Ashima Goyal

The nail that lost the kingdom

ASHIMA GOYAL | Updated on March 12, 2018

When vegetable prices rise, governments fall. — S. Siva Saravanan

Food inflation may have toppled many a state government. But this price rise cannot be blamed on rising rural wages.

India has had unrelenting food price inflation since 2007.

The Government neglected the problem initially: Perhaps, inflation was seen as politically tolerable because rising incomes and various welfare/income transfer schemes for the poor were thought to be protection enough.

But the recent major electoral reverses suffered by the main ruling party suggest that the above protection was inadequate. Food inflation could well be the nail for which the Kingdom was lost — as in the nursery fable where a horseshoe came off because of a loose nail, and because of which the horse tripped, the King fell….


One should place the Government’s inaction against the context of the policies that it regarded as political winners, but were themselves responsible for creating food inflation.

Thus, its moves to enact a nationwide food security legislation turned the Government into the nation’s biggest hoarder of foodgrains. Likewise, it resisted releasing the stranglehold of middlemen on agricultural mandis not only because these intermediaries enjoyed huge political clout, but also the fact that helped the Government’s procurement operations.

Besides, the Government’s many social programmes pumped money into rural areas. But since these patronage-based credit and other flows were designed to leak, they boosted consumption rather than adding to production and boosting overall productivity.

The growth in incomes, including from Government consumption spending, led to diversification of diets.

But at the same time, increased support prices for grains prevented corresponding diversification of cropping patterns. The supply response was inadequate, both quantitatively and qualitatively also because of the same middlemen, who soaked in most of the high prices consumers paid.

The above counter-adjustments, perhaps unanticipated, translated into near-zero public welfare benefits from the policies of the Government.


Food price volatility and the resultant rise in wages from it has also been an important factor in the Reserve Bank of India’s moves to tighten monetary policy.

Unlike temporary supply-side shocks that can be overlooked, persistent and steep food inflation tends to push up wages, creating second-round effects that raise prices again through a vicious spiral.

The RBI did take note of the perceptible rise in wages initially. But rather than food inflation, the central bank was more inclined to blame government spending and programmes such as MGNREGA for the wage-price spiral that it saw developing.

There is an opposite view, often articulated by the World Bank, that relative prices do not affect aggregate prices — provided there is no excess demand. The Bank’s early work actually showed real wages in India to fall during inflationary episodes.

But there is also research that highlights the role of the labour market structure in determining the second-round effects of prices on wages. These are typically higher in countries where the share of food in the consumption basket is large.

This is true in India, especially for subsistence wages. Such wages always adjusted to food price inflation, albeit with a lag.

But the post-2007 period was peculiar. Rural real wages that were earlier flat now showed a substantial rise. Nominal wage growth not merely caught up with, but far exceeded inflation.


A State-level dataset for wages of unskilled rural labourers from 2007 makes it possible to use regression analysis for identifying the key drivers of real wage increases over this period.

As per this, wholesale food inflation and the fiscal deficits were the two variables whose contributions to higher wages were consistently high and significant — the first one’s three times more than the second one’s.

The MGNREGA dummy variable’s impact was actually negative, meaning that it was overall Government spending rather than that for a single scheme that drove up wages.

At the same time, based on reverse regressions, the effect of wages on rural inflation was low even while positive.

Cyclical and monetary policy variables had an even lower impact on rural inflation, while the contribution of fiscal deficits was statistically not significant. Lagged rural CPI had the largest coefficient showing persistence.

These results suggests that it is the special circumstances (after 2007-08) of very large Government consumption spending, and repeated food price peaks, that has driven the unusually sharp rise in real wages in recent times.

However, since the impact of rural wages on food prices wasn’t so significant, it would point to some rise in farm productivity. It also, then, rules out a wage-price spiral.

Instead, our analysis suggests it was a series of multiple supply shocks that really impacted food prices—starting with the global food price surge of 2007, monsoon failures in 2009, and episodes of sharp rupee depreciation in 2008, 2011, and 2013.

The above multiple shocks raised social norms of what was the ‘fair’ subsistence wage to compensate for food price jumps. The ambitious programmes that the Government undertook, aimed at transferring spending power, would also have contributed to raising these norms. These programmes were initially funded by the high growth and revenues accruing to the Government from it, and subsequently the post-crisis fiscal stimulus.


In other words, the unprecedented real wage increase since 2007 may have been a one-time phenomenon, linked to high growth, Government spending, and food price spikes that had the cumulative effect of raising the norms for ‘fair wages’.

Contrary to what many believe, we may not really be caught in a permanent wage-price spiral, despite the Government’s decision to index MGNREGA wages to inflation. While indexation may prevent inflationary expectations from adjusting downwards, a rise in real wages can be accommodated without inflation if there is accompanying rise in productivity.

Food inflation, nevertheless, remains a critical concern. While real rural wage growth came down to 2 per cent in August, it may have gone up thereafter with vegetable prices once again driving up food inflation.

The Government needs to act on removing the impediments that prevent free movement of farm produce, marketing monopolies and power generation bottlenecks militating against creation of cold storage infrastructure, along with reducing unproductive transfers and spending for containing fiscal deficits.

Onions are a staple in Indian diets; whenever their prices have shot up, the anger of the electorate has brought down governments. A cartoon in 1998 pictured Amartya Sen, who had just been awarded the Economics Nobel, talking on the phone: `Yes Minister, thank you Minister, no, I do not have a theory to bring down the price of onions'.

Economists here have for long been suggesting dismantling of intermediaries and allowing direct marketing of perishables.

As onion prices have once again contributed to electoral reversals of the main ruling party, the Government has finally got cracking on this.

(The author is Professor of Economics, Indira Gandhi Institute of Development Research, Mumbai.)

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Published on January 08, 2014
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