It is not often that the humble South Indian snack, the ‘dosa’, enters the policy calculus of senior functionaries in charge of public administration in the country. As it happens, it did - not once but twice - in speeches delivered by Reserve Bank of India Governor Raghuram Rajan. The first occasion was when he was delivering the CD Deshmukh (the first Indian Governor of RBI) memorial lecture in New Delhi. He was making the point that the common man is generally better off under a regime of low inflation and low nominal interest rates than in an alternative scenario of high inflation and high nominal interest rates. This is what he said.
“Let me explain, starting with the retiree. The typical letter I get goes, ‘I used to get 10 per cent earlier on a one-year fixed deposit, now I barely get 8 per cent’, please tell banks to pay me more else I won’t be able to make ends meet.” The truth is that the retiree is getting more today but he does not realise it, because he is focusing only on the nominal interest he gets and not on the underlying inflation which has come down even more sharply, from about 10 per cent to 5.5 per cent.
Dosa-nomics
To understand this, let us indulge in ‘dosa’ economics. Say, the pensioner wants to buy ‘dosas’ and at the beginning of the period, they cost ₹50 per dosa. Let us say he has savings of ₹1,00,000. He could buy 2,000 ‘dosas’ with the money today, but he wants more by investing. At 10 per cent interest, he gets ₹10,000 after one year, plus his principal.
With ‘dosas’ having gone up by 10 per cent to ₹55, he can buy 182 dosas approximately with the ₹10,000 interest. At 8 per cent interest, he gets ₹8,000. With ‘dosas’ having gone up by 5.5 per cent, each dosa costs ₹52.75, so he can now buy only 152 ‘dosas’ approximately. So the pensioner seems vindicated: with lower interest payments, he can now buy less.
But, wait a minute. Remember, he gets his principal back also and that too has to be adjusted for inflation. In the high inflation period, it was worth 1,818 ‘dosas’, in the low inflation period, it is worth 1,896 ‘dosas’. So, in the high inflation period, principal plus interest are worth 2,000 ‘dosas’ together, while in the low inflation period it is worth 2,048 ‘dosas’. He is about 2.5 per cent better off in the low inflation period in terms of ‘dosas’.”
Of course, it could be argued that if the pensioner is better off today than in the past, it's not because things have improved in any absolute sense. Rather, it has to do with the fact an oppressive feature of his initial condition, where his savings were earning zero ‘real’ interest rate (with both the nominal interest rate and inflation prevailing at 10 per cent), which ought not to have existed in the first place, but has thankfully got rectified at a later point in time.
No simple Q&A
Using the analogy of ‘dosa’ prices, a student participant at a function in Kochi, in memory of the founder of the Federal Bank, asked a question of the RBI Governor, the chief guest: She wanted to know, “Despite inflation ruling in the region of 5.5 per cent from the earlier highs of 10 per cent, why haven’t ‘dosa’ prices come down?”
A plain answer would be that prices are still going up by 5.5 per cent as against 10 per cent earlier. By that logic ‘dosa’ prices should be up ₹2.50 or thereabouts. The student was therefore being unrealistic in expecting that ‘dosa’ prices should come have down. Alternatively, the prices are still where they were earlier because while rice prices may have come down by 20 per cent, that of urad dal (the other ingredient in a ‘dosa’) have gone up manifold and, hence, ‘dosa’ prices remain where they are.
Not a simple matter
But the Governor chose to offer a much more nuanced explanation. He said that the technology for making ‘dosas’ hasn’t changed at all, over the years. Of course, he wasn’t being 100 per cent correct. Some aspects of ‘dosa’ preparation have indeed changed. For instance, one no longer uses wood stoves for making them but employ ones that use LPG as the fuel which delivers more heat per unit of time. Also, the pans on which the batter is spread have also become more efficient at transmitting heat from the stove to the batter so those delicious ‘dosas’ get cooked faster. But in one crucial aspect, the technology hasn’t changed at all. The process employed by the ‘dosa master’, as he is called, remains largely the same. He uses a flat metal cup to scoop up the batter from a larger vessel; pours it onto the ‘tawa’ and then runs the base of the cup on the batter in a rhythmic circular motion to spread it thin; he then splashes some cooking oil on it and, when it is fully cooked, slowly rolls it over with a spatula; lifts it from the ‘tawa’ using the spatula and places it on an eating plate.
A ‘dosa master’ can, by a careful analysis of his actions, refine the work-flow to bring about some process efficiency. The muscles in his arm acquire a certain autonomous memory that always guides him to operate in the most efficient manner. Thus he simply gets better and better over time. But he soon reaches a stage when he can no longer improve on the time he takes to flip a ‘dosa’. In other words, the ‘dosa master’ would have soon reached a point when he can no longer turn in an extra ‘dosa’ in a normal work shift.
In a market for ‘dosas’ that is finely balanced between forces of supply and demand, any attempt at increasing the price of ‘dosa’ because labour costs have gone up would result in fewer ‘dosas’ being demanded by the market, assuming that all suppliers are faced with the same cost pressure on labour. The ‘dosa’ economy would now operate at a lower level of equilibrium measured in terms of the number of ‘dosas’ that are bought and sold. Thus, far from ‘dosa’ prices coming down, they will actually have a tendency to go up although, at each higher price point, fewer and fewer quantities would be made and consumed.
The dosa maker
Now this naturally gives rise to another question: Why do labour costs have to go up? The RBI Governor weighs in with an explanation that this is due to the ‘Balassa–Samuelson’ effect operating on the ‘dosa economy’. Now, what is this ‘Balassa–Samuelson’ effect? It refers to a phenomenon in an economy comprising many sectors, some of which are witnessing productivity improvements while others are languishing.
While wage levels in those sectors which are witnessing productivity improvements would most certainly go up, the ones that are lagging behind too, witness some sympathetic movement. This is due to the fact that workers in the stagnant sectors (productivity-wise) migrate to those sectors that are registering productivity improvements to take advantage of the higher wages they offer. The result is the ‘dosa’ industry too now has to offer higher wages in order to retain talent, even if it means operating at a lower level of equilibrium.
Let us assume that thanks to productivity improvements, software programmers are increasingly getting higher wages. Let us also assume that ‘dosa masters’ can somehow re-skill themselves to become expert programmers. Then migration (from the ‘dosa’ industry to software) is the inevitable result, with the consequent change in wage levels in the ‘dosa’ industry.
Change
What can change the situation for the ‘dosa’ economy? If the constraint of the maximum number of ‘dosas’ that a human being can make in a work-shift is somehow overcome, then ‘dosa’ economics can be dramatically altered. For then, we could be looking at ‘dosas’ being sold at lower prices (with prices of other inputs, such as rice and urad dal, remaining constant) and expand the market with prospects for even higher wages for workers. That would require a fundamental change in the way ‘dosas’ are made (technological change) as opposed to routine improvements in the technical efficiency of ‘dosa masters’. To Raghuram Rajan’s mind the ‘dosa’ industry is nowhere near witnessing any breakthrough change in the way ‘dosas’ are made.
But, as it happens, an entrepreneur has come up with a machine that mechanically applies a certain quantity of batter on a rotating table of a ‘tawa’ that is heated up from a heat source underneath. As the ‘tawa’ rotates it has to pass through a narrow slit that flattens out the batter and by the time it completes a full circle and comes back to its original the ‘dosa’ is cooked and neatly folded in a roll to be offloaded on a plate. See the video here.
If the annual capital servicing cost of the machine is more than the wage cost of the ‘dosa master’ and the machine can turn in more 'dosas' then the RBI Governor’s wish would have been granted.