If you are stranded in a traffic jam due to some constraint as simple as a lane closure, creating an incentive for a by-pass lane could do immense benefit to the easing of traffic snarls. This example could be extended to the general economy as well.

 

Taking the bypass lane would need additional work, but the right incentives will motivate enterprises to take that additional pain as it will eventually pay off.

 

On the other hand monetary policy alone would do little in a supply constrained situation. Working on the demand side of the economy when you are supply constrained also does not help.

 

 

Supply constrained economies are economically distressed to the point that monetary initiatives do not work; taming inflation in such an economy fails with the magic wand of interest rate adjustments.

 

Our economy is partially constrained and therefore we have the dual burden of moderately low inflation, which does not bode well for performing well against an inflation target and coterminously fails to create room for growth as investment environment remains moderately weak given the stock of investments already looming large as ‘work in progress’ with no end in sight.

 

Why are we supply constrained? To that we do not have a quick answer but many possible directions to point to. The first one is of course to point to very basics like having enough stock of projects in the energy area that are either in the production instance rather than on the drawing board.

 

This would point to very basics like coal and railways and then of course road network. Our stock of investments in this area is perennial y short of the need and those that are already committed to are slow to take off. The capital tied to these projects look vulnerable to say the least.

 

The actual production number says it all, from coal tons evacuated to giga watts produced. Production is at the core of supply and it could be constrained by a host of factors like clearances on land, environment included or simply the lack of skills needed to produce or in the application of technology.

 

Supply factors need incentivization as we cannot leave this to the vagaries of external factors. It also applies to the agricultural sector where such external factors include adequate water availability, which is the basic. This is also an area where monetary solution remains weak, extending credit or waiving a loan does not solve the root cause of the problem.

 

Incentives for kick- starting a supply constrained economy should not be aimed at the demand side as well, in that case it would aggregate the problem, although it might appease a range of constituents in the short run.

 

Incentivising demand when you are supply constrained is like waiving a toll in a traffic jam, more cars will be drawn into the jam, while none can move faster; making the by-pass lane is the more effective solution.

 

We have witnessed a host of measures on the demand side, raising minimum wage all across was a good measure which would do a world of good to the demand side. But if your supply side is constrained a flurry of measures to increase wages if continued will have a debilitating effect on the economy.

This is one of the reasons that raising farm wages may not be the only good measure for farmers although it could be the best in the short term.

What are these by-pass lanes in the economy, which will ease supply and make the supply side of the story better?

 

The supply side factors are pretty simple, quality and quantity of labor together with technology and the right blend of capability that matches the requirement.

Unfortunately quantity of labor is never in short supply, but quality is and that is where the by-lanes have to be constructed.

If India has to solve the supply side story, it is only the quality of labor and the expertise on which we have to make the by-lanes work.

Incentivizing demand side while you are supply-constrained?

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