One of the woeful legacies of John Maynard Keynes is that many people defend virtually any government spending in his name, saying that spending will stimulate demand, thereby cause increased production and lead to an increase in GDP.
The trouble with this claim is that this is much beyond what Keynes said.
Keynes did not say that government spending money will invariably stimulate demand. He said that it would only when there is a recession or a depression. To understand why, we shall return to the NREGA example. Nitin and Atanu have explanations of why it will cause inflation. I urge you to read Atanu’s explanation at least, because I will be continuing his example.
In Atanu’s example, when 10 extra people are given “employment” those people now have extra money. These people will demand something for their money. Will this demand magically lead to an increase in production? No it won’t – not even according to Keynes.
An increase in demand will lead to an increased production only when there is unused spare capacity lying around. When you have unsold inventory, factories with machinery idle, etc. demand for goods will help to “prime” the economy’s pump. In this case – and only in this case will artificially inflating the demand lead to any good for the economy. This was arguably the case during the great depression. Much of the argument over Keynesian economics is over how rare or how common this case is, and over whether this is the best way out.
No serious economist will claim that India is in such a situation now. We do not have inventories piling up for lack of demand. Instead, we have industrialists unable to fulfill demand, because they are unable to set up factories because they cannot buy land, or unable to run factories at full steam because they do not have electricity. In this situation, adding more demand is not going to do jack for our GDP.
In fact, the NREGA was not even set up with that purpose. It was set up to provide employment. The theory is that the landless poor are underemployed, because they get work only part of the year, during the crop season. The rest of the time, lack of work options forces them to migrate to the cities, where they work as construction labour. By guaranteeing 100 days of work a year at minimum wages, the theory is that the expense on the scheme will be self-limiting. It will act as an option of the last resort. Those who have other options will not ask for work under the scheme because it pays less – only the minimum wage.
The fact, however, is that unemployment is rarely a problem among the very poor. This might be surprising, but should not be. It is a well-known fact that in India, as you leave the ranks of the poor and enter those of the lower middle-class, the probability of you suffering unemployment shoots up. This is because very poor people cannot afford to be unemployed.
So, if the NREGA actually succeeds in providing employment to the poor – a big if – it will pull them out of other occupations that they are engaged in. The other occupations presumably involve producing something. Government work rarely involves producing anything. Even if it involves building roads, and assuming that the roads built last out the next rains, the increase in production because of the road lies a few years into the future. So a cut in whatever they were producing, coupled with an increase in demand has to an increase in inflation. In fact, if you are a supporter of the NREGA, you should be worried if there is no inflation.