lok-sabha-elections

Updated: Mar 23, 2019 20:29 IST

The rural economy and farm distress will be leading themes of the coming elections. Here’s a primer on the key issues with a focus on facts, economic analysis, and policy options.

Where are we today?

Policy makers and the public need to recognise four key facts about Indian agriculture. First, productivity per worker is abysmally low. India produces 300 million tons of cereals with 275 million cultivators and agricultural labourers. For comparison, the US produces 475 million tons of cereals with 8 million cultivators, agricultural labourers, and seasonal workers. Thus, per worker agricultural productivity in the US is around 50 times greater than in India, consistent with recent research estimating that agricultural output per worker in rich countries is 30 to 50 times higher than in poor countries. Reasons include very small plot sizes, inadequate public investments in research and irrigation, and limited mechanisation and technology adoption.

Second, value addition in Indian agriculture is low, especially for small farmers. Systematic analysis is limited by the lack of data, and the difficulty of measuring and valuing farmer’s labour on their own farms. However, recent estimates from an ongoing study are illustrative. Nicholas Ryan (Yale University) and Anant Sudarshan (University of Chicago) measured farmer profits and inputs used in Rajasthan in the 2017 Rabi season, and find that even with all government subsidies on electricity, fertilizer, and seeds, and valuing the cost of farmer time at zero, 17% of farmers made a loss. If the costs of inputs are calculated correctly at the economic cost (without subsidies), 35% of farmers would have made a loss. Finally, if we value farmers’ labour on their farms at the local wage, then 76% would make a loss. Thus, the effective earnings from farmers’ work on their own farms is considerably lower than the market wage.

Third, the status quo is ecologically unsustainable in many parts of India. Estimates from the Central Ground Water Board point to a 61% decline in groundwater levels in India between 2007 and 2017. This is in part the result of free or highly-subsidized electricity to farmers who then plant water-intensive crops in areas that are already water scarce. The large declines in groundwater suggest that this model is unlikely to be sustainable. Finally, the status quo is fiscally unsustainable. The fiscal pressure of subsidies, price supports, and loan waivers is so severe that a senior government official recently remarked to me that “it would be cheaper and better for the country to just pay (economically unviable) farmers to not grow anything rather than subsidising economically and ecologically unsustainable cultivation.”

How did we get here?

While there are several reasons for this gradually-building crisis, an important one is that the budget for Indian agriculture is spent quite badly — mainly on subsidies, price supports, and loan waivers. Subsidies and minimum support prices (MSP) may have made sense in the 1960s when India was responding to a food crisis, and needed to achieve national self-sufficiency in food production. However, 50 years later, these same policies now contribute to the agrarian crisis we are in. There are several reasons for this.

First, while these policies help farmers in the short-term, they limit fiscal space for productivity-improving public investments. The huge gaps in per-worker productivity noted above can be partly attributed to the cumulative effective of such underinvestment over time. Second, these policies induce and reward inefficient consumption, and contribute to the increasing unsustainability of Indian agriculture. For instance, free electricity for farmers encourages groundwater depletion, the structure of fertilizer subsidies contributes to systematic overuse of urea and a long-term decline in soil quality, and minimum support prices and procurement for rice, wheat, and sugarcane (combined with other subsidies) induce their cultivation in suboptimal areas and reduce diversification of crops.

How do we move forward?

The discussion above highlights that India needs a structural transformation that improves agricultural productivity per worker and frees up farmers to shift to higher-earning occupations. This will require shifting public funds away from subsidies, MSP increases, and loan waivers, and using those funds for productivity-enhancing investments, increased research in productivity-enhancing technologies and accelerating their adoption, and reducing risk for farmers through ex-ante crop insurance based on rainfall (that does not affective incentives for effort) rather than ex-post loan waivers (that penalise responsible borrowers).

These points are obvious to most economists, and have been made in official documents such as the Economic Survey 2015-16. However, we have to accept the reality that the political process will focus on short-term farmer welfare and votes. Indeed, this is a leading reason for why we are where we are. Thus, it is essential to design policy options that both alleviate farmer suffering in a visible manner, and facilitate the structural transformation above.

One promising way of doing this is to direct all additional budgetary allocations for loan waivers and MSP increases (both of which disproportionately benefit rich farmers and create perverse incentives) to direct income transfers to farmers. The good news is that the political success of the Rythu Bandhu Scheme (RBS) in Telangana has prompted both other states like Orissa and the central government to adopt a similar approach.

The next step will be for the central government to design a “grand bargain” with states whereby it calculates the total economic value of subsidies that different states are getting and then offers states the option of accepting a fiscally-equivalent lump-sum transfer in lieu of the subsidies. This will enable states to increase the value of the income support offered to farmers in lieu of subsidies. Over time, it may make sense to provide such transfers regardless of whether cultivation takes place. This will facilitate marginal farmers for whom cultivation is unprofitable to use the income to engage in other more productive economic activities. Receiving reliable income transfers for marginal lands (and facing the true economic cost of inputs) will also increase the likelihood that farmers lease out land for more productive uses.

Such a grand bargain will also give states the fiscal and policy space for other innovative reforms. One promising example is Punjab’s recent Paani bachaao, paisa kamao (Save water, Make Money) scheme (being designed and evaluated by JPAL). Farmers continue to get free power as before, but if they consume less than a benchmark (based on average usage in prior years) they get the subsidy amount transferred into their bank account. This is good politics because farmers cannot be worse off, and water conservation earns them money. But it is also excellent economics because farmers now consider the correct price of water in their decision-making and have incentives to conserve water.

The combination of low productivity, economic unviability, and fiscal and ecological burden of subsidies is taking Indian agriculture close to a breaking point. Sustainably improving farmer welfare requires a clear understanding of the issues outlined here, a single-minded focus on improving productivity per worker, and economically sound policies that farmers can see as being beneficial to them. The success of the RBS and its rapid replication suggest that unleashing the creativity of states through a grand fiscal bargain between centre and states may be a promising option for improving agriculture policy and outcomes.

(Karthik Muralidharan is the Tata Chancellor’s Professor of Economics at UC San Diego)