Economic thinking like habits die hard, rather refuses to die. Inflation in India has been there in India ever since I took my first lessons in Economics nearly 46 years ago in the higher secondary school.
It does not require economists to understand that inflation is bad for most citizens for most of the time (some times for some citizens it may be good, eg., with my salary being linked to inflation during the 1970s, I used to look forward to high inflation because my expenditure pattern was less sensitive to inflation than my income was and less sensitive to inflation compared to many others(maybe I had also sufferred from money illusion) or for example, recently sugar mill companies saw a four fold rise in their profits.
But every citizen is an inflation expert. Almost everyone has the same set of recommendations: government must fix prices of essential commodities and distribute them from fair price shops ( in our childhood days the emphasis was on raiding the traders who were also turned hoarders and on rationing), stop export of essential goods ( India of course have very little of such exports), import from abroad (this prescription is rather a recemt phenomenon after India has moved a little towards globalization: in our childhood days imports were considered as against the great virtue of self-reliance), call strikes and bandhs against the government's inability to curb inflation and so on. Unfortunately, the text books say that to curb inflation in an excess demand situation, one needs to cut demand by reducing disposable incomes in the hands of the people by raising taxes and reducing government expenditure. It is never clear to many students of economics why economics textbooks were so harsh to recommend reducing dispoable incomes by raising income taxes, reducing subsidies and increasing taxes on the production or sales of commodities. Why raise the price of commodities by levying highers taxes when the prices are already going up? Why reduce disposable income of people when they are already unable to make both ends meet. A veteran graduate of Delhi School of Economics and now a prominent communist party leader therefore has said that Finance Minister Pranab Mukherjee's Indian Union Budget announcement to increase the levy on motor spirit and diesel oil will increase inflation especially through the cascading effect. I understand that a rise in tax levies on these fuels will increase prices of commodities and services which consume these fuels for their production and transportation to reach the consumers. But leftist economists generally have difficulty in understanding economic theories developed in the Western countries, except of the Marxian variety. They are not analytically strong enough to differentiate between a one shot price rise (which is not inflation) and a sustained process of rising prices (that is what inflation is). With such economics education it is hardly surprising, no communist country has been able to solve the problem of inflation so far without making goods disappear from the government controlled shops and long queues at their ration shops. It is only more dangerous to India that such politicians claim to be economic experts and promote themselves as economics experts to the common people.
Pranab Mukherjee, the old, one-time economics college professor, Finance Minister followed the textbook prescription on the one hand by raising indirect taxes on these fuels and some services and followed them up on the other hand with his contra-textbook proposals to reduce income taxes in order to put into the hands of the people more disposable income so that could buy the goods and services at higher prices.
Economics is not what is written in the textbooks but what the politicians say and do!
Some clever chap in the media has worked out that a person earning Rs 8lakhs or more will get a savings of Rs 60, 000 while the higher petrol and diesel prices will mean a higher expenditure of Rs40,000 or so - the person however cleverly forget to mention that the large number of tax payers below the income level of Rs1.6 lakhs per year will receive no tax benefit, nor will those who are near or below the poverty line: presumably, he thinks that people below the poverty line will find their wage rtes increasing as the Governmenmt steps up rural development expenditure and spending under National Rural Employment Guarantee Scheme. This may in turn raise the money ncome of all those who are below the minimum taxable income, except for the low pension income retires who were not lucky enough to have worked in the Government tht pays high pensions with periodic adjustments for inflation. Good. Incomes would rise to compensate for inflation in expenditure.
The Delhi School Economics graduate communist leader was probably not so clever or quatitative enough to figure this out before giving his comment to be carried by the Press for the consumption of the poor citizens. Finance Minister however had calculated upfront the inflationary impact of his budget announcements and proposals at 0.41%. The communist leader may not have known that such simple calculations normally are done without the help of a pen, writing paper or calculator or computer.
Economics textbooks prescribe what governments are not to do to avoid inflation. If those prescriptions are not followed and inflation rate becomes high as a result, economics textbooks say that governments stop doing what they should have not done in the first place and urge citizens to tighten their belts till supply increases to match demand.
As in my childhood days, even now both educated and uneducated brains failed to figure out that governments are the basic cause of inflation in a country like ours. Foolish politicians fight their battles to ensure that demand increases more than the supply does. Inflation comes down as people have no alternative ultimately but to tighten their belts and as supplies manage to increase with a time lag: governments only take credit for inflation going down.
