Stubble burning has highlighted the distortions in the food economy in India more starkly than perhaps ever before. Policymakers need to address subsidies for procurement, power and water, as well as legal and administrative restrictions on agriculture.
On the one hand, farmers are subject to restrictions of various kinds. These enhance price shocks and the impact of the vagaries of weather. On the other, they are provided thousands of crores in subsidies for power, water, fertilisers, procurement prices, and now income support.
The policy framework for food first creates distortions, and then tries to make amends by creating further distortions.
‘Food-shortage economy’ mindset
At the heart of the problem of the food economy lies a historical insecurity — that India is a food shortage economy. Even though India no longer has a shortage of cereals, the legacy of the droughts in the mid-1960s and the food shortages they led to has shaped the foundations of the food economy. The country does not trust agricultural markets to work.
From the price of input (seeds, fertiliser, water, power) to the price of output (through minimum support prices), procurement by the Food Corporation of India at prices set by the government, laws to govern whom to sell to, restrictions on where to sell and bans on storage of essential commodities — there is no functioning “market” in agriculture.
The food market in India is characterised by mainly small producers. Farmers face monopsony (buyers with market power, in contrast to monopolies, which are sellers with market power), complicated legal and administrative structures, and ad-hoc state intervention. Sometimes the intervention favours consumers, as in the case of onion prices, when the state tries to keep prices down by banning exports, while sometimes it favours farmers, such as when it allows exports if there is a glut in the market. Ad-hoc policy changes and high volatility make the system unstable.
In the case of industry, India has moved to a market economy, progressively removing barriers to trade and reducing the arbitrary power of the state. However, in the case of agriculture, the existing system continues with outdated institutions, and then tries to compensate by subsidies and transfers.
Removing subsidies alone isn’t the solution
At first, it seems that subsidies are the problem and doing away with them is the solution. However, subsidies are a response to the distortions created in the market by a number of legal and administrative restrictions.
Along with getting rid of the subsidies, these restrictions need to be removed. A study by NIPFP identifies the following four key ways in which volatility in agricultural markets can be addressed.
Warehousing: With well-functioning storage, food could be transmitted from one time point to another, thus reducing the peaks and troughs of prices. Under the Essential Commodities Act, 1955, state governments have been delegated the authority to control the production, supply and distribution of essential commodities. Powers under this law are used to suddenly prevent storing of large quantities of agricultural commodities when the government perceives ‘hoarding’ is leading to price increases. This severely hampers storage capabilities of any ‘national’ business, which may smoothen demand by seasonal storage.
International trade: The world market can act as a buffer stock: When there is a glut in India, food would be exported, and vice-versa. Export and import controls are placed whenever domestic prices fluctuate. This reduces incentive for farmers to actually plan for export markets. In turn, international traders cannot depend on long-term contracts being fulfilled and may stop depending on Indian exports. This leads to lack of investment in production of food that may be exported. Intermittent and frequent export bans on onions and rice are examples of measures which may be destroying normal market mechanisms from being employed.
National market: A national market is required to achieve smooth operation between the large number of micro-markets within the country. Food would move from areas with high output to areas with low output. The barriers and restrictions on trade in agricultural goods placed by individual states are so high that it is not commercially feasible to enable a national market. The APMC laws, storage laws and other legal structures promote oligopsonies (small number of buyers, large number of sellers), with cartels of buyers within the state. National players without affiliation to such cartels are unable to participate in the agricultural trade.
Futures markets: Well-functioning futures markets can give guidance to private persons on decisions about sowing and storage.
In addition to legal barriers, there are technical barriers to trade. There are other state laws which require many technical compliance requirements, making it difficult to physically move goods across markets.
Some of these are the checks placed on each APMC border, the checks placed on each state border, the tax compliance procedures, and the time taken to comply with each check.
These are similar to ‘technical barriers to trade’, which sovereign nations sometime impose and are essentially transaction costs that can be compared to a “tariff” on inter-state trade.
Such a tariff adds to “final cost paid by consumers and creates a deadweight loss in the economy”. Therefore, each state essentially “treats goods produced in other states as equivalent to imports”.
As the food consumption basket changes, policymakers in India need to get out of the cereal-shortage mindset and find ways to allow farmers to tap markets better to improve their incomes while reducing volatility. It is time to review this basic framework.
The author is an economist and a professor at the National Institute of Public Finance and Policy. Views are personal.