Growth vs. Inflation in India:

The Agriculture-Industry Dilemma

For the last several months now, a debate is afoot about the sustainability of the much applauded Indian growth rate in the face of a seemingly uncontrollable rate of inflation. The inflation in turn has been raging mostly in our agricultural sector and it is worth our while to investigate the nature of the problem.

To start with, an important question to ask is why it is agriculture rather than industry that is more susceptible to inflationary pressures in the context of a growth scenario. An obvious answer to the question lies in excessive demand for food. Even the government’s salutary NREGA programme is being held responsible for the rise in food prices. If so, this is no less than a farce, for it implies that inflation is caused by the poor man’s food expenditure!

This quick answer ignores the supply side altogether. In this connection, Sergio Rebelo’s (1991)1 insights into the area of growth economics calls for attention. Rebelo, like many others, points out that the most important barrier to steady growth takes the form of a fundamental law in economics, viz. the law of diminishing returns (ldr). Put simply, the law states that in any production process, extra doses of a variety of resources combined with a fixed quantum of a given resource leads to a rise in output at ever decreasing rates. In other words, the rate of growth of output must fall in the presence of a fixed resource even if all other resources were to increase at constant rates.

The relevance of this law is all too obvious in the context of agriculture, where land constitutes the fixed non-augmentable resource, while seeds, fertilizers, water and so on are the variable resources. As per ldr, equal extra doses of the variable resources will yield less than equal extra quantities of an agricultural produce, say wheat. Alternatively put, to keep the output of wheat growing at a uniform rate, the variable resources must be increased not in equal doses, but in ever increasing amounts. To put this in technical terms, a given rate of growth of agricultural output calls for a larger rate of input consumption in that sector. This, so long as land size is constant and productivity is governed by an unchanging technology. This is not to deny the fact that if productivity rises due to technology improvement (as was the case for the green revolution), the constraints imposed by ldr could well be postponed, thereby permitting an equal rate of growth of outputs and inputs in agriculture.

Designating the variable inputs by the generic term capital, Rebelo argues therefore that in the absence of technology improvement, a steady growth in agriculture can be extracted from a fixed plot of land only if the growth rate of capital use is higher than the growth rate of output.

Once, however, the multiple inputs, fertilizers, pesticides and so on are captured under the blanket term capital, the word capital itself assumes yet another dimension. The purchase of capital, or all inputs put together, amounts to expenditure of money. On the other hand, money can be spent for non-agricultural activities as well, such as industry, of which manufacturing enjoys a lion’s share. For concreteness, one might choose the production of personal computers (pc) as an example. The inputs that go into such production, chips, wires, plastic and so on, are qualitatively different of course from those required by agriculture. However, as opposed to agriculture, extra doses of these inputs do not lead to diminishing extra produce. Two pc’s call for twice the quantum of inputs as one pc, three pc’s require three times. In a sense therefore, ldr does not work for manufacture the same way as it does for agriculture. But ldr does not disappear altogether. It assumes the form of an overall capacity constraint. Depending on the size of the factory, a certain maximum number of pc’s can be produced per week say. Till that capacity is reached, the ratio of pc production to capital remains unchanged. Beyond that limit, it drops as with the case of ldr, but the drop is drastic. It falls sharply to zero.

With excess capacity, equal extra units of capital in manufacture produce fixed extra units of pc’s, while in agriculture, equal extra units of capital produce diminishing extra quantities of wheat. If markets are free, owners of capital will seek maximal returns from the employment of their capital. Since manufacture yields a constant rate of return (a fixed number of pc’s) from each unit of capital and agriculture yields ever smaller units, the capital owner will agree to employ extra capital in agriculture only if the price of wheat increases relative to the price of pc’s as capital use increases in agriculture.

Thus, so long as ldr is in force and technical progress in agriculture is stagnant, there will be a natural tendency for agricultural prices to rise relative to that of manufacture, quite independent of demand forces. And, as Rebelo points out, this relative price movement must persist forever, unless agriculture is filliped by technical improvements. Moreover, for sustainable growth, capital employment in agriculture must increase at a higher rate than the rate of growth of agricultural produce.

The conclusions so far did not depend on demand forces at all. However, if demand is brought in and it grows at a rate higher than the rate of growth of agricultural output, the price of agricultural products will rise at an even higher rate than what is indicated by supply considerations alone. As noted, Indian policy planners have been harping on the demand problems alone, neglecting thereby Rebelo’s fundamental supply based argument.  

