The Hindu Business Line : Lifting productivity, the third tool

Economists operate with just two tools — the monetary, or interest rates, and the fiscal, or taxes and subsidies. Increasing productivity is the third alternative for which there is not the same enthusiasm, says P.V. INDIRESAN.

As expected, the Reserve Bank of India has raised interest rates once again. Interest rate regulation is like a thunder shower — it does not discriminate; it pours on the sinful as much as on the sinless with equal ferocity. Monetary economists accept the resultant loss as unavoidable collateral damage. That is more cynical than logical.

In addition to interest rate increase, the Bank has artificially kept the value of the rupee low. That helps exporters. On the other hand, if the rupee had been allowed to float upwards (as it would have done naturally), we would have paid less for oil imports and thereby reduced the oil subsidy and the resultant inflation.

Dilemma of policymakers

The conflict is between increasing IT exports and cheaper oil imports. That is the dilemma for which our policy makers have to find a solution. So far, they have bet on our exporters who constitute a powerful political lobby all the time and shown less concern about consumers who are important only at election time. No doubt, they have bought some peace with voters by increasing oil subsidy but the fact remains that oil prices have increased faster than exports.

India (and several other countries too) have been faulted on another ground. As The New York Times explains:

From Mexico to India to China, governments fearful of inflation and street protests are heavily subsidising energy prices — estimated at $40 billion this year in China alone — are also removing much of the incentive to conserve fuel. . . countries with subsidies accounted for 96 per cent of the world’s increase in oil use last year — growth that has helped drive prices to record levels.

In most countries that do not subsidise fuel, high prices have caused oil demand to stagnate or fall, as economic theory says they should. But in countries with subsidies, demand is still rising steeply, threatening to outstrip the growth in global supplies.

In other words, by not allowing oil prices to rise in tune with import prices, we are consuming more oil and enriching countries such as Saudi Arabia.

We should appreciate the dilemma of the government: If it keeps interest rates high, it incurs the wrath of business and of middle-class borrowers; if it keeps interest rates low, it incurs the risk of continuing inflation.

If it lets oil prices float, it incurs the wrath of consumers; if it subsidises them, it loses wealth permanently. It has tried to appease consumers a little by raising subsidies and appease business barons a little by suppressing the value of the rupee. This policy pleases no one; makes everyone unhappy.

Inflation is visible but growth is invisible. Few people really realise how high the growth rate is unless that is dinned into their ears, but price increase they can recognise immediately. To make matters worse, in the coming months, India will face increasing inflationary pressures for four reasons:

In order to gain popularity during the impending elections, the government is bound to increase populist but not proportionately productive schemes such as National Rural Employment Guarantee Act (NREGA).

The election itself will bring out huge amounts of black money into circulation. That money is unproductive and produces no new goods to match.

In order to collect the black money for fighting elections, the government will let accommodating businessmen create more black money. So, they will offer less value for the prices they charge.

The Government has so far been silent about Pay Commission recommendations to raise salaries of government employees. As elections approach, they will have to concede substantial pay rises — pay more money for the same work (if any) being done.

In this environment, raising interest rates is like washing your dirty linen in a coal bin: Politics will pour in muck much faster than the Bank can take out.

Economists operate with just two tools — (a) the monetary or interest rates and (b) the fiscal or taxes and subsidies. Increasing productivity is the third alternative for which there is not the same enthusiasm.

Admittedly, interest rates can be changed by the stroke of the pen and so can taxes and subsidies be introduced. They are both not only powerful tools but also instantaneous.

In contrast, productivity increase cannot be bought off the shelf from any store; it takes a lot of time to evolve, which does not at all suit politicians who are in a hurry and cannot think beyond the next (bye) election.

Tool to increase productivity

Nevertheless, it is worth taking a look at the possibility of increasing productivity more or less instantaneously. That can be achieved by shifting the direction of development from costly locations to cheap ones — for instance, from costly metros to rural areas.

Land in a metro can cost as much as Rs 1,00,000 a square yard — the price of land barely 30-50 km away will be a hundred or even a thousand times less. It is not logical to invest hard earned money where costs are so high to the neglect of other areas where costs are so much less. Apologists will argue that only large cities have all the services businesses need; they will add that skilled employees will be found only in large cities. They are wrong.

A businessman who wants to set up a factory to manufacture sugar or paper or cement or steel will not try for space in Mumbai, but will happily locate his business in the middle of nowhere. He will find all the services he needs as well as a complete range of skilled employees in the middle of a forest or a desert. In truth, the mad rush to expensive cities is more a fad than a necessity. Businesses make these excuses because they do not pay for the negative externalities they create.

Suppose the government rules that employers will be penalised whenever their employees are forced to reside in slums. Suppose further, employers are bound to treat the time employees take to commute to work as working time. Then, how many businesses will opt to locate in expensive cities?

Most of the expansion that is taking place in expensive cities is in the service sector. In this age of telecommunications and teleconferences, distance is no handicap. In fact, several years ago, Professor Prahlad advised Indian businessmen to concentrate on teleconferencing. His advice has not been taken. Rich countries are downsizing cities. We, who have ambitions of becoming rich, are not taking a lesson from them.

The moment Government decides to penalise extravagant locations, real-estate prices will tumble down. To that extent inflation too will come down. Truth to tell, no politician wants that to happen because real-estate is where politicians accumulate their hidden wealth.

Relocation of development to low cost rural areas is only one way of increasing rapidly the productivity of money. Cutting down waste, reducing administrative delays are other quick-fix solutions that can be quite effective because of their immediate psychological impact.

As for interest rates, the Bank would have done well to confine interest rate increase to expensive locations and to wasteful investment. Unfortunately, any such selection drifts into the political domain and there is no way the Bank can undo what electoral politic will do.

(Concluded)

(The author is a former Director of IIT Madras. Response may be sent to: indiresan@gmail.com)
(This is 231st in the Vision 2020 series. The previous article was published on July 21.)

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