by Utsa Patnaik
The war inevitably involved in all countries an immense diversion of resources to forms of production which, since they did not add to the volume of liquid consumption goods purchasable and consumable by income earners, had just the same effect as an increase in investment in fixed capital would have in ordinary times. The investment thus required was, especially after the initial period, on such a scale that it exceeded the maximum possible amount of voluntary saving which one could expect, even allowing for the cessation of most other kinds of investment including the replacement of wastage. Thus forced transferences of purchasing power in some shape or form were a necessary condition of investment in the material of war on the desired scale. The means of effecting this transference with the minimum of social friction and disturbance was the question for solution.3
He then went on to discuss the three different methods through which such “forced transferences of purchasing power” could be achieved: first, by reducing money wages while keeping prices steady; second, by letting prices rise more than money wages so as to reduce real wages; and third, by taxing earnings. Taking up the third course, he wrote that “the rich were too few,” and therefore “the taxation would have had to be aimed directly at the relatively poor, since it was above all their consumption, in view of its aggregate magnitude, which had somehow or other to be reduced.”4 But the additional taxation of wage-earners would have to be substantial, it would meet trade union resistance, and it would be difficult for the government to implement.
“It was a choice, therefore, between the remaining alternatives—between lowering money wages and letting prices rise.…it would be natural—and sensible—to prefer the latter.”5 Keynes argued that it would be as difficult to enforce the required 25 percent money wage cut as to impose heavier taxes: “I conclude therefore that to allow prices to rise by permitting a profit inflation, is in time of war, both inevitable and wise.”6
Keynes was positing money illusion on the part of workers; they would oppose money-wage cuts for given prices but they would not, to the same extent, oppose inflation without a matching money-wage increase, even though the second course lowered their real wages to exactly the same degree as the first. However, a profit inflation cutting real wages and raising profits would not by itself serve fully the aim of financing war spending, if all profits were retained by capitalists; taxation of profits was essential:
It is expedient to use entrepreneurs as collecting agents. But let them be agents and not principals. Having adopted for quite good reasons a policy which pours the booty into their laps, let us be sure that they hand it over as taxes and that they are not able to obtain a claim over the future income of the community by being allowed to “lend” to the State what has thus accrued to them. To let prices rise relatively to earnings and then tax entrepreneurs to the utmost is the right procedure for “virtuous” war finance. For high taxation of profits and of incomes above the exemption limit is not a substitute for profit inflation but an adjunct of it.7
Keynes’s reasoning is clear. There had to be a substantial decline in the real consumption of the ordinary mass of the population, and this could best be achieved without working-class political opposition, not through additional taxation, but by a profit inflation, by following policies that raised output prices without raising wage incomes at all, or to the same extent. This would redistribute incomes away from wages to profits, which should then be taxed.
Keynes’s views on raising resources for war spending in Britain were amplified in newspaper articles in 1939 and 1940 and in How to Pay for the War, where he repeated the necessity of reducing mass consumption through an engineered inflation and also discussed the methods of taxation and deferred payments.8 As an influential adviser both to the British Chancellor of the Exchequer and to the Prime Minister, in view of his long association with Indian fiancial affairs, Keynes “had special authority in discussion of Indian financial questions.”9 And this is how he came to implement his ideas on profit inflation as the means of raising finance to serve the Allies’ military spending in India.
War Financing through Profit Inflation in India
India’s export earnings recovered slowly from the mid-1930s as the developed world, especially the United States, started following expansionary policies. Total budget spending from 1937–38 to 1939–40 averaged Rs.888 million, while the average annual deficit was only Rs.13.3 million. (With the exchange rate averaging about Rs13.5 to £1, the initial budget size was about £66 million.) During 1939–40, gold worth Rs.347 million was transferred from India to London, and the Reserve Bank of India (RBI) was credited with equivalent blocked sterling marking, in effect a forced loan.