Going back to supply once again, if the required excess in capital growth is not maintained, the desired growth rate of agriculture too cannot be achieved. In the Indian situation, particularly in West Bengal, land policy has reduced the size of individual plots to such an extent that employment of increasing quantities of capital, say tractors this time, has turned literally impossible. The result is that ldr works now with a vengeance, assuming almost the form it has in manufacture. The extra capital being non-employable in agriculture, the extra output associated with it will be close to zero.

These arguments depended on the assumption of free markets where capital is allowed to move in the direction of highest returns. In practice though, markets are not really free. Secondly, endless fragmentation of land has made it technically infeasible for large capital to move into agriculture. Ultimately therefore, it is only small capital that is attracted towards agriculture in states such as West Bengal. This, in turn, brings about far too small a growth in agriculture compared to industry. Under these circumstances, even if the Rebelo argument of equalization of return to capital in alternative sectors were to be ignored, food prices should be expected to skyrocket. This, in fact, has actually been the case.

The problem can be addressed perhaps by opting for large scale agriculture, though this is no easy task. Any move in that direction is almost certain to lead to social tensions. On the other hand, attempting to shackle the food inflation monster by repeated increases in rates of interest charged for borrowing capital does not seem to be based on sound reasoning either. Since it is physically, rather than financially, infeasible to employ capital in agriculture, industry continues to be its only feasible destination. However, with increasing costs of borrowing, industry too is now struggling to survive. Neither agriculture nor industry it would appear is posed to attract capital. There is little wonder then that growth rates are not showing signs of improvement. And it is this insufficient growth rate that is the real cause of high inflation and not the other way around.

1. Long-Run Policy Analysis and Long-Run Growth', Journal of Political Economy, Vol. 99: 501--21.


More by :  Dipankar Dasgupta

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Views: 3404      Comments: 18

Comment Dear DKB, I was trying to draw attention to the histories of the Jews, the Americans and the Indians. All their histories are actually histories of immigrants which caused socio-politco-religious upheavals.

Sharbaaniranjan Kundu
04-Nov-2011 07:15 AM

Comment Dear sharbaaniranjankundu,

I did not understand the point clearly - could you please elaborate "While immigration is inevitable, growth elsewhere of a populace also creates unforseen problems"

Dinesh Kumar Bohre
03-Nov-2011 13:53 PM

Comment @ Dinesh Kumar Bohre and sharbaaniranjankundu


I think Dinesh's basic argument about middlemen being responsible for agricultural price rise does sound correct. However, as you have noted, the intermediaries cause havoc only when there is a shortage of supply. If production were to rise and surplus generated, middlemen would need to find a way of destroying the output to create artificial scarcity. That is a difficult target. (Of course, our own government destroys crops by refusing to build up proper storage infrastructure.) This is why large scale production techniques are called for. But, like you, I do not subscribe to capitalist agriculture. I think the solution lies in cooperative farming, though I am not sure if cooperative farming will succeed either. I am worried about man's selfish concerns, even if Gaurang Bhatt will probably point out instances from Behavioural Economics to counter this claim. I really don't know how the problem is to be solved or even addressed.

About Sharbaaniranjan's point regarding migration away from India, I think I have to agree with him on one basic point. The scientists that the IIT' and IIM's produce do not really pay for the education and training they receive in India. The large infrastructure that IIT's have is built from tax payers' money. So, in a sense, these brilliant intellectual growth is subsidized by the government. Consequently, the IIT etc. graduates certainly owe it to the country of their origin to help it progress. I read an article by a colleague in the Indian Statistical Institute that people who migrate away after receiving training here should be regulated through a special tax. It made him highly unpopular amongst the settled NRI's!

03-Nov-2011 01:34 AM

Comment @ Gaurang Bhatt

Dear Gaurang,

Although I am an economist, I have not pursued the Behavioral Economics developments all that seriously. This, I admit, is a shortcoming. But having been in academics, I had no choice but to specialize and publish in anonymously refereed journals. This left little scope for diversifying. As a result, much to my regret, I haven't read many of the references you cite. So, I cannot really comment on them. Of course, I can try to read these now that I am retired. Possibly I will. Let us see!

On the other hand, going back to the basic issue of the article I wrote, I would like to get your views on the basic question I was trying to draw our attention to. What is the nature of the Indian inflation? If it is ultimately caused by agricultural failures, then what was the point of raising repo rates at all?


