#148 All The Wrong Reasons

India Policy Watch #1: Nayi Umar Ki Purani Fasal Insights on burning policy issues in India — RSJ PM Modi, in an address to the nation at 9 AM on Friday, repealed the three farm laws that had been pushed through in the parliament without any debate more than a year ago. Choosing the occasion of Guru Nanak Jayanti, the PM said his government was unable to convince the farmers about the benefits of the laws. We have written a few times earlier about our view on farm reforms and these three laws in particular (we have linked them at various places in this edition). This repeal might well mean farm sector reforms are dead and buried for a decade, if not more. This is going to be terrible for Indian agriculture in the long term. That apart, as public policy watchers, there are few important lessons to take away from the entire episode. Before we get onto what we learnt, a short summary of where we stand on the farm laws. Firstly, on any measure of outcomes, Indian agriculture is in a terrible state. Things are so bad that you can safely say there's no change that can make it any worse. In edition #70 (Section: No Looking Back on Agricultural Reforms), we wrote: The dismal state of Indian agriculture bears no repetition. The farm income growth has been stagnant for the last 6 years. The small and marginal farmers who constitute 86 per cent of India’s peasantry barely make a living out of farming with average per capita annual income below Rs. 100,000. About 45 farmers die by suicide on an average every day. The Food Corporation of India (FCI) buys the produce at the minimum support prices (MSP) from the mandis and distributes it at a subsidised rate through the public distribution system (PDS). This subsidy bill has grown to an unmanageable level. The FCI borrows from National Small Savings Funds (NSSF) to keep its operations going. It is estimated this loan will rise to Rs. 3.5 lakh crores in FY ‘21 from Rs. 2.5 lakh crores in FY ’20. Millions of ordinary Indians trust NSSF with their lifelong savings. It is anybody’s guess when FCI will be able to pay back NSSF. If this appears like a giant Ponzi scheme, that’s what it is. The food grains stocked at FCI are at an all-time high but there’s no market mechanism for its distribution when people needed it the most during the pandemic. They had to wait for the largesse of the state for the stored grains to reach them. This is a broken system. Even if you set out to create a dysfunctional system, you’d have struggled to reach here. Who in their right minds would want this structure to continue? Who has it helped except entrenched cartels and a few dynasties of ‘farmer leaders’ who have built a system of patronage? Agriculture contributes to about 17 per cent of India’s GDP and supports almost half of its 1.4 billion people. With that kind of skew, it is no surprise then that they live in poverty that’s comparable to sub-Saharan Africa. It will be useful to frame a simple model of agriculture productivity to appreciate the issues here. In modern states, land is a finite resource for most owners. Land cannot be annexed from others nor can you squat on a piece of land, mix your labour with the soil and then claim ownership of it. This means landholdings continue to get divided and smaller as they get passed onto the next generation. Smaller holdings are less productive and this sets in a cycle of impoverishment. Almost every nation that transitioned from a low-income economy to a middle income or beyond learnt this truth the hard way. At The Root Of It There are two simultaneous moves that an economy must make to solve this. First, enable the creation of a huge number of low or medium-skilled jobs that can attract labour to move out of agriculture. And second, increase productivity for those remaining in the farm sector to increase their incomes. To put it charitably, we have had moderate success doing the first. The three decades since 1991 have created more non-farm sector jobs than the four before. We could have done more. Much more. But at least we tried. On the second, we haven’t even done that. Despite the many committees that have diagnosed the problem and recommended specific measures, we have baulked at carrying out any serious agriculture reforms. Things continued to get worse while urban Indians read articles that romanticised the Indian farmer and his sacred relationship with the land. Ironically, while being driven by someone who might have quit farming, preferring to live in urban squalor than dying on his land. The simple model of farm productivity then focuses on three drivers: * Optimal decision making: Farming is about getting a few key decisions right - when to sow, what seeds to sow, the likely pests, blight or negative weather events that can be predicted and how to insure the downside of things going wrong? Farming is a high-risk venture and getting the many small decisions right is critical. There’s science behind making these decisions and with greater availability of data and better connectivity, the farmers can make better choices. * Mechanisation: This is a no-brainer. A tractor-driven cultivator is about a hundred times more productive than an ox-driven one. Like this, across the farming supply chain, there are multiple opportunities for a machine to replace human labour. This and the use of ammonia-based fertilizers are what drove huge productivity jumps in farms in the western world in the early 20th century. * Logistics: Farm produce is either perishable or vulnerable to infestation and spoilage. The ability to store and move the produce safely between farms and markets have an impact on productivity Now, for these three levers to be used effectively, there are two necessary conditions - the ability of the farmer to sell their produce freely to anyone and at a price they both agree on. This is important to appreciate. This freedom to choose who to sell to and the role of price as a signal are both important for any producer to work on improving their productivity. Distort this and you take away the incentives from the producers. This is a counterintuitive notion for most people. Our natural intuition is I will be better off if I know what price I will get for my product. So, most of us think fixing a price in advance is good. Unfortunately, this kind of a price cap or a floor, makes things worse as it has been seen in agriculture in India. Deadweight loss is real in most instances. Price is an outcome of millions of voluntary transactions between buyers and suppliers. Like Hayek wrote (see the original article in the HomeWork section of this edition): The peculiar character of the problem of a rational economic order is determined precisely by the fact that the knowledge of the circumstances of which we must make use never exists in concentrated or integrated form but solely as the dispersed bits of incomplete and frequently contradictory knowledge which all the separate individuals possess. The economic problem of society is thus not merely a problem of how to allocate “given” resources—if “given” is taken to mean given to a single mind which deliberately solves the problem set by these “data.” It is rather a problem of how to secure the best use of resources known to any of the members of society, for ends whose relative importance only these individuals know. Or, to put it briefly, it is a problem of the utilization of knowledge which is not given to anyone in its totality. It is a terrible idea to fix prices as history has shown us over and over again. Instead of price caps, the answer to protecting against price fluctuations in any product is the creation of a futures market that provides a mechanism to protect the downside risk for the producers. The farm laws that have been repealed were a major step in going down this path of freedom for farmers. Any other alternative to these reforms must address these fundamental points. Else, it will not solve the productivity challenge in Indian agr… This is a public episode. If you would like to discuss this with other subscribers or get access to bonus episodes, visit publicpolicy.substack.com