After December 1941, when the United States entered the war against Japan, Allied forces poured into Bengal, and war spending grew by leaps and bounds. The category “recoverable expenditure” had been created under an agreement signed by the colonial government with Britain, specifying that the major costs of provisioning and operating Allied forces in India would be met through Indian resources until the end of the war. It represented a forced loan from India to Britain of unspecified value. The Reserve Bank of India would be credited with the sterling equivalent of the rupees spent by the government. However, the account would be frozen, no sterling would be made available for actual spending, and the account would be activated only at the end of the war, whenever that might be. The remaining war spending was to be borne entirely by India. It was the “recoverable war expenditures” that became a death warrant for three million persons in Bengal.
The movement of Allied troops and air forces into Eastern India grew rapidly from early 1942; construction of airstrips, barracks, and war-related industries was undertaken at a feverish pace. Private investment and output grew fast for munitions, chemicals, uniforms, bandages, and the like. The troops and supporting personnel had to be fed, clothed, and transported at public expense. A war boom of unprecedented proportions resulted as total spending by the central government exploded to reach Rs.667 crore by fiscal 1942–43, or a 7.5-fold increase in expenditure over the Rs.88.8 crore annual average for the triennium 1937–40, merely three years after the end of the triennium (see Table 13.1). Increased taxation had only doubled the revenues by 1942–43, and the government’s deficit on its own account had ballooned from near zero to Rs.112.2 crore in 1942–3. However, over the same period a more than four times larger sum was additionally spent every year under “recoverable expenditure” for the Allied forces, comprising additional deficit financing and amounting to 2.2 times the normal pre-1940–41 annual budget. The total deficit summed over the three years from 1940–41 to 1942–43 reached Rs.704 crore, or Rs.235 crore annual average (see Table 13.1). Eighty-one percent of the total deficit was on account of the “recoverable war expenditures” undertaken for the Allied forces, while nineteen percent was on account of the central government’s own spending.
This exploding deficit was entirely met by printing money, which was justified by treating Britain’s sterling-denominated entries with the Reserve Bank of India as assets. That this was not only specious but disingenuous reasoning is clear enough. Assets or “reserves,” as the term itself indicates, are meant to be actually there to be drawn upon in case of need, while these sterling reserves were a paper fiction; they did not actually exist since not a penny could be drawn. Nor was there any certainty of their being paid out in future, as promised, after the war ended. The nonexistent, so-called reserves were an accounting device for extracting massive resources from the Indian people.
TABLE 13.1: Central Government Total Outlay, Revenues and Deficits 1937–1946 in Rupees Crore 572.70 (one crore = 10 million)
Source: Report on Currency and Finance 1946–47, (Bombay: Reserve Bank of india, 1947), Table 15.10
During the Depression years, administrators trained in classical theories of sound finance and balanced budgets had actually cut domestic spending as revenues had fallen, thus intensifying the adverse effects of depression. Such
conservative officials in India did not decide on the opposite course of monetizing massive deficits every year amounting to a multiple of the entire normal budget. Indian monetary policy was now being directed solely from London, and all caution was thrown to the winds to serve metropolitan interests at the expense of the Indian people. The Reserve Bank of India, set up in 1935, served as a pliant tool and implemented the fiction that mere paper entries of sterling sums were the same as actual reserves. Corresponding to the suddenly expanding level of wartime activity, it expanded the money supply nearly sevenfold (Table 13.2).
The reckless deficit spending undertaken for the Allies grew fastest between 1940–41 and 1942–43. The 1940–41 outlay was already 69 percent higher than the previous year; the next year, it more than doubled, and nearly doubled again the following year. Over two years government outlays expanded at 98 percent per annum (Table 13.1). By 1942–43, total outlays reached a level equaling 35 percent of the initial, 1939–40, national income of British India, and they reached 51 percent of it as outlays peaked at Rs.970 crore in 1944–45.11 Keynes cautioned against excessive spending, but solely in the interest of limiting Britain’s postwar indebtedness. He showed no interest in the extent of adverse impact on the Indian population—after all, the whole point was precisely to reduce their consumption.
