Sunday, September 30, 2012

Corruption - Inflation & The Great Economic Malaise

This article of mine is published in Hindu Business Line on Oct 1, 2012. Link:

“When you see that in order to produce, you need to obtain permission from men who produce nothing -- when you see money flowing to those who deal, not in goods, but in favours -- when you see that men get richer by graft and pull than by work, and your laws don’t protect you against them, but protect them against you, then you may know that your society is doomed.” ~ Ayn Rand
These words foresight-fully surmise the root cause for most of the ills that have plagued our nation for the last 65 years. Notwithstanding the breath of fresh air brought about by the loosening of bureaucratic shackles as a result of the economic liberalisation, India finds itself at the bottom of the pile on various socio-economic indicators.  What’s worse is that not just have we been unable to catch up with the western nations but have fallen behind even when compared to many of our Asian & South American peers.

The only way for the living standard of millions in this country to improve is by increasing the availability of various goods and services in the economy (defined by GDP growth) and ensuring that these increased resources are not held by just a few people. Often inflation is defined as money losing its purchasing power, the fact is that this is the most innocuous form of inflation for e.g. 10% inflation in this case would mean a 10% increase in money supply distributed equally within the population while at the same time the supply of goods & services remain the same. The most damning from of inflation is when the same 10% increase in money supply goes to a handful of people and thus the living standard of almost the entire population shrinks by 10%; unfettered graft in the society is the main reason behind any prolonged inflation of this kind which leads to a large number of people in abject pecuniary even as the economy might clock a decent GDP growth for a few years.

It is important to understand how as a result of the unfettered graft this phenomenon of wealth transfer has been playing out in this country.
To start, a sectoral breakup of our economy reveals its fault lines. The output/per capita of agriculture (which sustains majority of our workforce) as a percentage of overall GDP has been declining over the years or in other words people working in this sector are increasingly finding it difficult to access resources produced in other sectors of the economy.
Considering that in a normal course it’s difficult for this sector to show high growth, the prognosis for the Indian economy looks simple; move the excess workforce into manufacturing and allied industries. With so much people employed, the supply of goods would increase and with it the living standards of a large population. The reason why this beautiful sculpture has never taken any shape is because the key to increase production dramatically is by improving the productivity of labour which happens only by using technology and capital goods/machinery. A developing nation like India can either hope to create them indigenously but that would mean slow growth rates or import these from abroad.
However corruption leads to a gross misallocation of capital which in turn implies that a lot of capital held by a few, goes into consumption especially of luxury goods, real estate, stocks etc. So while there is an actual need to import machinery and capital goods to boost supply instead funds are squandered on consumption related and other imports. As can be seen from the graph, India’s import of capital goods and other manufactures products as a percentage of total merchandise goods has been consistently lowest when compared to other developing peers.

Hence due to a lack of infusion of manufacture goods there is a natural dearth of supply of essential goods and services thus leading to an increase in their prices and hence depriving a large part of the population from access to these goods and thus lowering their living standards.
A decreasing supply (growth) in the face of a given credit growth leads to a consistent depreciation of the exchange rate thus making the import of capital goods further difficult and contributing to further increase in prices. Perhaps an apt example for this is the recent increase in the prices of diesel and LPG cylinders soon after "Coalgate" came into light. But for a depreciating rupee, the cost of petroleum products was much lower from their all time high (in USD). Had the mines been auctioned, the revenue from these auctions could have been used to reduce the outstanding debt of the GOI, a reduced non-productive government credit and thus money supply would have led to some appreciation in exchange rate and thus reducing the subsidies on petroleum products automatically negating the need for the price rise. People who would have bought the coal mines would have been largely for genuine business and would have started the production rather than holding onto them for trading profits and the country at large would have received increased supply of goods and lower levels of inflation, of course the mine owners and some investors would have seen lesser equity appreciation i.e. a transfer of wealth would have happened from a few to the masses.
Instead today as this episode has shown that because of graft the income is being transferred to a handful of individuals from the masses, partly reflected in the higher equity prices (see graph).

The good thing about this country is that people have the right to choose their own destiny. So as this nation fast approaches another election; if the Indian masses and it's diaspora want to see a better future for their children and not the ignominy that this nation has faced for more than half a century, they must keep in mind that this unfettered graft is not just a social evil but the root cause of the economic malaise prevalent in this country and the response that is needed is something similar to what happened when elections were held after emergency which instilled the fear of God among the political classes so as to not fiddle in that area again.


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