After losing their jobs to covid and closing their small businesses due to demonetization and GST, now the common man is hit by the third whammy of price rise. Standard economics tells us that if jobs are less and the people are earning less; this will lead to less demand in the market which, in turn, will lead to lowering of price just as the price of potato in the street corner market falls when there are no customers to be seen. However, in the present times we are finding that the people do not have purchasing power yet, contrary to the principles of economics, the price of goods in the market is increasing.
There are two reasons for this price increase. First and foremost, while the people have lost their jobs and businesses; the government expenditures have continued to rise. Government officials are being provided with SUVs and grandiose construction and projects like the Central Vista are being made. Government servants are being paid increased salaries and DA. Therefore, the reduction in demand from the people is more than cancelled by the increase in the demand from Government consumption. The reduction of demand from the people of Rs 100 is coming along with increase in Government consumption of Rs 120. The result is that the total demand in the market is increasing and this is leading price rise. Thus, Gita Gopinath, the Chief Economist of International Monetary Fund has said that increase in government borrowing leads to inflation. The Government borrows money from the market to buy SUVs. The commercial banks like Bank of Baroda buy Government Bonds to provide these loans to the Government. The Reserve Bank provides easy loans at low rates of interest to the banks to enable them buy bonds issued by the Government. The banks may borrow from the Reserve Bank at a rate of interest of 4% and buy bonds issued by the Government at the interest rate of 7%. The banks make a cool profit of 3% without making any effort whatsoever; and the Government gets as much loan as it wants without any difficulty. The people suffer, however.
The easy loans provided by the Reserve Bank to the commercial banks are used by the commercial banks to buy the Government Bond, and then used by the Government to buy SUVs. Economists have been in agreement that in situations such as the COVID pandemic, the policy of Government borrowing-and-spending is justified. However, the consequences of this borrowing has to be borne irrespective of whether it is justified or not—just the burden of repayment of a loan taken by the family for paying for education of its daughter will fall on the family irrespective of the entirely justified use of the borrowed money. Thus, the Government consumption is leading to increase in the prices.
The second factor leading to increase in prices is that of environment. We have seen a large number of natural calamities in the recent past such as floods and droughts occurring in different parts of the country at the same time. The reason is global warming which, though a global phenomenon, is yet accentuated by our local contribution to environmental destruction. For example we are cutting forests to make highways through them. This leads to lesser capture of carbon dioxide and also loss wildlife. We are making dams on rivers to abstract water for irrigation or for making hydropower. This leads to prevention of migration of fishes. The fishes begin to die. This leads to deterioration of water quality. The water that could be easily cleaned by the fishes is now cleaned through sewage treatment plants. We are seeing localized environmental problems due to these local policies of environmental destruction. For example, floods are reported to have led to lower production of tomatoes and consequent increase in the price in the market.
The Government should reduce its own consumption in order to prevent the price rise. We have mentioned above that a reduction of demand from the people of Rs 100 is coming along with increase in Government consumption of Rs 120. This needs to be reversed. The reduction of demand from the Government of Rs 100 should be secured along with an increase in people’s consumption of Rs 100. The total demand will remain unchanged and the prices will become stable. At the same time welfare of the people will be secured—which is the objective of the Government. The increase in Government consumption hits the welfare of the people in yet another way. The Government demand is mostly fulfilled by large companies. For example, the making of highways requires purchase of goods from large equipment manufacturers and steel mills.
Part of this demand actually goes to the foreign countries, for example, in the imports of large construction equipment. This leads to lesser production in the country and lesser economic and growth and lesser jobs for the people. Therefore, the Government should reduce its expenditures and transfer more money to the people. The same money, if spent by the street hawker will be used to buy items like paper and cloth and this will lead to increase of local production. Welfare of the people will be secured without inviting price rise. The second impact of reduction of Government consumption is that it will create confidence in the people that the economy will be on the growth path and they will be willing to spend their incomes. Let us recall that in 1960s, when the country was facing a drought, Prime Minister Lal bahadur Shastri had given a call that every citizen of the country should observe fast for one day. He followed this himself. The entire country stood behind Shastri. This led to reduced consumption of food grains. Similarly, if the Government wants the people to start consuming instead of savings, then the Government will have to instill a sense of confidence among them that the economy will look up. This cannot happen while the government is taking loans to provide SUVs to its officers. Secondly, the Government should give more attention to conservation of environment such as by discouraging the use of private cars and encouraging the use of public transport; and by protecting our rivers and forests. This will lead to less localized environmental damage and help contain the price rise.
(The author is formerly Professor of Economics at IIM Bengaluru)