The unprecedented explosion of public expenditure, combined with the private investment boom generated, through multiplier effects that were strong for a poor population, a sudden and immensely increased demand for food, clothing, and other necessities on the part of the rising numbers employed in the war industries, in addition to the demands of the Allied personnel. While multiplier effects that raise demand call forth increased output, where most of the demand was for primary products and expanded with such rapidity in a matter of months, the adjustment was bound to be through rise in prices rather than output increase. Agricultural output could not possibly grow fast, and in Bengal rice output had been in absolute decline for three decades owing to land and resource diversion to export crops. Nowhere in the world were such irresponsible monetary policies followed during the war as in India, and arguably nowhere else was inflation as rapid.
Figure 13.1: Central Government Total Outlays, Revenues and Deficits, 1938–39 to 1945–46, in Rs. Crore (one crore = 10 million)
Source: Table 13.1.
The personnel required for producing essential materials and war goods were protected from price rise to a large extent through a system of food procurement and rationing which was rapidly put in place by the government.12 The urban population in one way or another had access to food, though it did have to take large cuts in real consumption. The burden of financing the mountainous extra public outlays was passed on to the unprotected mass of the rural population, which was severely affected, other than a small minority of landlords and moneylenders who benefited by foreclosing on the mortgaged assets of the majority struggling to survive.
Most of the government provisioning for the troops, supporting personnel, and the new urban public distribution system was sourced from the surrounding hinterland of the towns in Bengal. Prices of all necessities started rising: the price of rice per maund (a maund equalled 82 lbs) in Calcutta quadrupled from Rs 6 in January 1942 to Rs 24 in April 1943 and nearly doubled again to Rs. 40 by October the same year. Small towns saw the price per maund rising to between Rs 60 and Rs.100.13 For comparison, in 1940 the per capita income was Rs.5.33 per month. While prices trebled in India as a whole by 1943 (see Table 13.2), the inflation was much sharper and compressed within a shorter period in Bengal where the bulk of the increased government spending and sourcing of food from rural areas actually took place.
Not an iota of sterling due to India as recoverable war expenditure was made available for food imports. India had again developed a merchandise export surplus, which, had it been a free country, could have paid for food imports. But these earnings continued to be entirely appropriated by Britain: from 1939–40 to 1943–44 India’s merchandise export surplus totaled Rs. 397 crore or about £290 million (Table 13.1) and a sum in excess of this was paid by the RBI to Britain as “debt repayment.”14
As rice prices doubled, quadrupled, and rose sixfold, the laborers, artisans, fisherfolk, and poor peasantry in Bengal did not know what had hit them. Food stocks physically disappeared, as the government bought up available supplies through contractors for urban distribution and as traders held on to stocks anticipating further price rises. Many thousands of rural families, already at the margin of subsistence, sank first into dearth, then into hunger, followed by starvation and finally by death. Many of those who survived and migrated in search of food to the cities, in their weakened state, succumbed to disease. The final death toll during 1943–44 has been placed conservatively, after reviewing the evidence, at between 2.7 to 3.1 million by A. K. Sen,15 while some authors writing at that time cite up to 3.5 million, taking into account secondary effects of higher morbidity. The sample survey carried out by Mahalanobis, Mukherjee, and Ghosh from the Indian Statistical Institute, on the after-effects of the famine, found that among the survivors, half a million families had been reduced to utter destitution.16 British rule in India had started with the massive famine in Bengal in 1770, which decimated 10 million people or one-third of the population of the province, the rapacity of the East India Company in trebling taxes over five years being a major reason for the high toll. British rule in India ended with a massive famine, yet again in Bengal, which was made to bear the brunt of resource extraction for the war.