03-Nov-2011 01:05 AM

Comment Dear Dinesh Kumar Bohre, see, what is happening because of growth of America. America, for the last few centuries, is a country of immigrees, creating problems for the whole world. While immigration is inevitable, growth elsewhere of a populace also creates unforseen problems. This most visibly has happened with the Jews since biblical times to modern times. This is happening with America now. This has happened with India throughout India's history. Though these can not be stopped because of expanding populations anywhere, we must try to understand this phenomenon and create policies in governance and have regulatory mechanisms so that there comes about universal growth and mitigation of possible problems. Export of manpower therefore should be regulatory and not be left to laws of economics only.

02-Nov-2011 23:26 PM

Comment Hello sharbaaniranjankundu & dipankardasgupta,

Yes, exactly - exporting of raw talent from IITs and IIMs (and many other institutes) does not serve any purpose. Options to use their potential for country's growth must be explored and implemented with urgency.

While, our media teaches us just opposite - that those exported talents are good for India as they invest back in India.

They(media) fool us, had that talent worked in India and developed the precious technologies it developed abroad, then India's forex market would have been vastly different (because we would be exporting nish technologies and large no. of tchnological products), and the huge profit earned would have surpassed manyfold the amount those NRIs invest back in India.

There is a greater concern about brain-drain, which no one talks about - that one talent gone abroad is not only one person alone, he carries the 'genetic talent' along with him which will be property of the foreign country for generations to come. And hence, if such brain-drain continues, India will really be drained-off the big talents one day !

Dinesh Kumar Bohre
02-Nov-2011 14:26 PM

Comment We do export skilled manpower, which for sometime was considered as brain drain, except that some of them buy up properties in India, pushing the property prices. Further, multinationals opening up shop in India skyrocketted wages, necessiating both Central & State Government to revise pays. This has also resulted in price hike of commodities. What is therefore needed is recuping the cost of manpower training from expatriates and multinational workers and passing on the same to the general populace in the health and education sector. Also any expansion plan by the industry should have the precondition of prior spending in the social sector of the country. Every industry should be made responsible for plantation for aforestation, river bed dredging, water body purification, pollution control, setting up of health centres and educational institutes to the tune of 30 to 40 percent of profit till 2025. This may be scaled down later to 25 to 20 percent. Also election commission can ask a potential electoral candidate his contribution to a constituency he wants to represent. We have to think innovatively and work beyond political party divide.

01-Nov-2011 07:49 AM

Comment @ sharbaaniranjankundu

Yes, something in the nature of the Amul movement could help, but as you correctly point out, politicization might stand in the way of success. What has turned into Gujarat's success, could well have belonged to Bengal as well had development been viewed through non-political glasses. On the other hand, if development is an economic phenomenon, then it can hardly be dissociated from politics, unless of course politics itself turns into an arm of religious fundamentalism. That is a paradox unfortunately.

Exporting our human capital could solve the food scarcity problem perhaps, but a skilled work force cannot be dispensed with if we wish to progress forward. We need to find out own technologies, not buy them from foreigners. And in any case, we do export most of our IIT, IIM and other graduates. Exporting them lock stock and barrel need not serve much purpose. Even if we assign them the status of government employees.

01-Nov-2011 02:31 AM

Comment While I am not sure why and how exactly prices of grains are increasing, I can surely say that the prices of vegetables are high because of short supply and the prices of fruits are high because of 'middle men'.

Prices of vegetables:

For vetegatirans, one adult should eat 250 to 400 gms of vegetable in a meal for a healhy life.
At Rs. 40/kg, this means Rs. 10 for raw vegetable alone. that's too much for most of the Indians. As a result, a large number of people have changed their eating style, where certain vegetables are brought home only once a fortnight and vegetable alone is consumed as 'chutny' daily !

The short supply in urban areas, especially metros, gives big opportunities for culprits to make money through unethical (and probably illegal) means. The vegetables sold in such areas are poor in quality but good in appearance, they are generally contaminated with tens of times of bacterias than allowed for foof dept. and also at times they have much more amount of toxin chemicals present than allowed.

All this to increase production while keeping cost at minimum - in order to gain maximum profit. (e.g. if Spinach is grown with sewage water, it grows very fast, gets big leaves and also get a large number of becterias inside).

