Worth its weights

Economists often tell the story about the drunk, the coin and the lamp-post. A drunk is searching around a lamp-post for a coin. On being asked where he dropped it, he waves unsteadily in the darkness beyond reach of the lamp-post’s light. Why not look there? Because, he tells you, the light’s over here. The point, for economists, is that our approach to problems is frequently warped by what data we have available. We tend to search for the solution in the light of good, comprehensive data — even when the problem’s somewhere out there in the dark. For a very long time, India’s inflation discussion has been premised around the wholesale price index (WPI). That’s because the WPI appears with less of a time-lag than the consumer price index (CPI), and macroeconomic policy needs the most timely data possible in order to respond nimbly. It’s also more comprehensive than the CPI — the equivalent of the retail price indices that are, for solid theoretical, practical reasons, used internationally.

But it isn’t very useful for several reasons. First, it doesn’t include the services sector, 60 per cent of the Indian economy. (Neither does the old CPI.) This severely compromises its reach. Second, a large proportion of wholesale prices are of tradables — goods and commodities subject to international prices. Having the primary index of local prices so sensitive to prices set outside your economy warps both national discourse and policy-making. Finally, it doesn’t have the right “weights”. In constructing an index, the crucial step is to weigh the prices in each sector with how much from that sector the average household buys. Food should be given more weight than energy, and so on. The inflation you calculate is sensitive to the weights, so its important to get them right. The new CPI uses weights that are based on five-year old survey data, much more recent and useful than those used by the old CPI or the WPI.

This is an important step towards modernising India’s most basic diagnostic data. The next step is to ensure that it’s used as the essential building-block for policy work.