Cost Price Relationship in Indian Manufacturing Industry

S Hajra

In examining the cost-price relationship in industry this paper challenges the view that rise in prices of industrial products has anything to do with rise in wage costs.

The evidence for the industries studied here suggests no a relation-ship between unit wage and material costs and prices. Nor does it suggest that growth of labour productivity has lagged behind rise in wages. On the con­trary, in most of the industries productivity has risen faster than wages.

THIS paper has been divided into three sections. The first section

reviews Sidney Weintraub's theory of inflation in India contained in his book, "Growth without Inflation" (Ra­tional Council of Applied Economic Research, February 1965). The second examines the variations in unit mate­rial cost, unit wage cost and wage and labour productivity in relation to va­riations in prices for selected indus­tries. The third section is a statistical study of the cost-profit relationship in manufacturing industries.

I In "Growth without Inflation" Sid­

ney Weintraub has offered an analysis of inflation in India. He has used a simple model to explain his theory which he has tested with Indian data. For the convenience of readers the model is reproduced here. Weintraub's is a single equation model, formulated on the assumption that "sales proceeds are some multiple of wage pay-news" (p 55). In equation form:

From the model Weintraub con­cludes: "So long as k is constant or

nearly so and A, average productivity of labour, changes slowly or not: at all then it must follow that every change in w, the average money wage per employee, must, lead to a direct and proportional change in the level of prices" (p 56). Weintraub defines k in his equations as the mark-up fac­tor, which is the "reciprocal of wage-share" (p 56), and calls his theory as the wage-cost mark-up theory (WCM). His results from Indian data are sum­marised in Table 1. The empirical evi­dence has led Weintraub to argue:

"The definite rise in W, The slow steady rise in A, the mild trend in k, and the somewhat undue rise in unit labour costs represented by w/A are very apparent. The rise in labour cost of some 13 per cent over the full period and some 23 per cent since 1955 can be alleged with little fear of contradiction as responsible for infla­tion" (p 62). His conclusion is that: "the inflationary problem in India has

involved a wage and salary inflation ... income payments have been grow­ing at an undue, if not alarming, pace relative to the movement in labour productivity ... this has been the grow­ing stream of individual income pay­ment rampaging over the dam of pro­ductivity" (p 67).

What is required, then, is that: "India will have to face up to this question of holding individual income payments in check and instituting a wage-income policy, if it is serious about its endeavours at economic sta­bility and inflation control" (p 67)

P S Lokanalhan, Director General of NACAFR, in his introduction to the book mentions a few limitations of Weintraub's policy recommendation for India. He points out that in the agricultural sector whatever be the la­bour productivity a living wage must be paid and, second, that as a result of market imperfections profits and rents may not be stabilised simultan­eously with an income policy. He also

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T H E E C O N O M I C W E E K L Y October 23, 1965

mentions that government deficit and increases in money supply are also responsible for aggravating the situa­tion so that it is difficult to label any one factor as the culprit (p vii).

To the present writer it seems that Weintraub's conculsions are not ade­quately supported by his evidence. Unit wage cost has increase:! in ma­nufacturing by 1.5 per cent and has declined by 8 per cent in Government enterprises, whereas money income in these two sectors have increased by 131.5 and 50.25 per cent, respectively. In the manufacturing sector producti­vity has increased by 128.5 per cent. The wage-productivity disparity is no­where as large as Weintraub's expres­sion "growing stream of income pay­ment ... rampaging over the dam of productivity" suggests. What is this "growing stream of income payment"? Does it refer to (i) rise in wage rates of the existing employed or (ii) addi­tional employment?

Obviously (i) and (ii) cannot have 'the same effect on P (prices). If the increase in income payments is due to (ii) and the larger part of the ad­ditional employment created falls in the (non-productive) tertiary sector (that is, increase in employment and income payments are not accompanied by an increase in 0) then i t will de­finitely be inflationary. But the cure for this type of situation is not res­

traint of all money wage. Weintraub suggests "an alternative

formulation of the WCM truism that is more apt for the studies of economic growth that give weight and a stress to the capital-output ratio and to the amount of capital per employee" (p 66). This formulation he presents as

where K= capital; K/Q —capital cutput ratio and K/N = capital labour ratio. Weintraub argues that "Data c o u l d be fitted to this equation, but in view of the truistic nature this is superfluous at this stage ... neglecting the changes in wage share as relatively unimportant and as the capital-output ratios do not vary greatly in short periods, the money wage will rule the price level roost" (p 67),