Prices of fruits:
This is certainly driven by middle man, apart from supply. Otherwise, how else could someone justify apples at a higher prices in India than in Europe while the quality and type is same ?

How else could one justify that the orage that can be bought at Rs. X per dozen is sold at Rs. 4X per dozen in Pune ?

For grains, I think we have a bit complex problem than fruits andf vegetables. there are multiple factors affecting. e.g. irrignation, labour problem, lack of equipments, lack of awareness, etc. each factor working in combination or alone.

and I am against Industrialisation of agrecultural sector. To say in short, those greedy corporates will not hesitate in taking unethical steps and will lead us into a feeper problem in future, apart from huge negative impact on social fabric structure in rural (agrecultural) areas.

One more point, a farmer would sell his crop at rates that do not serve its needs, but a corporate will never sell the crop at rate that does not fetch decent enough profit to its investors.

Dinesh Kumar Bohre
31-Oct-2011 15:05 PM

Comment Dear Dipankar, If wishes were horses, beggars would ride them. The problem is not new, it was there in the case of Plato and even our own Hindu heritage. Plato and the Hindus put restrictions on the rulers philosophicall, which could not be carried out practically. Many philosophers since and then have accepted that people are selfish and even economists have built up houses of cards on the flimsy infrastructure of homo economicus. It is to our fortune that Kahnemann and Twersky have destroyed that myth, but even the most modern behavioral economics only emphasizes the illogical and greedy aversion to loss as the dominating theme of evolutionary behavior and constraint. This is why David Graeber's recent book on "Debt-Five thousand years" is what I would like your opinion on. For somebody who has a long connection to the US historically, one has to really think about its origins by way of the writings of Madison, Hamilton and the founding fathers. As an economist, I would love your opinion on Charles Beard and Richard Hoftstadter. Anyway this is not a forum for personal correspondence and to pursue this if you care to, my e-mail is

Gaurang Bhatt
31-Oct-2011 10:07 AM

Comment To continue the discussion, I would like the participants to recollect a statement by the American President wherein Indian consumption was held responsible. We felt bad but now probably we realise that it was not really totally untrue. But actually it is desireable. One rider though. Demand should be more and more from the under-privileged. Out of several measures, one measure that will promote a healthier population in all sense of the term, would be export of human resources promoted by Government. In fact there can be an Export of Human Resources Ministry. Government diplomacy should make it a point that MoUs are signed for export of human resources to countries in Africa, South America, Australasia, even Europe, Canada. These people can be called foreign Government servants, Internation Sector Undertaking personnel. Government can pay them salary. That way Government employment will rise. A detailed scheme can be drawn out in this area. It has not missed the general citizen of this country, Government has recruited young workers in the banking and postal services recently. The credit I believe should go to Pranab Mukherjee.

30-Oct-2011 22:07 PM

Comment In a state like West Bengal, an attempt can be made on the lines of Amul movement for milk production. Here we can not have big farmlands like in America or Punjab in India. So what is required is conglomerated farmlands and operate them at the Block level. But it is easier said than done. Rise of the Middle Class has resulted broken home and divided farmland. To walk in the opposite direction, now that Bengal has winessed biological family set ups in the last few generations, will be a difficult task. Biological family structures have come about because of industrialisation and profession-centric life and population migration. Evolving a cooperative system for farmland management calls for state intervention through block development officers and participation of different departments of the Government. But can it be achieved because a high politicisation of the population has come about because of passionate ism adherance? Bengal has almost got rid of religious bigotry because of stalwart personalities of Bengal in the last two centuries. But political divide is so strong that it is almost reaching the proportion of religious fundamentalism. Bengal's intellectualism should learn from Jainism's tenets. Bengal must see that tolerance actually leads to growth, as it has happened with the Jains in India! Cholbe naa cholbe naa is destructive and leads only to harikiri as probably we are forced to understand by now.

30-Oct-2011 14:32 PM

Comment @ Krish

I agree with you 100 per cent. The government should provide incentives to agro-scientists to find out avenues leading to improvements in agricultural productivity. Otherwise, 5 years down the road, our society will not have at its disposal the basic means of subsistence. As Gaurang Bhatt has pointed out, we are probably headed towards a situation where "the rich unrestrained would ... plunder the poor". It is not as though this is not happening right now. But the intensity will increase several-fold. I think sharbaaniranjankundu too has captured the matter rather well in his statement "This inflation is distribution related. Nobody can stop it because Rajib Gandhi facilitated IT growth, Sam Pitroda led telephony growth and Atal Bihari Vajpayee promoted infrastructure growth."

