How Not to Make Sense of Rising Inflation

Today's op-ed by C.P.Chandrasekhar really ought to be read backwards. The last sentence is more illuminative of his sentiments than any other:

In particular it [the problem of rising inflation] requires reversing many elements of the liberalisation resorted to in recent years.

That pretty much sums it up. He sees the post-1991 liberalization agenda as the source of all evil. No surprises there - anyone who has read his writings earlier is well-aware that he and Jayati Ghosh have long been virulent opponents and have been rewarded for that very reason as distinguished advisors to the Achuthanandan government in Kerala (even the WB government does not see much merit in taking their advice anymore).

To put it in a nutshell, his central argument is to revert to the old ways - a government monopoly over foodgrain purchase and supply. The FCI ought to maintain a huge stock of grain bought at a price fixed by the government and use that to supply it to supply at a subsidized rate to an expanded market that includes the middle class (unlike the current system where it is pretty much limited to the BPL segment). The idea is that this will shield both growers and consumers from the vagaries of the marketplace. I highlight here a few of the problems with this approach.

The current system is that the government allows farmers to sell their produce in the open market, i.e. to exporters and other buyers, and the FCI competes with them to purchase the same. That way, the farmers get a price determined by market competition rather than a government-fixed one. That is however a double edged sword - in good times, that can mean a better price but in bad times, it can also be worse. The trade-off is that if the commodity price falls in the market, farmers would also end up taking a hit. The FCI however exercises some degree of control over the price by virtue of being a large-scale buyer: it can buy or release grain in sufficient amounts to alleviate the impact of market forces. However, unlike in the past, the more limited PDS requirements nowadays means that the FCI no longer utilizes the huge stocks that it used to have in the past. So its stocks have diminished to some extent - Chandrasekhar says it has come down from 16.8 and 14.8 million tonnes recorded in 2003-04 and 2004-05 to 11.1 million tonnes in 2006-07. He and the Left have been making two main allegations: one is that this reduced size of its stocks has correspondingly reduced its ability to buffer prices. The government seems to have accepted this on its merits - Sharad Pawar announced yesterday that the government was planning to import foodgrains to prevent any shortfall. But Chandrasekhar is against that as well. He says:

Advocates of liberalisation would argue that this should not be a problem since the government can use the currently abundant foreign exchange reserves to import food and augment domestic supply. But the impact of such measures on producers would be damaging. Imports supplied to the domestic market at low prices (sometimes using subsidies), displace domestic production and worsen food security. The task is not to displace domestic production, but strengthen it so as to enhance food security. If not India would be a chronic victim of fluctuations and shocks in global markets.

I am unable to make much sense of this. He says that supplying imported foodgrains will lower domestic prices and hurt domestic producers. But when prices are high (meaning disproportionately high compared to the prices of other commodities), it means the domestic producers are already getting a good deal at the expense of the consumer, so why should bringing down prices to an acceptable level be unreasonable especially if one expects the government to bail out the very same producers when the situation is reversed and they find themselves in distress? In his view, the only viable solution is for the government to remain a captive market for domestic producers - that way, they get a fixed price for their produce and market fluctuations will remain solely the government's headache. The trouble with this strategy is that it rewards the uncompetitive domestic producer at the expense of the government. Farmers will be free to grow whatever they want and the government will be bound to buy the stuff at a good price no matter whether it sells in the market or simply ends up rotting in the FCI godowns. In other words, for any ensuing demand-supply mismatch, the government is expected to take the hit.

The other problem that he correctly recognizes is the close relationship between domestic and international prices.

Finally, liberalisation has meant that domestic prices tend to align with international prices not just in the case of products where part of supply is imported, but also in those where part of domestic production is exported. This is what has been happening in the case of commodities like iron and steel and other metals, in whose case international prices have been soaring because of increased demand especially from China. Indian firms participating in this international boom through rising exports at soaring prices are obviously adjusting or manipulating domestic prices upwards. This has forced the government not only to control the rise in prices but restrict exports.

Divorcing domestic from international prices is something the government already did for many years in the pre-1991 period. In fact, it is still doing that with many products. The trouble with that is that when it is done to shield the populace from price rise, the difference is borne by the government (one claim is that if the government is buying locally exclusively, it does not matter what the international price is; unfortunately, every product requires raw materials many of which are not available locally. When the cost of those materials goes up, the price of the finished product gets tied to international prices as well. To keep it low, the government will have to lower it artificially and internalize the difference). And when that disparity grows large, the subsidy burgeons turning into a major and unproductive expenditure that has the potential to wreck the economy. That was precisely what happened to the Soviet Union. Prices were kept artificially low through heavy subsidies paid for with oil revenues. When world oil prices collapsed in the early 1980s, the revenues fell forcing the government to confront a difficult predicament - either to open up the economy or simply raise prices without political reform forcing an unprepared public to pay more with their limited incomes for the same products. Does the Left want to repeat the same mistakes again?

He also talks of how falling rural expenditure has kept productivity from rising. Yet, while no leftist economist fails to mention the hurting rural economy and how it is the small and marginal farmers who have suffered the most, they leave out the other side of the story. In developed countries, 5-10% of the population is engaged in agriculture whereas the last time I read, the number was 68% in India and a significant number of those have small land holdings and not enough margin to sustain the vagaries of the marketplace. Why is it that we have so many small and marginal farmers? Answer: Land reform. By dividing up large land holdings and distributing fragments to the poor who in turn each divide it up amongst their many children, the state has directly set up this disaster. Like small companies which are the first ones to shut shop during recession, it is the small farmers who are forced to beg, borrow and commit suicide or sell their land and migrate when they cannot meet their obligations. More rural investment may be a good idea to keep rural economies afloat and mitigate the burden cities face from large scale migration but a reckoning with reality will compel one to conclude that rural economies, as they exist currently, are unsustainable. The long-term solution must therefore remain more of the same: The economies of scale that are necessary for increased production can only come into being through land consolidation and therefore, the state's priority ought to be to expand urban (not rural) infrastructure to accomodate the increased rural efflux and in the short term, to invest just enough in rural areas so as to mitigate, not prevent, this migration to bring it down to sustainable levels. This has indeed been the consistent direction that successive governments have taken (though the tilt was more pronounced during the NDA's rule) and to some extent, has stayed that way even during the UPA's tenure much to the chagrin of the Left.

As he correctly recognizes, protecting one part of the economy from liberalization is difficult when the rest of it is being subjected to the same process given that prices especially cannot be bracketed easily commodity-wise. To be sure, this is a difficult issue with different strata of society requiring different levels of state intervention. By pushing the government too far however, the Left risks driving the state into bankruptcy once again. That is exactly what they did in the past and what has left their views discredited to a significant extent ever since. To give in to more of the same and expect a different result this time is more than stupidity; in an increasingly integrated and interdependent world where India has come to acquire a significant stake, it is suicidal.