A CERTAIN VIEW OF HISTORY, beloved by the Victorians and the Edwardians, made much of the significance of particular dates—history by the numbers, with a few years remembered for their momentous events (and always for just one) while all the others are relegated to obscurity. Unsurprisingly, this sort of list-making still flourishes in our schools, where one might be forgiven for thinking that nothing of note happened in India between, say, 1707 (“Death of Aurangzeb”) and 1757 (“Battle of Plassey”). Along similar lines, for modern Indian schoolchildren, the year 1974 figures as an “important date” because of the nuclear “device” detonated at the insistence of that Bangladesh-liberating, Pakistan-splitting only-man-in-the-cabinet, Indira Gandhi.
But 1974 was noteworthy for another reason, and one that children are unlikely to be memorising: through the entire year, the country’s inflation rate was never lower than 20 percent. September 1974, in fact, was a “record month”: inflation as measured by the wholesale price index touched 33.3 percent. (In other words, prices were a full one-third higher than a year earlier.) Perhaps it should come as no surprise that Mrs Gandhi, never less than shrewd, chose that particular year—when the average Indian was earning essentially the same pitiful amount as he had done a year earlier (as was typical in those years of anaemic growth) while paying at least 20 percent more for his meagre purchases—to set off a bomb and whip up the jingoist fervour so beloved of embattled politicians.
If this was the gambit, it seems to have worked, because one rarely hears talk of the fact that 1974 marked the worst inflationary episode in the history of independent India—even worse, though only slightly, than the only comparable period, between 1979 and 1981, when wholesale price index inflation remained in the double digits, often above 15 percent, for more than two years. Looking back today, in the midst of another sustained period of high inflation that began in mid-2010 and has continued for roughly the past 18 months, one sees both similarities and contrasts: as in 1974, the present spell of inflation has taken place against the backdrop of a global spike in crude and commodity prices and a period of economic weakness in the developed world. But in many other ways, today’s crisis looks very different from the one an earlier Mrs Gandhi had faced: inflation has peaked at around 11 percent and mostly remained in the high single-digits, which would have represented a trough in either earlier cycle. At the same time, the average Indian now sees his or her purchasing power double roughly in a decade; under the growth rates that prevailed between 1965 and 1979, doubling per capita GDP would have taken a century.
Judging from the exasperation seen in the press at the government’s failure to rein in inflation—invariably accompanied by the fear that high inflation will irretrievably damage the “India growth story”—Indians are clearly agitated about inflation. And there are perfectly good reasons to worry. While the current bout of inflation is far less severe than those India has experienced in the past, several troubling aspects stand out: first, that it came in the wake of a period of broadly low and stable inflation, with a quick spike and a very slow return to “normal” levels; second, that while overall inflation hasn’t touched the heights seen in earlier such episodes, it has remained steadily high in large part due to more drastic spikes in food prices—which also means that this wave of inflation has disproportionately hurt the poor. Food inflation has begun to moderate in recent weeks, as one might expect after a reasonable monsoon. Yet this is hardly cause for comfort. Indeed, the very fact that food prices ebb and flow so sharply with the seasons points to serious structural problems that underlie the way Indian inflation behaves.
But the fact that there are indeed real reasons to be concerned has not prevented opposition politicians and answer-demanding opinion writers from failing to ask the right questions. Part of the problem is that many among the political class are fixated on the inflation rate itself rather than its movements; on a single data point—the current rate—rather than on whether inflation is slowing or accelerating. According to this worldview—or so it would seem—the ideal rate of inflation would be negative, or at least zero: it’s hard to draw any other conclusion from repeated expressions of outrage over “rising prices”.
Yet while modern macroeconomic theory is reasonably convinced that inflation should remain stable, it offers little guidance as to what that stable rate should be (except that it should not be negative or zero). Most inflation-obsessed central banks in developed countries aim to keep inflation in a band between two and three percent, but that is as much the result of convention as anything else. This is why Olivier Blanchard, the chief economist of the International Monetary Fund—and possibly one of the world’s leading macroeconomists—has mused aloud about whether it is time to revise these targets upwards, so that four or five percent inflation might be considered the new norm.
At the moment, most emerging economies are experiencing higher than normal rates of inflation: China, Indonesia, Russia, Turkey, Brazil, Egypt and South Africa are all likely to have annual inflation rates in excess of five percent this year. The reason, at least in part, is that the present global economic situation is leading money to flow into these countries—all of which have high growth prospects and higher interest rates—from the developed world, where growth is generally sluggish and interest rates are at historic lows. The resulting pressure on inflation and exchange rates in these developing-world economies is essentially inevitable. If headline inflation in the UK—which normally aims at inflation around two percent—is currently at five percent, is it reasonable to expect that the rate in India should be the same, given the global economic scenario sketched above?
The other preoccupation of the commentariat, which is that high inflation is killing growth, turns out to be equally facile. There is, in fact, almost no evidence that moderately high inflation leads to lower GDP growth, in spite of the common argument to the contrary. One of the best studies on this subject, by Michael Bruno and William Easterly, opened with a now-classic line: “Is inflation harmful to growth? The ratio of fervent beliefs to tangible evidence seems unusually high on this topic.” The economists’ findings, which have stood the test of time, were quite clear: as long as inflation does not reach what they classify as “very high” levels—in excess of about 40 percent—there is no effect on long-run growth. Countries manage remarkably well with an inflation rate that is higher—at least within an order of magnitude—than the one to which they are accustomed. On the other hand, while repeatedly raising interest rates in an economy like India’s may do little to reduce inflation, it will certainly hurt growth.
So the real problem in India is not inflation per se: it is that inflation has always been seen as the disease rather than the symptom of some deeper malaise. The underlying problem, in this case, is that India is chronically supply-constrained: there is little spare capacity, which means that inflationary pressures become exaggerated during shifts in either direction in the economic cycle. This explains why inflation has been unusually high in 2011, but also why the country essentially went into a deflationary phase in 2009 when growth began to slow. Such swings are far from ideal, but tackling them is a long-term process that requires making the economy suppler by investing in better supply chains, transportation networks, and reforming markets for labour and other inputs so that supply can better respond to changes in demand without leading to dramatic price swings.
The fact that the wildest gyrations are seen in food prices points us towards a particularly pervasive problem: our food production and distribution system is an even bigger mess than the rest of our economy. It can’t even cope with predictable seasonal price shocks, let alone unpredictable events like spikes in fertiliser and fuel prices. It is possible, of course, to iron out some of these inefficiencies over time. But doing so will require our political class to countenance the uncomfortable notion of a retail sector that is not entirely the preserve of small, unorganised traders. In the US, the best estimates suggest that the ruthless efficiency of the big retail chains (read Walmart) and their ability to source goods from the cheapest places around the world have played a key role in keeping inflation in check.
As discussed above, keeping inflation low is not necessarily an end in itself. But politicians who are raising a ruckus over “rising prices” need to decide whether they really care about the price of food or only about making noise about it in Parliament. There are ways to move India onto a lower, less volatile path of inflation, and particularly food inflation. But it will not be accomplished by theatrics about the price of whiskey or the plight of vegetable vendors.