UPA has stoked demand and inflation; the next govt has to fix the supply side

If the Right is rising today in the avatar of the BJP, it is partly because the country intuitively realises that the Leftward redistributive tilt under the Congress-led UPA may have gone too far.

India’s polity seems to react dialectically to the challenge of change. When the country tilts too much towards reform and growth, the electorate shifts Leftwards and seeks more redistributive policies. If it goes in the other direction, the voter instinctively shifts Rightwards.

Consider recent history. After the 1991 reforms restored growth, the electorate shifted to a combo of regional and Left parties. After this centre-right combo failed to deliver, we got a Rightward-leaning BJP-led NDA for six years. In 2004, even when the economy was reviving, the electorate shifted Leftwards again and elected the UPA.

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Now that the UPA’s excesses have corroded the wheels of growth and slowed the economy down, the voter is receptive to calls from the Right. The UPA was re-elected in 2009 because the growth binge was not over, and the negative effects of redistributive policies were as yet unclear. Now they are crystal clear. And whether you are a beneficiary of the UPA’s largesse or not, you can see the damage it has done.

That’s the political economy part, but economically speaking, what the country needs is a corrective towards supply-side economics - which means deregulation, reform and pro-business, market-friendly policies that will let entrepreneurship flower without any cronyism creeping in.

The UPA did the opposite. Its redistributive policies stoked cronyism and corruption as everyone - rich and poor - turned up at the feeding trough. UPA’s policies boosted demand without creating the supply-side revolution necessary to address this demand. This is why we have both slowdown and inflation - stagflation of sorts.

One of the side-effects of endlessly legislating rights and entitlements is that it creates demand by putting money in the hands of more people. Socially it may be just what the doctor ordered, but without balancing this expanded entitlement programme with supply-side reforms, the economic engine will keel over. This is what happened and this is why UPA may be losing the next elections.

Consider what it did with its policies, especially during UPA-2.

First, oil prices were kept at hugely below-market levels. This boosted demand for cheap petro-fuels, but supplies stayed constricted as the oil marketing companies went into losses and the oil producing companies (ONGC, Oil India) saw no incentive to raise production when margins were low. Reliance Industries, the other oil and gas giant, saw its gas supplies falling and exported almost its entire refinery output. India didn’t benefit from UPA’s subsidies.

Second, with subsidies eating up tax revenues, the government had little left over to invest in capital outlays and infrastructure. These are exactly the areas that drive private capital investment and increased supplies. Infrastructure is now the biggest crimp in India’s supply chain. Unpaid subsidy bills on fertiliser have retarded capacity creation in fertiliser, which could affect future agricultural output, or prompt increased imports.

Third, the UPA’s make-work schemes (NREGA) ensured a spike in rural wages without commensurate improvements in rural infrastructure. These costly boondoggles put money in the hands of rural folks and reduced poverty - this is one achievement UPA can truly claim credit for - but they have created demand for non-cereal proteins and fed food inflation. They have also boosted farm mechanisation as labour costs soared, thus reducing the normal job-generating capacity in rural areas. On the plus side, increased rural incomes created opportunities and demand for consumer products, but in the absence of fresh capacity creation, inflation is now endemic. Wages are chasing prices in an upward spiral.

Fourth, the most recent UPA legislations will clog up supply even more. If industry has to grow, land must be available at fair prices. But the Land Bill will artificially boost land prices by two times in urban areas and four times in rural areas, apart from imposing other costs (rehabilitation of those uprooted, etc) on infrastructure and manufacturing projects. In short, land supply will be artificially constrained by legislation.

As TN Ninan notes in Business Standard, land prices had already risen four- or five-fold over the last decade, and “significant stretches of rural India now have land prices that are higher than those in any rural area of the United States, and in almost all of Europe barring countries like Holland.” Now, if the prices to be paid are four times over and above an already established four-fold increase - that is, a 16-fold rise over the last decade - which infrastructure project will be viable? UPA has poured sand in the wheels of development.

Fifth, not just land, the other UPA laws will also build demand and constrain supply. The food security bill will make cereals so cheap that the money saved will boost demand for protein foods, where the inflation - already bad - will worsen. When milk, pulses, vegetable and meat production call for huge increases in farm productivity and herd sizes, how will food inflation ever come down? Food security will cause protein insecurity.

Sixth, even social legislation like the Right to Education (RTE) will drive demand without increasing the supply. The RTE mandates private schools, which account for about 10 percent of the education system, to take in lots of new students when 90 percent of schools are in the state sector - and deteriorating in quality. Can the problem with poor quality in 90 percent of the schools be solved by shifting the burden to the 10 percent that is relatively better? Will education quality improve or deteriorate with this expansion of demand for private education, when the state sector cops out?

The UPA boosted demand without making it easier to increase supply in almost all sectors. The next government needs to be a committed supply-sider. This means a reformist, deregulating, market-oriented, pro-business government. We need small government, which focuses on removing the hurdles to boosting production and growth.

No prizes for guessing who might do a better job in this area.