HomeSeventh Pay Commission

The recommended 7th Pay Commission hike will not create a boom: Economic Times

The recommended Seventh Pay Commission hike will not create a boom

The Seventh Pay Commission award will boost central government wages by 23.5 per cent. So, many analysts have predicted a consumption boom, lifting corporate revenues and profits. Whoa!
Some corporates may gain, but others will lose, so the aggregate effect may be minimal. If consumer goods sector gains while capital goods sector loses, arguably, the net effect on the economy will be negative.
Remember, the government has no money except what it takes from others. It can’t raise spending on any one item — like government salaries — except by taking this from somebody else, directly or indirectly. So, the pay commission award will mostly mean robbing Peter to pay Paul. Aggregate demand will not rise.

The left hand knows very well what the right hand is up to

Inconspicuous Consumption

The government has four standard robbery routes. First, it can raise taxes. If so, higher salaries will come at the expense of all taxpayers. If taxpayers typically consume less than government servants, the transfer might produce a small boost to consumption. But if the opposite is true, the transfer will actually reduce overall consumption.
The second route would be to finance higher salaries by printing money — technically called monetising the fiscal deficit. This would be an ‘inflation tax’, picking people’s pockets through higher prices. But it would be nixed by RBI governor Raghuram Rajan, an inflation hawk. He is determined to keep money tight enough to reduce inflationary expectations. That rules out printing money.
Third, the government can finance higher salaries by borrowing more from markets — taking away, partially or wholly, what would otherwise have been lent to the private sector. To that extent, it would again be a transfer from Peter to Paul. More important, additional borrowing would increase the fiscal deficit.
Finance minister Arun Jaitley is absolutely committed to reducing the fiscal deficit, from 3.9 per cent of GDP this year to 3.5 per cent next year and 3.0 per cent the year after. So, he cannot use this route to finance higher salaries. The same is true of state governments, which must also prune their fiscal deficits in line with their financial responsibility and budget management targets.
Fourth, the government can finance higher salaries by cutting its own spending. It can’t reduce interest on past debt, and obviously cannot reduce salaries — it has to increase them. So, spending cuts will have to come mainly or wholly by slashing investment. This will be one more way of robbing Peter to pay Paul, and a particularly bad way. The need of the hour is to boost investment.
This discussion should make one thing clear. Whatever route — or combination of routes — the government takes, aggregate corporate sales and profits will not receive a boost. The transfer from Peter to Paul can change the fortunes of different sectors. If higher salaries are financed mainly by investment cuts, then sales of cars and TVs may go up, but at the expense of machinery sales.
Many analysts are harking back to the experience of earlier pay commission awards to judge the impact this time. Such comparisons need great care. The last salary hike in 2008 was much higher at 35 per cent, against 23.5 per cent this time. Moreover, the last award included pay arrears for almost two years, putting far more cash in the hands of government servants.

Wrong Precedent

Yet, consumption growth actually decelerated compared with the earlier two years, because of the global recession. The government resorted to amassive fiscal and monetary stimulus. This included slashing the excise duty on autos, lifting sagging sales of cars and motorcycles.
However, the key factor here was the fiscal and monetary stimulus, not the pay hike.
The shoe is on the other foot this time. Both fiscal and monetary policies are going to be relatively tight. The finance minister is committed to reducing the fiscal deficit for the next two years. So are most state finance ministers.
We are in a period of fiscal consolidation, not loosening. In such circumstances, any spending increase on one item will be more than offset by cuts in others. This cannot constitute an overall boost.
The same holds for monetary policy. Consumer price inflation, targeted by the RBI, is an uncomfortable 5% year-on-year, and is trending up a bit. A second bad monsoon in a row has sent up the price of vegetables and pulses to politically embarrassing heights. This has been offset partially by the fall in prices of metals, oil and other commodities.
The RBI has no intention of loosening money just to finance the pay commission award. Interest rates may fall a bit, but will remain among the highest in the world, given that Indian inflation is also among the highest in the world.
There is just one way we can have a free lunch. If oil prices continue to fall, the finance minister can mop up the windfall through higher taxes that, happily, don’t raise consumer prices of petrol and diesel.

Economic Times

Stay connected with us via Facebook, Google+ or Email Subscription.

Subscribe to Central Government Employee News & Tools by Email [Click Here]
Follow us: Twitter [click here] | Facebook [click here] Google+ [click here]