Liquidate labour, liquidate stocks, liquidate farmers, liquidate real estate…it will purge the rottenness out of the system .

– US Treasury Secretary, Andrew W. Mellon, during the Great Depression

The current slowdown in the Indian economy goes back to July 2011. That was when investments started drying up, captured by the negative-to-low growth rates in the index of industrial production (IIP) for ‘capital goods’.

The slowdown is more recent if viewed through the lens of consumption; it is only after July 2012 that income and job losses from flagging investments began to show up in the IIP for ‘consumer durables’ as well.

But slowdowns aren’t just about investment or consumption goods . They are also about people — capitalists, workers and farmers. The anatomy of the present downturn is, hence, worth examining from the perspective of its main dramatis personae .

A good starting point could be the Annual Survey of Industries (ASI), the most comprehensive source of industrial statistics extending to all factories employing ten or more workers (20 if these don’t use power). The last ASI for 2010-11 covered as many as 2.13 lakh establishments.


The accompanying graph maps the share of profits and wages in the ex-factory output value of ASI units between 1994-95 and 2010-11. Wages here refer to total emoluments inclusive of all expenditures, direct or in-kind, incurred on employees.

The graph shows profits going up every year between 2001-02 and 2007-08, from a low of 3.6 per cent of output value to a high of 10.7 per cent. But this share has registered a secular decline since then, touching 8.3 per cent in 2010-11. We have no ASI data thereafter, but the profit ratio is likely to have dipped even more in 2011-12 and 2012-13.

One indication of it is the Reserve Bank of India’s (RBI) latest Performance of Private Corporate Business Sector report, based on data relating to 3,000-odd listed non-financial companies (see RBI Bulletin , October 2013).

The average net profit margin for these firms has fallen from 9.4 per cent in 2009-10 to 9, 6.4 and 5.9 per cent in the following three years, after scaling a peak of 11 per cent in 2007-08. This more or less conforms to the pattern from the ASI numbers.

Profits and investment

The above shares are significant for their strong correlation with investment activity. Capital spending decisions of capitalists are influenced by profit expectations. These are, in turn, a function of actually recorded profit rates. As profits go up, so do investments, usually with a lag.

Thus, while profit shares rose from 2002-03, private corporate sector investments really picked up only in 2004-05, crossing 10 per cent of GDP for the first time and soaring further to over 17.3 per cent by 2007-08.

The process works in the reverse when margins are under squeeze.

The ratio of private corporate capital formation to GDP plunged to 11.3 per cent in 2008-09, though this may have been more an outcome of the global economic meltdown specific to that year. The corporate investment rate, in fact, recovered to 12.1 per cent and 13.4 per cent in the following two years. The actual fall — to 10 per cent and below — took place only from 2011-12, matching our hypothesis about the lagged response of investments to recorded profit rates.

All this also adds up to a general theory of the business cycle. To the extent growth in output and employment are dependent on investment activity that is ultimately determined by profit rates, the ebbs and flows of the business cycle are also closely tied to the latter.

This ‘theory’ can explain how the preceding investment boom from 1994-95 to 1997-98 ended as profit shares in output declined and when that became obvious to businessmen. The next boom took off only in 2004-05 when they clearly saw profits rising again.

And at that point, their animal spirits simply took over.

We are now at a stage of the business cycle where the profit squeeze that corporates truly started feeling from 2011-12 — reflected in their capex programmes — is still continuing. But the unusual thing this time is that it hasn’t percolated to wages.

According to the ASI data, total emoluments have actually increased marginally as a percentage of factory output after hitting a low in 2006-07. The ratio of staff cost to sales for the RBI sample companies has, likewise, gone up from 7 to 7.3 per cent between 2010-11 and 2012-13.

The last downturn, by comparison, saw the share of both profits and wages decline almost simultaneously. Moreover, the latter’s fall, as the graph suggests, did not stop even after the former’s recovery.

The fact that there has been no wage squeeze corresponding to the shrinking margins experienced by firms — at least till 2012-13 — makes the current slowdown different from the earlier ones.

The reason for it has to do with food prices. High food inflation — averaging 9.9 per cent annually from 2005-06 to 2012-13, as against only 3.9 per cent in the preceding eight years — have made wages sticky and less amenable to downward adjustment even in a slowdown.

This phenomenon is also linked to the general improvement in the terms of trade for the farm sector, which, as I have argued elsewhere, has been a distinct feature of the nine years under the United Progressive Alliance dispensation (“Hardly a muqabla ”, Business Line , July 21, 2013).

The previous slowdown during 1998-2004, in marked contrast, coincided with a period of severe agricultural distress and depressed crop prices. The situation was, therefore, conducive for wages to make the requisite downward adjustments to set the stage for the subsequent recovery.

Tightening the screws

Today, double-digit food inflation means forcing down wages isn’t all that easy for employers.

They are, then, increasingly resorting to the only option of shutting down factories. As layoffs grow and the chances of reemployment recede, workers are bound to accept wage cuts at some point. The RBI’s current monetary tightening — unprecedented during a time of slowdown — will only further aid this process.

We are possibly already witnessing the beginnings of a wage squeeze in real terms. Growth in real rural wages has, indeed, moderated to 2.2 per cent in August, while there is anecdotal evidence of modest salary hikes happening across sectors.

If 2011-12 and 2012-13 were the years of profit squeeze, the current fiscal and the one following it could turn out the same for wages and, may be, for crop prices as well.

Only when capitalists are convinced that profits are firmly headed upwards and the squeeze is truly over will we see them once again putting shovels in the ground.