For dual pricing of money

These days, corruption is hot news. Across the spectrum, virtually every political party, from the BJP, the BSP, the Congress, the DMK and the SP have been accused of wrongdoing. Yet, when a TV channel held a straw poll in the six metros, the top complaint was not corruption but price rise. Apparently, people accept politicians to be corrupt, but expect them to keep inflation in check.

As of now, discussions on inflation have been confined to esoteric debates among experts, but few people have asked the basic question: “How do we cure inflation?”

Ideally, inflation is cured when more money is invested to produce more goods (for the future) and less is consumed immediately. That introduces the element of time. More money should be consumed for long-term investment and less for current consumption.

Unfortunately, money is fungible. Probably for that reason, faced with inflation, central banks raise interest rates all round and make money more expensive. Then, they curb current expenditure — which is desirable — and simultaneously also curb long-term investment, which is undesirable.

That is the reason why inflation has remained unchecked in spite of repeated increases in interest rates. High cost of money reduces investment and curbs the availability of goods in the future. Thus, pressure on inflation remains because there are less goods on offer.

PRICING OF MONEY

In that case, we need a dual policy: Low cost of capital for long-term investment and high cost of capital for current consumption. In other words, banks should charge a high rate of interest for working capital only but keep interest rates for long-term loans low. Then, price of investment will be low and that of current consumption will be high.

Taking the analogy of electricity, money is like power but prices are like voltage. Electrical power can be delivered at any desired voltage — at low voltage for domestic consumption but at high voltage for high-power industrial consumption. We need a similar system in economics, too. Unfortunately, in economics, we have only money (which is power) to play with. Unlike in electricity, we do not have a simple system by which that money can be delivered at whatever price we desire.

However, dual pricing is not unknown. Then, why should we not have low-price money for investment and high-price money for current consumption? In other words, why should we not have low-interest rates for long-term loans and high rates of interest for working capital? That is not easy, but not impossible.

ACCOUNTING METHODS

A question will be raised that such a dual-price regime will lead to corruption — low-cost, long-term capital will be used for current consumption. The same complaint can be made about electric power, too. A businessman can transform low-cost high voltage power and use it to supply the same for domestic consumption. That may happen but can be checked.

Likewise, there are usable accounting methods that will distinguish between long-term investment and working capital for current consumption. In fact, that is the basic difference between business accounting and government accounting. In business, there is a strict isolation of assets and current expenditure. Unfortunately, the government makes no such distinction.

Therefore, I suggest that we utilise the business accounting system and fund loans for asset building at low interest rates, but charge high rates for working capital for salaries, advertisements, consumption of materials and the like. In that case, investment for future increases in production will grow fast but high prices for current consumption will curb such consumption; both ways inflation will be curbed.

ANOTHER KIND OF TAX

The government may also curb inflation by a fiscal rather than monetary technique – it may tax increases-in-income on top of income tax. Will people pay that tax or will they evade that, too? We may induce them to obey by a simple rule – allow the taxpayers to stipulate where that money should be spent. For instance, they may be given the freedom to contribute the tax amount for improving a school or a hospital, for better water/sanitation systems and maybe even for public transport.

The advantages are several. For a start, government's investment in social services is woefully low. That is why we remain a lowly 134 among around 180 nations in the Human Development Index — despite the fact that our GDP growth is very high and per capita income constitutes a third of the Human Development Index. We can also be reasonably certain that taxpayers will check that their money is well spent and quality of education and healthcare improves in the institutions they patronise.

Likewise, they will also check that water, sanitation and public transport improves. At the same time, the taxpayers' prestige will also go up — headmasters and doctors will be after them to induce them to make their contribution to their own institution. The government may not accept this kind of (partial) democracy but the Reserve Bank should have no problem with dual pricing of investment and working capital.

(The author is a former Director, IIT, Madras. Response to >indiresan@gmail.com and >blfeedback@thehindu.co.in )

This is 308th in the Vision 2020 series. The previous article appeared on July 16.

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