30-Oct-2011 10:42 AM

Comment @ sharbaaniranjankundu

I agree with you that sacrificing a bit of growth in the interest of more healthy distribution of income should be the goal for us. Indeed, in this article, I was not advocating the Rajiv Gandhi et al policies. On the contrary, I was trying to point out that agriculture faces a serious crisis in India. If land has to be acquired, it has to be acquired for increasing agricultural productivity, not for manufacture growth. Or else, inflation will destroy whatever social fabric exists.

30-Oct-2011 10:33 AM

Comment @Gaurang Bhatt

Thank you for reading my piece and putting in your thoughtful comment.

If I understand your observations clearly, you are worried about the farm size point I made in the last paragraph. As I mentioned there, "Any move in that direction is almost certain to lead to social tensions." And indeed, as you corroborate from the American experience, "in medio stat virtus" remains an un-achievable dream. The way I look at it in the Indian context, large farms should not be run on the capitalist model. Instead, if possible, though I doubt that it is, cooperative farming is what we should opt for. At the same time though, I am not aware of too many instances of successful cooperative farming initiatives.

What worries me in today's Indian scenario is that a great deal of arguments are being proffered in favour of land acquisition for industrialization. But per capita agricultural output has been falling for a number of years. Such a situation is not congenial for industrial development at all. Agricultural surplus is a sine qua non for industrial growth. Right now, I am no longer sure that this all important surplus is actually available.

Thanks again.

30-Oct-2011 10:26 AM

Comment In India the biggest hurdle to agricultural productivity improvement is the tiny land holdings.With the current status of holdings it now becomes the responsibility of our agriculture scientists to bring out: a) Non-toxic Hybrid and high yielding seeds to take out more yield from the same area and b) Suggest sustainable ways of agriculture like crop rotation that rejuvenate rather than degrade the cultivated land.Unfortunately we don't have dedicated and committed agriculture scientists who can come up with sustainable solutions to this very real problem.

29-Oct-2011 06:29 AM

Comment Today what we are seeing all over the world can be termed as Americisation. This can not be stopped. But America very soon will no longer be America we know about. America has to Indianise. China is a different proposition. But India triumphed once, through triumph of Buddha. But China has always kept its identity. It will continue to keep its identity. India sooner or later will get back its glory of Bharat or Hindostan. It is better that India should follow the middle path. A growth rate just a little higher than the Hindu rate of growth would be ideal. Conscious Americisation or China-isation should be averted. A little daliance will not harm. Current inflation will not harm India as it did not harm Brazil. Let us tell people the truth. This inflation is distribution related. Nobody can stop it because Rajib Gandhi facilitated IT growth, Sam Pitroda led telephony growth and Atal Bihari Vajpayee promoted infrastructure growth.

28-Oct-2011 21:40 PM

Comment In the US which like India has a lot of arable land, the government policies have promoted large farms and with its industrialization moved labor to urban manufacture and wage slavery, and yet produced bountiful yields with minimal numbers of farmers. India with its sort of even rural land ceilings and overly socialistic policies and the unchecked Malthusian population growth has ended up with very small farms where technology and fertilizer like inputs or agricultural techniques are not feasible due to the lack of knowledge, expertise and finance of uneducated poor farmers with less than a hectare of land. Now the ever selfish haves are promoting and preaching austerity for the poor after having been bailed out by the state espousing crony capitalism. It is worth remembering that consolidation to the extent of having large corporate farms in America has led to capture of regulators and government and humongous farm subsidies which then because of the neo-liberal policies of the US and the West results in desperate suicide or illegal migration of Indian, Mexican and African farmers.
The Founders of the USA, as Richard Hofstadter puts it so well, were fearful that the poor would plunder the rich, most of them would probably have admitted that the rich unrestrained would also plunder the poor. As even Governeur Morris, like practically all the founding fathers of the US, and thus a candid aristocrat with little sympathy for the poor have-nots eloquently told the Convention, "Wealth tends to corrupt the mind and nourish its love for power, and to stimulate it to oppression. History proves this to be the spirit of the opulent".
We all know that, "Medio stat virtus", but how do we keep the vehicle of virtue in the middle of the road and prevent it from going to the edges of disaster?

Gaurang Bhatt

Gaurang Bhatt
28-Oct-2011 09:55 AM

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