India is already stuck in a vicious cycle of unemployment and price rise, both of which are major hindrances in the way of growth. To end this cycle, experts have to first give India’s inflation tendencies its individual merit and carve a way forward, writes Tripti Sangwan
The Indian economy is facing a twin problem of inflation and alarming unemployment rates. According to William Phillips and John M Keynes, there exists an inverse relationship between these two. However, history has shown that there can be a direct relation between them as well.
This has happened during the decades of 1971-1991, when the US economy was facing supply shocks in terms of increased oil prices, which resulted in the increase in cost of production, leading to a decline in the output, employment and increase in the price level.
Thus, it is not wrong to say that the relation between the rates of inflation and unemployment is dependent upon the type of inflation existing in the economy or the policy-makers wants to adopt to reduce the unemployment rates. If there is demand-pull inflation and economy is producing below full employment level, it will increase the output level and in turn the employment level accompanied with an increase in the price level.
On the other hand, due to cost-push inflation, the aggregate supply will reduce, accompanied by increasing unemployment and price level. Thus, there is an inverse relationship between inflation and unemployment rates, in the case of demand-pull inflation, and positive relation if there is cost-push inflation.
Therefore, in order to understand the type of relationship between the two in India, it is important to first scrutinise the nature of inflation existing in India. Twelve million people enter India’s workforce every year, this accompanied by increase in imported capital goods; both quantity and price.
Further, an increase in the number of unskilled labour force leads to increasing marginal costs. These factors combine together and lead to cost-push inflation.
Along with it, due to a manifold increase in population, there is a hike in the aggregate demand which should increase the price level but reduce unemployment rate.
But this excess demand is accompanied with shortage of capital, and leads to further increase in the price level and wipe out the excess demand. Hence, the positive impact of the demand-pull inflation is crowded out due to cost-push inflation. Thus, India is grappling with the high rates of unemployment and inflation.
Even if India accepts a higher inflation rate, it will not be able to reduce the unemployment rates in the current scenario.
It should be taken as a wake-up call to first encounter the factors leading to cost-push inflation, so that excess demand can lead to increase in the output and reduction in unemployment rate.
Thereafter, the focus should be on the reduction of demand-pull inflation after achieving the full employment level of output.
(The writer is Assistant Professor, Delhi University, and a PhD scholar of Economics)