In a recent interview, Deputy Chairman of the Planning Commission, Montek Singh Ahluwalia (MSA), made certain observations on a few issues that lacked logic. His three prominent observations that are fundamentally flawed are as follows:
1. Inflation, or more accurately an increase in prices, is caused by economic growth (MSA quote: “as long as recession continues there’s no chance of oil going to $100 a barrel.”).
2. Government through NREG scheme can create ‘Work’/output (MSA quote - “NREGS… basically ensures that people who need work are assured of 100 days of employment per family annually at the minimum wage.”).
3. We will have to increase our consumption of fossil fuel for the next 20 years (MSA quote - “I don’t see any phasing out of coal plants in the next 20 years. The total use of coal in India would only increase.”).
In fact, the entire interview was an economic version of ‘Yes Minister.’ But since I have to limit my comments to some numbers, three seemed appropriate enough. Before I go on to explain why these observations are mistakes, it is probably worthwhile to point out the source of the observations. The readers can eliminate the usual suspects of misquoted, misrepresented, quoted out of context, etc. by reading the verbatim transcript of the complete interview at http://business.rediff.com/interview/2009/apr/30/interview-with-montek-singh-ahluwalia.htm.

Flaw 1: Inflation is caused by growth
Inflation is essentially a monetary phenomenon and the suggestion that Inflation is an acceptable trade-off for growth is one of the excuses that politicians use for transferring wealth from the citizens to themselves through the mechanism of inflation. Consider the historical evidence against what MSA is saying:
● For some 150 years before 1914 (that's before the world at large moved into the concept of Central Banking), the world as a whole witnessed one of the highest growth rates in conjunction with falling consumer prices - courtesy the Gold Standard.
● A more recent example discrediting MSA's pronouncements would be the stagflationary 1970s. During the entire 1970s, while the world suffered an extended recession, commodity prices sky-rocketed (Oil from $2 to $50/barrel, gold from $35 to $850/ounce, so on with other commodities such as agricultural products and metals joining the party).
● An easier proof, though somewhat misguiding, would be what happened subsequent to the end of 1970s inflation. During the 1980s and 1990s, probably the longest uninterrupted peace time of economic expansions witnessed in recent times, commodity prices fell during the entire two-decade period (oil from $50 to $10/barrel, gold from $850 to $250/ounce.)
● What is happening in Zimbabwe today ie. a condition of collapsing economy in conjunction with sky-rocketing consumer prices.
I certainly think it would be a good idea to send the RBI and the Planning Commission economists to ‘live’ a month in Zimbabwe before they start suggesting any policies to be implemented in our country. Not that Zimbabwe offers any great insight into basic economics, but since our bureaucrats refuse to learn either from the experience of others or through the teachings of Hazlitt or Mises, the only way out appears to be to force them to experience the outcomes of their policies.
Now for some theoretical explanations on why MSA’s pronouncement on inflation is ridiculous. The definition of inflation is “an increase in the supply of money and credit relative to the goods and services produced resulting in higher prices.” So it is nothing more than too much money chasing too few goods. Growth, by definition, is increased production and, if anything, growth leads to falling prices (exactly what we witnessed for a 150 years prior to 1914) and not increasing prices as MSA suggests.
For those wondering as to why commodity prices have fallen in the current recession which makes MSA’s claims appear seemingly correct, the answer lies in the phenomenon known as ‘Money Velocity.’ This is a temporary one-time effect unrelated to the fundamentals of the long-term inflationary pressures building up within the system. A symptom of this drop in money velocity is the formation of the biggest bond bubble in history – especially in the US treasury market and to a limited extent in bonds all over the world. When this bond bubble bursts, commodity prices will skyrocket – whether the world is growing or is in a recession will be immaterial. That said, I am also certain that the US is going to be in a depression for the next decade anyway (refer “The Coming Greater Depression” and “The $787 Billion Stimulation of the Depression” in my blog).

Flaw 2: NREGS creates work
On a literal interpretation of this statement, MSA is probably correct. But we need a better definition of ‘work’ before discrediting the claims - Can digging holes and filling them up be considered as ‘Work?’ Most certainly ‘Not.’
We do not need ‘work’ for the sake of ‘work’ - What we need is an effective utilisation of the factors of production (labour, resources and capital) and that can only be done by an entrepreneur who does so in search of a profit by providing goods and services purchased voluntarily in the free market by consumers.
Who are the consumers of the output of NREGS? The work is practically worthless and even if MSA is to argue that free markets cannot take care of infrastructure issues such as canals and check dams (a perfectly disprovable claim as much as his assertions on inflation are), building the same using labour instead of capital equipment is no more than following the footsteps of Mulayam Singh Yadav who has promised to curb the usage of computers to create more employment. The economic truism that MSA ignores as much as Mulayam does is that it is not employment that counts, but production.
More insidious effects are much less written about. In diverting scarce labour resources (not to mention capital) towards worthless projects, productive agriculture suffers on account of a scarcity of labour at acceptable wages. So NREGS ends up destroying production by spending capital and labour. If agriculture has grown over the last one year at a faster clip, it is despite NREGS and not because of NREGS. A more pertinent reason as to why agriculture has grown is because of the increase in price of agricultural commodities attracting more investments to this sector.

Flaw 3: Increase in fossil fuels consumption
MSA thinks we will be increasing our consumption of fossil fuels for at least the next 20 years. The earth has a limited supply of these resources and we are probably at or possibly even beyond ‘Peak Fossil Fuels’ - if not at the levels of total quantity, at least on a net-BTU basis. Readers interested in understanding this further can look into http://kinghubbert.blogspot.com
The problem is that the Planning Commission predicates their entire projections on the claims made by International Energy Agency (IEA). Despite verifiable expert testimonials and the irrefutable historical track-record that IEA numbers/projections are plainly absurd, our Planning Commission continues to blindly accept the same. In fact, our entire Integrated Energy Policy authored by the Planning Commission is based on these assumptions. The only way the report can contribute some energy to our country is by converting all remaining copies of that report into heat energy by burning them - at least a fraction of the money spent can be recovered by doing this.
What is even more amazing is that while the annual IEA reports till 2007 presented a rosy projection of the fossil fuel supplies in the future, their 2008 report was a stark contrast. This is the beginning of the “Annual Confession Reports of IEA,” where they admitted that their projections could well be very wrong. Now despite IEA’s own admission, our Planning Commission refuses to come to terms with reality.

What does this mean for us?
We have concentrated decision making in the hands of individuals and organizations that do not understand the basics, refuse to learn at a pace that is required for the country and operate within the confines of a system that lacks an effective feedback mechanism. I accept that they learn, albeit very slowly. After almost 40+ years of misguided faith in socialism, we have definitely made great strides in becoming a market-oriented economy.
What is the solution that I propose? Abolish the Planning Commission. The very concept that we need a central planning body is an anachronism in a society that is moving towards a market economy. As soon as they are liberated from their comfort zone, I am sure these intrinsically bright people would contribute in a productive way to the development of our nation.