How the agrarian crisis can be eased

The current agrarian crisis in India is a product of two factors: failure to recognise when the Green Revolution started giving diminishing returns and taking steps to come up with alternatives; and the economic impact of subsidies.

The current crisis can be summed up as diminishing soil fertility, sinking water table, increasing costs (all effects of the Green Revolution) and poor returns to farmers, periodic unaffordable spikes in key commodities, and periodic excess production which are dumped on the roads ruining several farmers and a huge burden on the government.

The policy failures have arisen due to not recognising the nature of demand and supply curves for agricultural commodities. The demand is highly inelastic — in a market which consumes 100 kg tomato if one supplies 125 kg, the prices collapse, since not much demand is there for the excess. Contrarily, when only 75 kg is supplied, the prices skyrocket since everyone wants to garner their daily supplies.

The graph plots the demand and supply of a typical agri crop. The cost build-up of various suppliers is arranged from lowest to highest and its ridge on top becomes the supply curve. In agriculture, the demand curve is steep and supply curve is relatively flat. Where this is the case the market price is closer to the supply curve. This leaves a huge consumer surplus (excess of what the people are willing to pay and what they actually end up paying) and thin profits.

Where the demand curve is flat, the price line stays closer to demand and hence smaller consumer surplus and higher profits for producers.

Many people have argued for breakup of cartelisation of middlemen and dismantling or reforming APMCs (Agricultural Produce Market Committees) as the panacea for better farm-gate prices. This is as naïve as it can get. The middlemen are performing important functions like taking immediate delivery of perishables, financing farmers, storage, connecting with customers and markets, and inventory-holding. If left to government agencies, they would mess it up.

Sure most farmers are small (crops from 2-3 acres to sell) and their reach is at best the village boundaries or 4-5 km. How can they perform all the functions the middlemen do? At the mandies of course it is a case of ‘many sellers’ versus a ‘fewer buyers’. But it is foolish to think that fewer numbers by itself creates usury pricing power. Most markets should have at least 40-50 buyers (or middlemen) versus maybe 500-1000 sellers.

But this is statistically enough to create conditions of undistorted trade. Imbalance might creep in if there are only 3-4 on one side and can collude overtly or covertly. Most suggestions on ‘reining in’ middlemen for tackling agrarian crisis is bound to be ineffectual.

Flatness of supply curve

But the real problem is the supply curve’s flatness. This is largely the result of the government’s ill-advised subsidy policy which makes no discrimination whatsoever on the various input subsidies to agriculture. When everything from electricity, water, seeds, fertiliser, interest, are given free or subsidised without any limits of landholding or size, it leads to similar cost structures for most suppliers and hence the supply curve becomes flat (as shown in ‘Before’ segment in graph). Even if all mandies are handed over to the farmers, with such a curve, their profitability is unlikely to improve much.

The solution should revolve around exploiting the inelasticity of demand. The sure-fire solution is to make the supply curve more elastic and harvest a huge ‘consumer surplus’ (which is what the middlemen do — they don’t take away farmers’ profits; they take away consumers’ willingness to pay).

This can be achieved by rationalising subsidies. This can be done by restricting subsidies to only those holding 2-3 acres or to the first 2-3 acres only for even for larger farmers. With precise targeting through DBT (Direct Benefit Transfer), it is possible in the current scenario. Or it can be graded like 100 per cent of current levels for 2-3 acres, 50 per cent for 4-8 acres and nil thereafter, like in the graph. This will increase the cost for larger farmers (all units with ‘L’ label on X-axis) and induce a steepness (as shown in the ‘After’ situation in the graph).

The prices as is seen in the graph will rise ( from ₹69 to ₹84). This shifts a portion of consumer surplus to producer profits. This will mostly benefit the small and marginal farmers. This transfer is perhaps much needed. We cannot have a society where 55-60 per cent of people get a share of 15 per cent of GDP.

The quantities bought and sold will fall. But given the inelasticity of demand, it will be relatively much less.

The larger units which lose a part of their subsidies will become uncompetitive in their traditional crops. They will diversify into other commercial crops or crops for which there are no subsidies now so that they won’t suffer in relative terms versus subsidy-supported small farmer.

This is an important necessity. Our foodgrains production is in surplus and for increasing its income, diversification is a pre-requisite. This will also partially address the rural income inequality problems.

Governments ‘ finances

The government will save a lot by curbing subsidies going to larger farmers. It can reduce the crops procured under MSP since the market prices would have substantially moved to enhance their incomes. This would have come from consumers who were willing to pay, hence maybe without much pain (other than a one-time price adjustment as inflation).

The government may have to spend a part of its savings on covering some poorer marginal sections (who are net buyers of food) through higher PDS subsidies.

A portion of PDS procurement can be reserved for organic farming by larger farmers. With the promising growth for organic products the world over, it could give an early-mover advantage.

The government need not do this rationalisation for all products. It can start with those where there are surplus buffer stocks. If prices of those products move up, consumers will diversify their consumption basket to other products and their prices of un-subsidised products will also start moving up. Larger farmers would gravitate towards such products.

The writer is the author of ‘Making Growth Happen in India’.

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