However, in India during the Five-Year Plans the capital-output ratio has shown changes and the assumption of secular constancy of the ratio is also contrary to the evidence of other countries. As regards the short period movement of the capital-output ratio. we may quote here Kaldor: "It. is of the essence of the acceleration princi­ple that it regards the ratio output capital determined by technical fac­tors, which cannot undergo any significant alternation even in the short period; while it is the

essential feature of the cycli­cal movements that this tela lien is subject, to continuous changes in the course of i t". Hicks suggests a scries of partial coefficients instead of a sin­gle one, each applicable to a dilfeienl-period,

Weintraub's model of inflation is a single equation one, which includes (a) a real part with Q and N and (b) a monetary part with P and w. His equation, further, is an identity which deals with ex post quantities. Single equation regression models which con­sider data as stochastic to the extent that an error term and its random distribution are assumed have been neglected by Weintraub. And the spe­cification of The money wage rate has helped him to draw all his conclusions. A conclusion that the rise in price has led to the rise in money wage is equal­ly possible from his equation if the price is identified rather than the mo­ney wage. One further limitation of Weintraub's analysis is that he has used his productivity index in con­stant prices and wage index in cur­rent prices. What does such a compa­rison mean? The appropriate compa­rison should lake cither both in cur­rent prices where marginal revenue productivity is compared with wage, or both in constant prices where 'real' productivity is compared with 'real' wage.

Table 4: Changes in Money Wage and Unit Labour Requirement, Labour Cost and Labour Productivity

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I I We now proceed to examine how

far price movements in manufactur­ing industries can be explained by movements not only in money wage and unit wage cost but also by varia­tions in unit material costs since raw material prices have increased daring the period and raw material cost forms a large proportion of total ope­rating cost. Twenty three manufactur­ing industries are covered here. This section examines the movement of unit material cost, unit labour cost, wage and labour productivity for individual industries. The data are given in Table 2.

Total cost of production has been classified as: (1) wage cost; (2) mate­rial and other input costs; and (3) ca­pital cost. Prices has been defined as equal to the cost of production plus entrepreneural profit. With this defini­tion of price there are two cources of price variation: variation in cost and variation in entrepreneurs' profit ex­pectation. In this paper we will con­sider the first, taking only wage cost and material cost, since data on capi­tal cost are not available.

The data used are from the Census of Manufacturing Industries and the period, 1947-58. The relevant data, as compiled from the Census, are given in Table 2 to 4. The concepts used arc similar to those used by the Cen­sus and are briefly discussed below:

(a) Value-added is the measure of output used here; it is equal to ex-factory sales value of output less cost of material, fuel, electricity, etc, con­sumed and depreciation.

(b) Unit wage-cost is wage-cost per unit of value added where wage cost includes wages, salaries and other be­nefits paid to workers.

(c) Unit material cost is total input cost per unit of value added, where input cost includes cost of raw mate­rial* fuel, electricity, lubricants, etc, consumed and payments to other con­cerns for work done by them.

Table 3 gives wage cost as a propor­tion of material cost as defined above. Table 4 gives percentage increase in money wage, percentage decline in unit-labour requirement (1952-58), per­centage increase in labour productivity (1952-58), percentage decline in unit labour cost (1952-58) and percentage increase in money wage (1952-58). Table 5.1 gives the price-index (base 1947) and Table 5.2 the price index (base 1952). A small comment is call­ed for here about the price indices, Both the price indices are published

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by the Ministry of Commerce. One cannot be sure that the industry clas­sification in the Census and that in the price indices are the same, but in the absence of any other price indices these have been used. The first index covers 14 industries and the second one 18 industries. Cost-price rela­tionship study has been, therefore, limited to these industries for which data are available.

It can be seen from Table 4 that during 1947-58 wages have gone up in all industries. Percentage increases in wage between 1947-52, 1952-55 and 1955-58 are given in the Table. With rising wage, unit labour cost (see Table 2) also increased during 1947-52 in 18 out of the 23 industries, but since 1952 the trend of unit labour cost has been almost reversed. A l ­though wages continued to rise, unit labour cost declined during 1932-55 in 19 out of 23 industries and in one it remained constant. The trend was similar in 1955-58. In 1952-58 unit

labour cost declined in 20 industries; in 1947-58 it declined in 17 industries. The evidence for most of the indust­ries for the period as a whole points to a consistent rise in money wage and decline in unit labour cost.

Table 2 shows that unit material cost increased in 16 industries during 1947-52, but since 1952 the trend has been almost reversed. During 1952-55 unit material cost declined in 14 in­dustries and during 1952-58 unit ma­terial cost declined in 17 industries.

