Psychology, cyclicality or social programs: Rural wage and inflation dynamics in India

The paper analyzes causes of movements in Indian wages for rural unskilled male laborers, and assesses their impact on inflation. Theoretical priors derived from an analytical framework based on the concepts of fair wages, salience and over-reaction are tested using a State level rural wage data panel. The model predicts that a rise in food price inflation, non-traded wages and productivity, reduction in net labor supply, rise in labor demand and employment in the traded goods sector would raise wages in the traded goods sector, while changes in the exchange rate could have ambiguous effects. In dynamic panel regressions, food price inflation and the fiscal deficit share were two variables that were consistently high and significant, with the effect of the first three times larger. The spread of MGNREGS did not raise wages, but the sharp jump associated with wage indexation, itself a response to high food prices, did. The set of government programs impacted wages, more than a single one. Cyclical or policy variables had a minor impact. The results are in line with the predictions of the model and support psychological and social as compared to cyclical factors. The impact of wages on rural food prices was not as large, indicating some rise in productivity. Since multiple supply shocks impacted food prices and special circumstances drove the unusual rise in real wages, large nominal wage growth may not persist if food inflation and the fiscal deficit moderate.