The third pillar of the economy, low-income consumption, is holding up remarkably well
Written by Neelkanth Mishra | April 12, 2013
(This article was published in the Indian Express: link)
The level of pessimism about the Indian economy continues to rise as the downturn enters its most vicious phase – that of contagion. Slowing investments hurt consumption and slowing consumption is now hurting investment demand. The short-lived spurt in business and investor sentiment after the government’s newfound resolve on economic reforms late last year has long petered out. “Currency crisis” and “meltdown” are phrases bandied about with increasing frequency,as the economy’s dependence on foreign capital flows reaches alarming levels.
Quite clearly, two of the three pillars of the Indian economy are weakening dramatically: investments and middle-income consumption. Most large pillars of investment, such as power, metals, railways, national highways, have weakened,and are unlikely to recover for several years. The middle classes, mostly urban, are under severe stress. For the first time in living memory, entry-level software engineers take home less cash than taxi drivers in Mumbai. For government and public sector employees, who constitute almost one-third of the urban middle class, the 150-200 per cent increase in compensation a few years back due to the Sixth Pay Commission is now history. Until the Seventh Pay Commission recommends another adjustment, unlikely before 2018, their pay hikes will lag inflation.
When both investment and consumption cycles start rolling over, conventional economic theory says the government must generate demand by increasing spending. Unfortunately, given the pro-cyclical acceleration in public spending over the past several years, fiscal deficits are already high, and the government’s hands are tied. No wonder the pundits fear the worst for India.
And yet, all is not lost. In what we call “the silent transformation” of India, the third pillar of the Indian economy, low-income consumption, is holding up remarkably well. In the last five years, wages at the bottom of the income pyramid have risen by levels unseen in several decades and most likely since Independence. This wage increase is well known: the rising costs of farm workers and even urban unskilled labour (particularly the newfound difficulty in holding on to domestic help) seem to be a common theme across India. What is not as well understood, though, is why this happened. This is important, if only to assess how sustainable this trend is likely to be.
Nobel Prize-winning psychologist Daniel Kahneman notes that people tend to think what they hear most often is most important. A classic example is the thinking that NREGA has been driving this wage growth. The initial fillip to minimum wages provided by NREGA may indeed have allowed unskilled landless workers to buy cellphones,which in turn increased their productivity, or to get the initial capital to start a grocery store. But our research suggests it cannot explain the wage growth of the last two to three years. Then what can?
The Credit Suisse research team conducted several field trips across the country and extensive secondary research earlier this year. We concluded that India is going through a once-in-a-lifetime-of-a-country transformation. The remarkable spread of rural roads (4,00,000 km built in the last 12 years), cellphones and electrification are changing lives in ways often hard to imagine for most middle-class city-dwellers: by creating local economies of scale.
This concept is so important that it warrants elaboration. As British author Matt Ridley observes in his book,The Rational Optimist, underlying the success of the human species is specialisation. Imagine sewing your own clothes, growing your own food and building your own house – one would probably be living on a tree wearing a loincloth, struggling to find food. There just wouldn’t be time enough to do anything well. The reason the species has succeeded is that each of us specialises in one activity (engineers build houses, farmers grow food, analysts analyse), and then we trade goods and services, which then benefit everyone.
The trouble is, you cannot trade efficiently without roads and phones. Large parts of India, especially in the erstwhile BIMARU states, lived in splendid self-sufficient isolation for centuries. Few left the village, there was very little trade, and even less awareness of the world outside. The spread of roads, phones and electricity (among several other changes brought about by state governments forced to act by a far more alert electorate) has, in a period of four to five years, shaken up the whole economy.
For example, during our trips we were amazed to find multiple grocery stores, even in villages in remote areas of Madhya Pradesh, Chhattisgarh and Bihar, stocking everything from packaged pickles to gulab jamun instant mix. People in villages have clearly moved beyond focusing on costs and purity (that’s the reason I still get pickle my mother makes) to optimising time and convenience. This is a good example of productivity improvement: instead of everyone mixing their own gulab jamun mix, a factory 100-150 km away does it more efficiently with a machine (and creates factory jobs), stockists (more jobs) store and distribute it to the village (jobs created for small truck drivers and khalaasis), and stores then sell it to the consumer (job for the store owner). The time freed up in the household is then used in other more productive activities like poultry farming or weaving.
In fact,the common chicken may have crossed the road to beat NREGA: poultry farming seems to have created more person days of work between 2005 and 2010 than NREGA. This is a classic example of a win-win: chicken is the cheapest source of meat protein,and also a source of jobs. In the past,the chicken-eater and the chicken-farmer could not meet (as the economy was limited to the village), but now they do. Result: more jobs and more cheap chicken.
This has fascinating implications for politics, society, and of course the economy. A senior and erudite investor recently sent us an article by Karl Marx written in 1853, which predicted a similar transformation of India driven by the spread of railways and telegraph. While the British did their bit, sadly, it seems to have taken our policymakers and rulers more than six decades to provide this basic infrastructure to people to help them pull themselves out of poverty. But now that they have, the silent transformation is on.