Blog: Why Uday Kotak's Right About India Needing To Print Money

Uday Kotak, who surely knows a lot about money, told NDTV last night that the government needs to print money and spend more. This would surprise most people who have learnt textbook economics in high school, college or through pink-paper-punditry. Received wisdom tells us that printing more money not only can't buy you love, it buys absolutely nothing at all. It only makes things more expensive. How?

Imagine you make cotton shirts. The cloth, thread, sewing machine, buttons and labour cost you Rs 500 and you want to make a profit of Rs 250. But when you try to sell it at a total price of Rs 750, customers say it's too expensive. So, you settle for Rs 150 profit and sell the shirt for Rs 650 instead. You had made 100 shirts and at Rs 650, they sold out.

Now imagine that the government prints money and hands it over to your buyers. Instead of 100 buyers, 150 turn up because they now have money in their hands. You still have only 100 shirts to sell, so you raise your price to Rs 700. Now there are still 120 buyers demanding your shirt. You raise the price to Rs 800. Only 100 are willing to buy your shirt at that price.

What has happened here? The extra money printed didn't change anything in the economy for consumers at large. The same 100 shirts were sold, but at a much higher price. The same number of consumers paid more to buy the same number of shirts. All that changed is that you became richer.

But remember that what you gained while selling your shirts will be lost when you go to buy your daily bread. Once again, the number of loaves being produced remains the same. All that the baker does is push up the prices. You end up getting the same amount of bread by spending the extra profit you made by selling shirts.

Real economies, however, have no obligation to live according to the banal rules described by mainstream economists. In real economies, producers rarely operate at full capacity. That means that if demand increases, producers can often increase their output to ensure supply matches the rising demand. In fact, in economies like ours where factories are operating at way below their installed capacity, stoking demand by printing money can actually bring prices down.

To understand this, think of a factory that produces passenger cars. If it runs 8-hour shifts, 5 days a week, it can produce 100 cars. But due to an economic slowdown, such as the one India has been facing for the past three years, there aren't enough buyers. So the company produces only 60 cars per week. Let us assume that the raw material cost per car is Rs 10,000. However, the company also has fixed costs, such as land, equipment and permanent employees, that remain the same whatever its output might be.

Let us assume that the overall fixed costs per week amounts to Rs 3,00,000. If the company produces 100 cars, the average fixed cost per car is Rs 3,000. If it produces 60 cars, the average fixed cost per car is Rs 5,000. So, the total cost per car when the company operates at full 100-car capacity is Rs 13,000, where Rs 3,000 is the fixed cost and Rs 10,000 is the raw material cost. If it operates at 60% capacity, producing just 60 cars per week, the total cost of producing the car is Rs 15,000, where Rs 5,000 is the average fixed cost and Rs 10,000 is the raw material cost.

Now, if the government prints money and effectively pushes up the demand for cars, the car factory can produce at higher capacity, reduce the average cost of production of each car and sell at a lower price. The car company can even make higher profits, while reducing the selling price of the cars. All they have to do is not pass on the entire saving they made on the fixed costs per car when they increased their output.

In other words, printing money in demand-constrained economies, where factories are producing below capacity, can lower prices instead of causing inflation. The RBI's data tells us that in the quarter ending December 2020, Indian companies have been producing at two-thirds their capacity. During the lockdown last year, their capacity utilisation was just 47 percent. Chances are that we are back to those levels during the second wave. Compare that to the 'policy paralysis' days of 2013, when India's factories operated at 74 percent capacity.

One could ask what would happen if too much money is printed? What if the total demand goes beyond what our economy can supply, even if it is running at full capacity? Even that is good, because it will end up stimulating investment. When a factory sees growing demand for its products, it first increases the number of shifts and runs its machines for longer to produce more. At the same time, the management draws up expansion plans. It takes loans, orders new machines and begins looking for new hires. That is something that has been missing in India for almost a decade now. Printing money can not only stimulate demand, increase output and reduce inflation, but also stoke future investments.

Of course, this is only if things are properly planned. Printing money and then just letting 'market forces' determine how it is spent will not work. The government has to plan who to give it to, what kind of demand to stimulate. The money needs to go to those who need it the most, it needs to be spent on sectors that generate the maximum employment. Otherwise, it will end up lining the pockets of the wealthy and increasing India's incredible inequality.

(Aunindyo Chakravarty was Senior Managing Editor of NDTV's Hindi and Business news channels.)

Disclaimer: The opinions expressed within this article are the personal opinions of the author. The facts and opinions appearing in the article do not reflect the views of NDTV and NDTV does not assume any responsibility or liability for the same.