Comparing unit material cost and unit labour cost, it can be seen that during 1952-58 the trend of the two is very similar. During this period both unit labour cost and unit mate­rial cost have declined for 17 indus­tries. Table 3 gives the relative mo­vement of wage cost and material cost, where wage cost has been ex pressed as proportion of material cost. It can be seen that during 1947-58 wage cost as proportion of material cost declined in 21 industries, jute

T H E E C O N O M I C W E E K L Y October 23, 1965

and matches being the exceptions. During 1952-58 the proportion de­clined for 17 industries with biscuit-making, soap, cement, plywood and tea-chests, cotton textile and jute tex­tile as the exceptions. For most in­dustries, therefore, the evidence is that wage cost has declined faster than material cost so as to depress the ra­tio.

From Table 3 it can also be seen that wage cost forms a quarter of ma­terial cost or in other words . wage cost is less than a quarter of the to­tal cost in the manufacturing sector as a whole. Inter-industry variations in the proportion of wage cost to ma­terial cost are wide: it is much below 10 per cent in industries like wheat flour, rice-milling, vegetable oil anrT soap, and as high as 90 to 100 per tent in ceramics. The coefficients of variation of the proportion of wage costs to material costs are 73.29 per cert, 82.63 per cent, 84.78 per cent and 76.48 per cent, in 1947, 1952, 1955 and 1958 respectively.

Rising wages accompanied by de­clining unit wage cost is not very di­fficult to explain. Unit labour cost is the product of unit labour require­ment and wage rates. If, therefore, unit labour requirement declines rapidly because capital is being substituted for labour due to a change in the rela­tive prices of capital and labour then the product of unit labour require­ment and the higher wage rate in alternative situations may decline even in the absence of technical progress. In the language of economic theory, when wages rise capital is substituted for labour and when the elasticity of substitution is greater than unity la­bour cost declines.2

The decline in unit material cost (in the face of constant or rising raw material prices) cannot be explained unless a further assumption is made. The assumption is one of technical progress, t e, rising technical effici­ency which makes possible efficient use of raw materials and hence de­cline in unit material cost. The declin­ing trend of unit labour cost and unit material cost in Indian manufacturing industries may be, therefore, attribut­ed to:

(a) elasticity of substitution of ca­pita! for labour being greater than unity; and

(b) technical progress, i e, rising technical efficiency.

Unit Material Cost and Price: The 1952-53 based price-index (Table 5.2) shows movement very similar to that of

unit material cost. It shows decline over 1952-55 for 14 out of 18 industries. The exceptions are cotton textile, woollen textile, aluminium, copper and brass and general and electrical en­gineering for which the unit material cost increased during 1952-55, Com­paring the movement of unit material cost and price during 1952-58 it can be seen that the movement of mate­rial cost and prices are not similar for rice-milling, soap, matches, cement, paper, sugar, cotton textile, woollen textile, chemicals, bicycles, aluminium and general and electrical engineering (tools and implements in Table 5.2). If the 1947-based price index (Table 5.1) is compared with movement in unit material cost it can be seen that prices increased for all the industries during 1952-58, except glass and jute, whereas unit material cost declined for all industries. The evidence, there­fore, does not support similar move­ment of unit material cost and prices.

Unit Wage Cost and Prices: With the 1952-53 based price index (Table 5.2) it can be seen that prices are higher in 1958 for 13 out of 18 indus­tries. However, of these 33 industries unit labour cost increased during 1952-58 in soap and cement only. With the 1947-based price index (Table 5.1) it can be seen that prices in 1953 are higher for 13 out of 15 industries. In most of these 13 industries unit la­bour cost declined during 1947-58. The evidence, therefore, is that move­

ment of unit wage cost and prices are also not similar.

Labour Productivity, Wage and Unit Labour Requirement: Table 4 gives the variations in labour produc­tivity and wage (both in current pri­ces) and unit labour requirement during 1952-58. From the table it can be seen that unit labour requirement has declined in almost all industries. The extent of variation is not uniform. Labour productivity has increased in all industries except soap and cement and in most cases the increase in pro­ductivity is higher than that in wages. The exceptions are soap, cement and plywood. It is, therefore, also not true that wage-productivity disparity is a general phenomenon.

III The movement of costs (wage and

material cost) in the different indus­tries has been examined above. Move-ments of costs and prices have also been compared. The comparison do not suggest any unique relationship between cost and price for every in-industry. In this section the lindings are summarised by a simple statisti­cal technique.

The data used in this section are: (a) index of wage and material costs combined with 1952 as base; (b) wholesale price indices with 1952-53 as base; and (c) index of rate of re­turn with 1952 as base — we call this

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