TABLE 13.2: Index of Money Supply, Wholesale Price Index, and Total Deficit,1940–1946
Source: Report on Currency and Finance 1946–47 and 1947–48 (Bombay: Reserve Bank of India, 1948).
Amartya K. Sen, in Poverty and Famines, had rightly concluded: “The 1943 famine can indeed be described as a ‘boom famine’ related to powerful inflationary pressures initiated by public expenditure expansion” and had traced “failure of exchange entitlements” to such inflationary pressures.17 Utsa Patnaik had earlier identified the famine as the result of an engineered profit inflation as described by Keynes in his Treatise on Money but did not know then that Keynes was personally charged with advising on Indian monetary matters from 1940, this information becoming available in A. Chandavarkar’s Keynes and India.18 The digitization of the Reserve Bank of India records has made it easier to access the detailed data presented in Table 13.1,19 and the publication of a definitive study of India’s national income has enabled us to relate deficit financing to
GDP.20
Even though deficit financing continued at a high level until 1946, prices ceased to rise after 1943 (see Table 13.2). This was owing to the severe compression of mass demand throughout the country and the three million excess deaths, which together outweighed the continued increase in demand from organized labor employed in war-related activities, whose wages were indexed, however inadequately, to inflation. In an advanced country with unionized labor and wage indexation, a wage-price spiral would have taken place, and the inflation might have acclererated. But in India, even at its height, the organized labor force, at one million. was very small relative to total labor force; and the mass of unorganized labor, along with petty producers, simply suffered absolute immiserization.
Profit inflation saw its inception when the colonial government agreed to meet Allied war spending to an unlimited extent from the Indian budget, incurred deficits each war year to the tune of a multiple of the entire prewar budget, and monetized the deficits, printing money using the fiction that mere paper entries of sterling sums owed could be treated at par with actual reserves. The resulting inflationary war boom meant that the enormous excess of government deficit plus private investment over voluntary savings was brought to equality through the forced savings entailed in the inflation. The real income decline was so inequitably concentrated on the poorest and most vulnerable segments of the population, and the inflation was so rapid that it physically eliminated m
illions through starvation.
Utsa Patnaik wrote over a quarter-century ago: “Such a savage and rapid compression of the real income and consumption of the most vulnerable sections of a population as a direct result of financing expenditures far in excess of voluntary savings can find few parallels in the modern world.”21 Bengal’s population was especially vulnerable because its per capita absorption of foodgrains had fallen to the largest extent, by 38 percent in the interwar period, compared to 29 percent average for British India.22 During this period there was absolute decline in rice output in Bengal while exported commercial crops continued to grow.
The civilian mortality alone during the two years of famine in Bengal was over six times the total war-related deaths of armed forces personnel and civilians, estimated at less than half a million, in Britain during the entire war period. The age structure of the population in India shows that 37 percent comprised children, defined as those aged fourteen years and less. Even if we assume that child death count in total famine mortality was a lower proportion than this, at least twice as many children died from starvation during the two years, compared to the below half a million total war-related deaths in Britain over the entire war period.
While no previous author to our knowledge has linked Keynes directly to the great famine in Bengal, after putting together all the facts we have cited, there is no doubt that Keynes himself, charged with advising on Indian monetary policy, was fully aware of and directly involved in Indian fiscal and monetary developments during the war. The profit inflation resulted in forced consumption decline, hence forced savings of such a drastic magnitude that it killed three million people through starvation. Wholesale prices rose by 70 percent in England comparing 1944 to 1935, while the rise was over 300 percent in India as a whole and even higher in Bengal.23 Keynes’s advice that after “pouring the booty” into the laps of capitalists they should be taxed, was also implemented faithfully. Direct taxes in India, including the corporation tax, rose more than tenfold, and their share in total tax revenues rose from below one-quarter to seven-tenths (see Table 13.3); this, however, contributed a negligible share, below 7 percent of total additional expenditure, which relied on massive deficit financing.
