections who have little savings to fall back on. There is no unemployment dole, unlike in the advanced countries, so they cannot afford to stay unemployed. Taking advantage, employers grant little wage increase.

In the organized sector the workers are able to bargain with the employers to get a higher wage as prices rise. This is the dearness allowance. But this comes with a lag and in the interim their real income declines. The unorganized workers also act as the reserve army of labour to keep the wage increase of the organized sector workers down. The latter are scared of losing their job since that would force them to work in the unorganized sector where they will get a fraction of the wage they were getting.

If there is an international recession, demand will decline and moderate prices. Government may be banking on it. But, that medicine is worse than the disease. As demand falls, production, employment and wages will decline. The citizens would then be worse off.

Rising Corporate Profits

When prices rise faster than the wages paid to the workers, profits rise. Of course, there is a difference between the big producers and the small ones. The former enjoy a higher market power and can raise their prices more easily. Further, they can also squeeze the margins of their ancillary suppliers from the smaller units. The small units then squeeze the workers and do not raise their wages.

The pricing power of the larger units and traders needs to be checked to control inflation. This is not easy. The only way out is to put a tax on the extra profits and use that to a) reduce indirect taxes and b) give support to employment generation schemes for the workers.

In brief, the steps announced by the government are only a first step. Prices of essentials have to be brought down (not just rate of inflation) and wages indexed to inflation. Neither is likely to happen in spite of the steps taken. Provision of essentials at subsidized rates is another possibility. That would require the government to collect more revenues which also seems to be unlikely as the economy slows down. Anyway, much more is required to be done to give relief to the marginalized sections, hurting from high rates of inflation which can have serious social and political implications.

Author of `Indian Economy’s Greatest Crisis: Impact of the Coronavirus and the Road Ahead’. 2020. Penguin Random House.

Arun Kumar is a veteran Indian economist. He studied at Delhi University, Jawaharlal Nehru University (JNU) and Princeton University, USA, and taught economics at JNU for three decades till 2015. His areas of interest include public finance, development economics, public policy and macroeconomics. Kumar has written widely on these subjects, both in the popular press and for academic journals. At present, he is the Malcolm S. Adiseshiah Chair Professor at the Institute of Social Sciences, New Delhi.