If citizens have to live with large government budgets, people have to live with inflation. There is no escape. Countries which had experienced long periods of low inflation are countries with citizens who could during those periods force their politicians to stay away from the profligacy of big and grwoing spending, borrowing, deficit financing and taxing operations.
Treat the irresponsible patient first instead of allowing the patient to create havoc in the hospital, if you want to live comfortably. Politicians need to be taught the lessons again and again as they are irresponsible mentally-disadvanaged patients.
Saturday, February 27, 2010
Friday, February 26, 2010
Pranab Mukherjee Sets Example as A Policy Economist
The Union Budget presented on February 26 helps a better appreciation of the competence and skill of the Indian Finance Minister, Pranab Mukherjee. He has proved that he is indeed capable of utlising himself most effectively to the cause of the nation as the most experienced politician and minister in the country with diversified exposure. His maturity, skill and insights lead him to tread the course of the possible , to allow youthful, exuberant opposition within his party or coalition government to correct government action further time to understand the writings on the wall and to let the stale head-count, vociferous opposition to waste more of their energy in criticising him in ways that would sooner or later make them irrelevant to the common public. He puts more money in the hands of taxpayers to pay higher prices of food and higher taxes on fuel should they want to consume more fuel in preference to other iotems of consumption and chose to add 20,000 more savings.
The economy has been largely growing, not because of what Government does but inspite of what politicians and governments do. He has learnt this lesson and therefore carefully avoided doing things that could spoil the economy's tempo of growth. Rather, he has allocated more money for infrastructure, education and rural development to facilitate private sector economic activities that result in economic growth.
He knows that governments can do very little to control inflation and left it to market forces to augment supply or shift supply curve rightwards with the little help he could provide through tax sops and allocation to agriculture. So long as the growth momentum is sustained by the economy, it contributes to his fiscal consolidation objective. This is the first budget in Indian history that is consistent with an economy that really depends on and utilises market mechanism whereever it is appropriate. He has successfully unlearnt the old practice of strong-arm God-playing Government role that he had to practice when he first became a finance minister decades back. He promises to be out of Government when the tenure of the current Lok Shabha ends. Hopefully, younger politicians across parties learn the wisdom of accepting the power of the market forces with humility and restrain themselves from fighting the market forces with economic terrorism through use of unlimited State power - an addiction that almost all politicians in India enjoy from the extreme right to the extreme left. Pranab Mukherjee has set examples for the ardent advocates and activists of both economic reforms and State command economy: 'do not hurry with missionary zeal to impose the Truth you have realised by using all of the powers you derive from being a part of the State/ Government or from being a leader of the people - tolerate petulant behaviour of others and give them more and more time to recognise their foolishness'.
The economy has been largely growing, not because of what Government does but inspite of what politicians and governments do. He has learnt this lesson and therefore carefully avoided doing things that could spoil the economy's tempo of growth. Rather, he has allocated more money for infrastructure, education and rural development to facilitate private sector economic activities that result in economic growth.
He knows that governments can do very little to control inflation and left it to market forces to augment supply or shift supply curve rightwards with the little help he could provide through tax sops and allocation to agriculture. So long as the growth momentum is sustained by the economy, it contributes to his fiscal consolidation objective. This is the first budget in Indian history that is consistent with an economy that really depends on and utilises market mechanism whereever it is appropriate. He has successfully unlearnt the old practice of strong-arm God-playing Government role that he had to practice when he first became a finance minister decades back. He promises to be out of Government when the tenure of the current Lok Shabha ends. Hopefully, younger politicians across parties learn the wisdom of accepting the power of the market forces with humility and restrain themselves from fighting the market forces with economic terrorism through use of unlimited State power - an addiction that almost all politicians in India enjoy from the extreme right to the extreme left. Pranab Mukherjee has set examples for the ardent advocates and activists of both economic reforms and State command economy: 'do not hurry with missionary zeal to impose the Truth you have realised by using all of the powers you derive from being a part of the State/ Government or from being a leader of the people - tolerate petulant behaviour of others and give them more and more time to recognise their foolishness'.
Saturday, February 20, 2010
Wonderland Economy03: InternationalTrade
What did the Wonderland citizens do in the fourth year? An interesting event took place in the beginning of the year. One morning, Econ and Wonder while taking bath in the sea noticed a boat sailing at a distance and were thrilled. They waved their colored clothes to attract the attention of the people in the boat, hoping that they would rescue Econ family to their mainland home. Fortunately, the people in the boat noticed Econ and Wonder and turned their boat towards their island. Unfortunately, a man and a women came down from the boat after anchoring it near the beach and it turned out that this couple was in the same situation as Econ family: they had also lost themselves in the sea storm and currently living in another uninhabitated land a few nughtical miles away. Both families were please to meet each other and had lunch together. The visitors mentioned that they had named their island as Greatland and they were living on daily diet of only roasted chicken as there were planty of such birds available in that land. Since they had no fruit-bearing trees in Greatland, they could not eat fruits.
