THE West Asian war has pushed world oil prices well beyond $100 per barrel. The Indian government, which had kept domestic prices of oil products unchanged until the elections to several state legislatures had been completed, has now started raising their prices; it has already raised prices in three rounds and is no doubt going to raise them further. And a large number of economists, not all belonging to the Bhartiya Janata Party stable, have seen such “passing on” of higher world oil prices to domestic consumers as the obvious and natural thing to do. This view however is based on a flawed understanding of the functioning of the economy.

The basic point is that the demand for petro-products is price-inelastic which means that as their prices rise, their demand does not fall to any proportionate extent. The users of these products shift expenditure from other avenues to spend on such products to keep up their demand; a rise in petro-product prices in other words leads not so much to a fall in their demand as to a fall in the demand for other goods. It therefore has a recessionary impact on the economy as a whole. The greater the reduction in the supply of oil or petro-products, the steeper therefore would have to be the rise in their prices, if their demand has to fall sufficiently to match the reduced supplies; and the more acute therefore would have to be the recession in the economy because of the diversion of expenditure from elsewhere.

Most of the time of course it is not an actual shortage of supplies that underlies the price-rise; the running down of existing stocks has often sufficed to keep supplies going, as has been broadly the case until now even in the context of the present war, but the expectations of shortages and price-rise in the days to come are what drive up the actual prices. But let us assume that there is some fall in supplies which has pushed up world prices.

Now, there can be two alternative policy responses within the country to such a rise in the world oil prices. One would be to let the domestic prices of petro-products, and of all goods into whose production such products enter as inputs, rise, so that demand for such products is reduced through a combination of the effects of both price-rise and recession, to match the reduced supplies. A recession in this case is not only inevitable, but is actually one of the means of bringing about equality between demand and supply of oil. The other possible policy response would be not to raise the domestic prices of petro-products, and hence the level of domestic prices, but to ration the supplies of such products, so that there is no diversion of expenditure from other avenues, and no chance of any recession; and the rationing can be done in such a manner that only the final consumption of such products is curtailed, that too by the more affluent sections, and not their use as inputs.

What would happen in this second case is that with the final consumption of petro-products being rationed out, the unspent purchasing power that remains in the hands of consumers, would be spent on other domestically-produced goods, boosting demand for them and hence their output and employment. Thus while the first route generates recession and unemployment, the second route has the potential for generating larger employment and output.

This claim may appear odd at first sight. How can a reduction in world oil output and hence in oil imports into a country give rise to an increase in that country’s employment and output? The answer is that we visualize the impact of the reduced oil imports to fall entirely on final consumption, so that there is in effect an import substitution, because of which the reduced imports raise the demand for domestically-produced goods; this then has its multiplier effects on the economy as a whole.

Of course, if world oil prices have gone up while the domestic petro-product prices are kept unchanged, then the domestic petro-producers and distributors may have to be covered by a subsidy. But even if this subsidy is financed by a fiscal deficit, then that per se should not be a matter of concern. Let us assume that the world oil price goes up by 20 percent and imports into the country go down by 10 percent, then the dollar payment for the oil imports to foreign oil producers goes up by 8 percent. This additional foreign exchange has to be mobilized anyway; suppose it is mobilized by a running down of foreign exchange reserves. Then in the first case, where prices are raised, the petro-product producers and distributors obtain the rupee resources required for buying this foreign exchange from the consumers; in the second case, where prices are not raised, they do so from the government.

Keeping prices fixed and subsidising petro-product producers and distributors through a fiscal deficit simply puts claims upon the government in the hands of the central bank (against foreign exchange purchases), and/or in the hands of these producing and distributing companies, which also include public sector enterprises. The larger fiscal deficit is what financially sustains aggregate demand in this second case, and, while preventing a recession, actually makes possible an increase in total employment and output. And since rationing is directed against the final consumption of the relatively more affluent groups, not only will there be a rise in employment as a result of keeping petro-product prices unchanged and resorting to rationing, but additionally there will be no reduction in the living standards of the working people.

Two questions may be raised over this argument. First, if the unspent purchasing power, owing to the rationing of petro-products, is not spent on other goods but remains unspent (what economists call “saved”), then the above argument about expansion in employment becomes invalid. In such a case however the government can always increase the fiscal deficit beyond what is needed to subsidise domestic petro-producers and distributors, and spend more to boost demand and hence employment and output. Second, petro-product rationing to curtail their use for final consumption of the affluent may not reduce the domestic demand for such products sufficiently, to match reduced supplies. But once the logic of the above argument is understood, rationing can be extended from affluent consumers to  petro-product use by a large consumer, namely the defence sector, through proper discussion (there was such rationing of defence purchase of petro-products in 2013), and the fiscal resources saved thereby can be diverted to other government expenditures to boost demand and output.

This alternative policy however is precisely what globalized finance opposes; hence it is ruled out under a neo-liberal regime. Rationing of petro-products, maintaining living standards of the working people, and fiscal deficits, are all completely unacceptable to international finance capital. Not surprisingly, the BJP-led government, under thraldom to international finance capital, is going on raising the prices of petro-products to the detriment of millions of poor and working people, and simultaneously opening doors to a serious recession in the economy.

In pursuing this course of inflationary recession, not just the Indian government but governments elsewhere in the capitalist world are repeating a mistake they had made in 1973-74 in the wake of the first oil-shock. That shock had meant a very sharp rise in oil prices, because of which there had been a reduction in expenditure in all countries on non-oil items of consumption in order to meet the larger oil expenditure necessitated by the price-rise. It therefore had a demand-compressing effect, to counter which there should have an expansionary fiscal policy. But because the oil-price-hike was passed on to buyers and had led to higher all-round inflation, and because the conventional wisdom of finance capital holds that whenever there is inflation, “austerity” measures must be followed (even when that inflation is of the “cost-push” variety which “austerity” cannot possibly counter), governments pursued the exact opposite policy of cutting down on their expenditures. The world economy as a result was pushed into a severe recession in 1975 in addition to the massive inflation unleashed by the oil-shock. The same mistake is being repeated today: a policy is being followed because of which the working people everywhere would suffer the consequences of both inflation and recession.

It is not as if the idea of petro-product rationing for final consumption is completely foreign to India. In cities like Beijing and Paris even in normal times there are restrictions on vehicles with certain number-plates being on the roads on certain days, and in Delhi itself there had been an experiment with odd-even number plates for a while. The primary motivation at that time had been to cut down on pollution, though it had not been very successful in doing so because of the numerous exemptions that had been granted; it had however led to some economy in fuel use. The point is that such measures of rationing are well-known and have been tried even in India; instead of building on them and generalizing them for the country as a whole, the knee-jerk reaction of the BJP-led government has been to jack up prices to buyers. This is fraught with serious adverse consequences for the working people.