The crucial interlinking of class conflict and inflation
What causes inflation in an economy? There are many takes on inflation — excessive money supply, demand outpacing supply, cost-push — but there is one route of inflation, caused by class conflict, which is hardly ever discussed. The root of this goes back to Karl Marx, but a modern version of it was developed by Michal Kalecki and Bob Rowthorn.
What is inflation? It’s a rise in the prices of different commodities. Commodities can be divided broadly into two categories — agricultural and non-agricultural. Kalecki suggested that the prices of the first are demand-determined, whereas the second are cost-determined. The reason is simple: For agricultural commodities, supply (in the absence of decent storage facilities) is fixed in the shortrun, so excess demand (apart from costs) plays a crucial role in their inflation.
On the other hand, the supply of manufactured goods and services can easily adjust to demand since, in normal circumstances, you have excess capacity in these sectors. The prices of cars, motorcycles, or toothpaste don’t rise (or fall) just because their demand has increased (or decreased) but their prices can, and do, rise if the cost of production (or profit margins) has risen. Why and when do these rise?
The price of a manufactured commodity to a consumer (MRP or the maximum retail price) consists of cost of production, profit margin of the firm, and indirect taxes charged by the government. So, a rise in any (or all) will increase prices. This is where class conflict enters the picture. Such a process of price formation is like a division of a pie among different claimants over a share in it. These claimants can be categorised broadly as workers, raw material producers, other input suppliers, rentiers, government and – the highest in the pecking order of fixing prices – capitalists.
Each of these claimants has a tool to bargain with in this class conflict. It is wages for workers, terms of trade for raw material producers and other input suppliers, oil prices (after accounting for depreciation of the currency) for oil barons from whom we buy crude, interest rates for rentiers, indirect taxes (Goods and Services Tax or GST, customs duty or VAT) for the government, and gross profit margin for the capitalists. If in the process of this bargain, the total claim is equal to the size of the pie, prices will remain stable. If, however, these claims are larger than what the pie can accommodate, it leads to a rise in prices and sets a process of a price spiral we know as inflation.
Three important lessons follow from this. One, irrespective of who kickstarts the spiral, the greater the bargaining power of each of the classes, the higher the inflation will be. So, in comparison to the 2009-11 inflation, when the wages of workers were also rising, inflation today is relatively muted because the workers are on the backfoot. Inflation rates would have otherwise been much higher today.
Two, by inference, while inflation can be controlled by suppressing one or more of the classes, the burden of adjustment is more likely to fall on those who are the weakest in the pecking order. Classes such as the workers, petty producers or agricultural producers – against whom the terms of trade can move – act as the shock absorbers of the system, but in doing so, their own class position deteriorates.
Three, a rise in the repo rate – the rate at which the central bank gives loans to commercial banks against government securities – to control demand, may be counterproductive, because it increases the claim of the rentiers which, if anything, will feed into inflation and, by contracting industrial production, may cause stagflation. This was witnessed during the 2009-11 episode of inflation targeting when the growth in the index of industrial production (IIP) fell even as inflation remained high.
As for the agricultural prices, demand plays (along with the input costs) an important role. But even there what matters is demand relative to supply, so, in terms of policy, whatever can be done by suppressing demand can also be achieved by enhancing supply. The latter is a better strategy because it means there is no trade-off between inflation and the level of activity (and employment). So, increasing imports or restricting exports of commodities, at least in the shortrun, could ease situations of inflation in such commodities. But those are just stop-gap arrangements.
What is needed in the medium- to longrun is increasing agricultural productivity, which is going to be a challenge under conditions created by the climate crisis. This, along with the efficient use of good storage facilities, can act as a cushion against both falling and rising inflation.
What all of this tells us is that inflation targeting as a framework, which focuses exclusively on demand-pull inflation, can be quite limiting in controlling inflation.
At a time when wholesale inflation is the highest in almost three decades and retail inflation, despite softening, remains above the central bank’s comfort level, what is required is a fiscal response of using indirect taxes to absorb rising prices in the case of manufactured commodities, and increased public investment in the case of agricultural commodities.