They showed interest in exchangung some chicken for fruits of wonderland. Both the families entered in to an agreement to trade. W-land would supply fruits to G-land and G-land would supply chicken every month. G-land would use their boats to bring chicken and ferry back fruits. The G-land citizens calculated that they could in a year have 2000 surplus chickens that could supply to W-land. However W-land citizens calculated and said that they could not consumed more than 1000 chickens a year. The G-land said they would like to have 3000 fruits from W-land. But Econ did some calculations and said they could offer only 2000 fruits a tear. The G-land couple pointed out that since they only have a boat, the chicket and fruits can only be transported by them and in the process they would lose their productive time. Econ then proposed that they would give 400 fruits to G-land for the boat transport service (12 times a year of boat trnsport for moving chicken and fruit). They then entered in to a trade agreement valid for one year.
At the end of the year, Econ recoded the accounts of the economy for the year. Since they gathered 6500 fruits during the year, GDP=X=6500. The couple and their child consumed 4500 fruits, besides 1000 imported chickens equavent to 2000 Fruits. They also purchased 400 fruits worth of imported transportation services from G-land. So, their consumption was C=4500+2000+400 =6,900. Ekon was surprised as to how they could Consume more than their income Y? He checked the fruit stocks. The stocks had declined from 2500 to 2100. Thus, change in capital stock over the year amounted to dK= -400. This meant I= -400. This meant they had negative Saving (drawing down of past accumulated savings. So, S=-400. He also noted that there were two new items to be accounted for: Exports (X) and Imports (I)Now he checked that total income and expenditure matched. 6500= Y= C+I+X-M=6900- 400 + 2400 -2500=6500. He also noted that exports and imports exactly matched.
Now, he thought about growth. In the previous year there was a growth in GDP because their productivity of fruit collection increase due to capital investment on storage and ladder and plucking sticks. But this year their saving and Investment became negative. So, how could the GDP increase? The GDP increased because this year their labor effort increased as both the husband and wife could work for more time as they were not sick or pregnant. So he concluded that Y increases if Investments increased and productivity increased or labor effort increased. But trade increase their Y? He noted while Y increased due to exports, there was an equivalent decline in Y due to imports.
What if X was greater than M? (X-M) would be positive and hence would have increased Y. But if domestic output did not increase, Y could not have increased nor would X increase.
He started wondering about how to increae Y further. Wonder came up with an idea. She said that she could reduce some chicken consumption and use part of the imported live chicks to raise more chicks from their eggs. The next year they did just that. What happened next?
They showed interest in exchangung some chicken for fruits of wonderland. Both the families entered in to an agreement to trade. W-land would supply fruits to G-land and G-land would supply chicken every month. G-land would use their boats to bring chicken and ferry back fruits. The G-land citizens calculated that they could in a year have 2000 surplus chickens that could supply to W-land. However W-land citizens calculated and said that they could not consumed more than 1000 chickens a year. The G-land said they would like to have 3000 fruits from W-land. But Econ did some calculations and said they could offer only 2000 fruits a tear. The G-land couple pointed out that since they only have a boat, the chicket and fruits can only be transported by them and in the process they would lose their productive time. Econ then proposed that they would give 400 fruits to G-land for the boat transport service (12 times a year of boat trnsport for moving chicken and fruit). They then entered in to a trade agreement valid for one year.
At the end of the year, Econ recoded the accounts of the economy for the year. Since they gathered 6500 fruits during the year, GDP=X=6500. The couple and their child consumed 4500 fruits, besides 1000 imported chickens equavent to 2000 Fruits. They also purchased 400 fruits worth of imported transportation services from G-land. So, their consumption was C=4500+2000+400 =6,900. Ekon was surprised as to how they could Consume more than their income Y? He checked the fruit stocks. The stocks had declined from 2500 to 2100. Thus, change in capital stock over the year amounted to dK= -400. This meant I= -400. This meant they had negative Saving (drawing down of past accumulated savings. So, S=-400. He also noted that there were two new items to be accounted for: Exports (X) and Imports (I)Now he checked that total income and expenditure matched. 6500= Y= C+I+X-M=6900- 400 + 2400 -2500=6500. He also noted that exports and imports exactly matched.
