Inflation is lethal because of corruption

“ 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 pithily describe the root cause for most of the ills that have plagued our nation for the last 65 years.

The only way by which the living standard of millions in this country can 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 example, 10 per cent inflation in this case would mean a 10 per cent increase in money supply distributed equally within the population while, at the same time, the supply of goods and services remain the same. The most damning form of inflation is when the same 10 per cent increase in money supply goes to a handful of people, with the living standard of almost the entire population shrinking by 10 per cent.

Unfettered graft in society is the main reason for any prolonged inflation of the latter variety, which leads to a large number of people living in economic misery, even as the economy may clock a decent GDP growth for some 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.

CAPITAL GOODS IMPORT

The sectoral composition of our economy reveals its fault lines. The output per capita of agriculture (which sustains the majority of our workforce), as a percentage of overall GDP, has been declining over the years. 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 is 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 many people employed, the supply of goods would increase and, with it, the living standards of a large population. The reason why this ideal scenario has never taken shape is because the key to increasing production dramatically is improving the productivity of labour. This can happen 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 them.

However, corruption leads to 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, and so on.

So, while there is an actual need to import machinery and capital goods to boost supply, funds are instead squandered on consumption-related and other imports.

As can be seen from the graph, India’s import of capital goods and other manufactured products, as a percentage of total merchandise goods, has been very low when compared with peers from other developing countries.

Due to a lack of infusion of capital goods, there is a natural dearth of supply of essential goods and services, thus leading to an increase in their prices. This has deprived a large part of the population of access to these goods, lowering their living standards.

COALGATE AND ECONOMY

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 more 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 would have been much lower. Had the mines been auctioned, the revenue from these auctions could have been used to reduce the outstanding debt of the GOI.

Reduced non-productive government borrowings and, thus, money supply would have led to some appreciation in the exchange rate, reducing the subsidies on petroleum products, automatically negating the need for price rise.

Those who bought coal mines would have started production, rather than holding onto them for trading profits. The country would have benefited from increased supply of goods and lower levels of inflation.

Of course, mine owners and investors would have seen lesser equity appreciation in the absence of windfall profits. There would have effectively been a transfer of wealth from a few to the masses.

Instead, as a result of graft, income is transferred to a handful of individuals from the masses, partly reflected in higher equity prices (see graph).

Fortunately, the people of this country have the right to choose their own destiny. So as this nation fast approaches another election, the Indian masses should realise that this unfettered graft is not just a social evil, but the root cause of the two-pronged economic crisis of slowing growth and high inflation.

(The author is an independent financial consultant at Random Chalice Financial Research, Delhi. The views are personal.)

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