There has been an fairly sharp increase in food price inflation in the India in the last one year. The politicians are busy trying to strengthen the public distribution system to bring the food price inflation under control. It would be a miraculous if that has any impact on the food prices.
To hone in on the source of the inflation, it would be useful to examine the issue that affects the supply and the demand for food. Even though the urban(e) India seems to be sceptical about NREGA, it is potentially a radical change as far as the poorer half of India, geographically concentrated in rural parts, is concerned.
Guaranteeing 100 days of labour for everyone raises the reservation wage (the best alternative) and thus should impact the rural or agricultural labour market. Faced with higher labour costs, the land-owning farmers may either reduce or change the pattern of food production across the country. It is too early to pin down the new pattern of food production in the country. Though, this could be a potential supply shock for the food market in the country, pushing up the prices.
On the demand side, we know that the food elasticity of income is very high for the poorest of the poor. We also know that the very poor tend to derive their calorific intake from staples like cereals or lentils. As income increases, they diversify their intake and move towards the nutrient rich foods like vegetable, milk and meats.
NREGA’s affect on the demand side is two folds. It increases the labour endowment of the poor unskilled workers. It also reduces the income uncertainty for the poor by giving them a steady predictable employment for 100 days in a year. Given the high income elasticity of food, we would expect this to increase the demand for food across the country.
Food demand could also be impacted by the 6th Pay Commission — the body that determines the salaries of the all the central and state government employees in India. The 6th Pay Commission, like its predecessor, has been extremely generous. These generous payoff to hitherto relatively impoverished government employees has been financed by a ballooning budget deficit.
Inflation being confined to mainly food is unusual and the high income elasticity of food for the poor maybe useful in providing an explanation for this phenomenon. Would be interesting to see how this pans out. What is certain is that with the price rise, the relative prices for staples and cash crops has changed dramatically and would lead to radical changes in crop pattern across the country in years to come. Interesting times.
Howard Davies has been a regulator (as the head of FSA) as well as a central banker (Deputy Governor of Bank of England) in the last decade. I went hesitantly, bracing myself for the kind of mind numbing defence of their respective roles we have seen from the likes of Greenspan and Bernanke off late. What I instead encountered was a really pleasant mannered man, who took a fairly comprehensive look at the past decade.