Now, he thought about growth. In the previous year there was a growth in GDP because their productivity of fruit collection increase due to capital investment on storage and ladder and plucking sticks. But this year their saving and Investment became negative. So, how could the GDP increase? The GDP increased because this year their labor effort increased as both the husband and wife could work for more time as they were not sick or pregnant. So he concluded that Y increases if Investments increased and productivity increased or labor effort increased. But trade increase their Y? He noted while Y increased due to exports, there was an equivalent decline in Y due to imports.
What if X was greater than M? (X-M) would be positive and hence would have increased Y. But if domestic output did not increase, Y could not have increased nor would X increase.
He started wondering about how to increae Y further. Wonder came up with an idea. She said that she could reduce some chicken consumption and use part of the imported live chicks to raise more chicks from their eggs. The next year they did just that. What happened next?
Thursday, February 18, 2010
Wonderland Economy 02: Growth
In the third year, Econ and Wonder did not spend time collecting fruit for the first 45 days. They survived by eating the Fruits in the stock and put their hard labor in building a thatched hut with three rooms: one for storing fruits and the other two for their living and working. They also made two thin but stout long wooden sticks and two ladders made from branches of trees that would enable them to collect more fruits. The stock of apples therefore got converted into physical assets: house, working place and a storage. All these are durable assets for productive use or consumption over longer periods than one year.
Since both worked together with equal effort, they received income of F250 each during this period. Their past savings first got converted into stocks of friuts for future use and then into some physical capital assets.
With the production of capital assests, their productivity and production increased. Together they collected during the third year 6,000 fruits. Since Wonder had to deliver and look after a baby, her contribution was 2500 and Econ's F3,500. But they had also produced physical capital assets worth F500. So, what was Nation Income or GDP? Y= F6,500. What was the income distribution? Ekon earned F3750 and Wonder F2750. What did the citizens do with the income. They consumed 4,000 fruits. So, C=F4000. Therefore Savings S= F2500. They invested all their savings into investments by just increasing the capital stock from F500 to F3000 (Physical Capital of F500 and fruit stock of F2500). So Investment in the third year was F2,500. This is exactly equal to the increase in capital stock from F500 to F3000. They checked their calculations and Found that GDP=Y=C+S= C+I, I=dK and S=I. In the third year, third citizen was born: the baby was named Wondeful Economist the First or WE1 for short.
How did the economy grew? Y in the first year was F4000, in the second year F3000 and in the third year F6500. So, the economy grew by a negative 25% in the second year (i.e., declined or shrinked by a fourth from the first year's level) and increased by 116.7 % in the third year. With capital stock, productivity and production increased considerably.
Since both worked together with equal effort, they received income of F250 each during this period. Their past savings first got converted into stocks of friuts for future use and then into some physical capital assets.
With the production of capital assests, their productivity and production increased. Together they collected during the third year 6,000 fruits. Since Wonder had to deliver and look after a baby, her contribution was 2500 and Econ's F3,500. But they had also produced physical capital assets worth F500. So, what was Nation Income or GDP? Y= F6,500. What was the income distribution? Ekon earned F3750 and Wonder F2750. What did the citizens do with the income. They consumed 4,000 fruits. So, C=F4000. Therefore Savings S= F2500. They invested all their savings into investments by just increasing the capital stock from F500 to F3000 (Physical Capital of F500 and fruit stock of F2500). So Investment in the third year was F2,500. This is exactly equal to the increase in capital stock from F500 to F3000. They checked their calculations and Found that GDP=Y=C+S= C+I, I=dK and S=I. In the third year, third citizen was born: the baby was named Wondeful Economist the First or WE1 for short.
How did the economy grew? Y in the first year was F4000, in the second year F3000 and in the third year F6500. So, the economy grew by a negative 25% in the second year (i.e., declined or shrinked by a fourth from the first year's level) and increased by 116.7 % in the third year. With capital stock, productivity and production increased considerably.
Wonderland Economy 01: Income & Expenditure
Econ married Wonder and set of on sail for Honeymoon in the sea in their small boat. They wre unfortunate and faced a storm. The boat capsized anf after hours of swimming they found themselves in an unhabitated island. Since there was no way of going back home, they decided to settle down in the island that Econ named Wonderland after his beloved wife. There was nothing to eat on this island except fruits. They lived on fruits. Both of them plucked fruits. In the first year they plucked in all 4000 fruits. Econ told his wife that the Wonderland's economy had a National Income of F4000 where F stood for Wonderland Unit of money. They of course needed no currency nor money because there was no exchange to be made among the citizens of Wonderland yet. But Econ calculated that he himself gathered 2000 fruits, Wonder 1500 and the remain 500 fruits cam through joint efforts. So, Wonder said that his income was F2250 and Wonder's F1750. During the year they consumed all the fruits they had gathered. So, their National expenditure worked out to F4000.
In the second year, Econ fell sick in the initial three months and Wonder became pregnant and unable to work much in the last quarter of the year. Their fruit collection (effective production) during the year was: Econ 1300 and Wonder 1300 and jountly 400.Thus Gross Domestic Product or GDP was F3000 (Fruits that were not collected, eaten or stored but remained on the trees were not really effective production and therefore not counted}.The output produced had to be distributed in some manner as income: distribution was Econ F1500 and Wonder F1500. Thus, they reckoned the National Income as Y=F3000. More fair distribution of income came about this year due to sickness and pregnancy. This year however, they consumed only 2500 fruits because of sickness or loss of appetitie due to sickness, pregnancy and their decision to save for the rainny day. So, Natiional Saving was S=F500 and National Consumption Expenditure was C=F2,500. Since Wonder ate 1200 fruits, her consumption expenditure was F1200 and Econ's F1300. Naturally Econ saved less: his saving was F200 and Wonder's saving F300. Wonder became wealthier than Econ. But the entire National Income had to be spent. Consumption expenditure was C=2500. The rest was saved meaning not consumed. They called this as Investment (I) expenditure which resulted in an inventory or stock or capital for use later. Earlier there was no capital stock. But because of Saving and Investment expenditure, there is an increase in Capital from K=0 to K=F500. Thus Investment was nothing but increase in Capital ssstock. They wrote in symbol: dK=I, where d denoted change and hence dK was change in capital stock.
What happened in the next year? They used this capital stock to productive use by building up an asset. We also note thatonly hard labor effort by the husband and wife resulted in GDP or National Income as also consumption, Saving and Capital formation or Investment. Everything happened because of labor effort of the two citizens of the country. Income was distributed as per the contribution or productivity of the two citizens of Wonderland. Capitalism, Socialism or Communism have not come to confuse the citizens. Nor has Government come to tax away the income of the citizens. This would continue for some time. Things wou;d get progressively complicated and cause philosophers to get confused and pick up the business of confusing other people.
We come to the thirrd year later. Just now we note that GDP = National Income=Y=C+S=C+I=Nationa Expenditure.
In the second year, Econ fell sick in the initial three months and Wonder became pregnant and unable to work much in the last quarter of the year. Their fruit collection (effective production) during the year was: Econ 1300 and Wonder 1300 and jountly 400.Thus Gross Domestic Product or GDP was F3000 (Fruits that were not collected, eaten or stored but remained on the trees were not really effective production and therefore not counted}.The output produced had to be distributed in some manner as income: distribution was Econ F1500 and Wonder F1500. Thus, they reckoned the National Income as Y=F3000. More fair distribution of income came about this year due to sickness and pregnancy. This year however, they consumed only 2500 fruits because of sickness or loss of appetitie due to sickness, pregnancy and their decision to save for the rainny day. So, Natiional Saving was S=F500 and National Consumption Expenditure was C=F2,500. Since Wonder ate 1200 fruits, her consumption expenditure was F1200 and Econ's F1300. Naturally Econ saved less: his saving was F200 and Wonder's saving F300. Wonder became wealthier than Econ. But the entire National Income had to be spent. Consumption expenditure was C=2500. The rest was saved meaning not consumed. They called this as Investment (I) expenditure which resulted in an inventory or stock or capital for use later. Earlier there was no capital stock. But because of Saving and Investment expenditure, there is an increase in Capital from K=0 to K=F500. Thus Investment was nothing but increase in Capital ssstock. They wrote in symbol: dK=I, where d denoted change and hence dK was change in capital stock.
What happened in the next year? They used this capital stock to productive use by building up an asset. We also note thatonly hard labor effort by the husband and wife resulted in GDP or National Income as also consumption, Saving and Capital formation or Investment. Everything happened because of labor effort of the two citizens of the country. Income was distributed as per the contribution or productivity of the two citizens of Wonderland. Capitalism, Socialism or Communism have not come to confuse the citizens. Nor has Government come to tax away the income of the citizens. This would continue for some time. Things wou;d get progressively complicated and cause philosophers to get confused and pick up the business of confusing other people.
We come to the thirrd year later. Just now we note that GDP = National Income=Y=C+S=C+I=Nationa Expenditure.
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