Misplaced Hopes on MSP

Misplaced hopes on MSPs

V Kumaraswamy

There is some growing frustration over governments procurement of key grains under its Minimum Support Prices (MSPs) not being to lift the open market prices of those commodities and benefit the farmers. What the policy makers and economists forget is that our MSP procurement is not an end in itself but has to be studied with its end use – distribution of such procurement under our PDS programmes and how they work at cross purposes.

Effect of MSP procurement

It is generally assumed or hoped that once the MSPs are increased the open market prices would also rise in sympathy. There is insufficient realization that such procurements hardly create incremental demand. The government has limited flexibility in increasing the quantities procured under MSP which may be a surer way of enhancing prices and how increasing farm productivity from the current levels only harms the farmer interest not help them.

The effect of procurements under MSP is quite often overestimated. It is necessary to visualize the impact of procurement operations to separate reality from hope and wishes. Lets try and understand the impact through graphical exhibits. Picture 1 orders the demand from the buyers at various prices in decreasing order of prices. The thick ridge line at the top forms the demand curve as is depicted on the left side. Any procurement by government agencies at any price leads to a kink (drawing on right side) in the normal demand curve as is shown on the right picture. It shifts the demand curve horizontally in proportion to the quantity bought (dd’ in Picture 1) at the price point equal to the MSP for the crop.

 

demand supplyIn Picture 1 due to the governments initial extra demand the total demand increases but as we will see later once the government supplies the same though PDS, the effect is neutralized.

mspdsinterplay

Picture 2 studies the combined effect of demand and supply of the same commodity as in Picture 1. The normal (without intervention) demand curve DD’ is represented by the solid blue line which shifts to Ddd’d” (partially dotted line) after procurement.

The supply curve is shown as SS’ (in solid Red line). The market price without any government intervention settles at P(free).  When the Government intervenes and procures dd’ from the market at the MSP price indicated it will move the market price of independent sellers or buyers which will not be

equal to the MSP: it will settle at lower levels. Where it will settle depends upon the elasticity of the supply curve; the flatter it is, the lesser will be the price increase. In agricultural markets there are many tiny suppliers whose cost structure hardly differs from one to another since many inputs come heavily subsidized or free to most players. Hence supply curve is often flat and highly elastic. The market price will settle at P(MSP) which is way lower than MSP but higher than the free market price of P(free).

It is a fallacy to think that hiking MSPs from the current levels will result in higher open market prices. Unless the quantities procured are increased from year on year (which will keep pushing the dotted d’d” segment further and further to the right), mere yearly MSP increases will have nil or negligible impact on open market prices.  Where P(MSP) settles will depend more on the width of dd’ than where it is above the P(free) levels. (MSPs below the free market prices are useless anyway). That’s the reason why formulas like 50% over all-in cost of farmers will prove innocuous, except benefitting those fortunate to sell their crops at MSPs directly by the Government.

Given the current levels of buffer stock in FCI go-downs, any significant increase in procurement quantities will be a hazardous exercise.

Effect of PDS distribution on prices

The crops procured under MSP are used in supplying them at cheaper (than free market prices) cost through the public distribution system to end consumers. This has the effect of changing the supply curve from SS’ (without PDS operations) to Sss’s” (partially in red dotted line in Picture 2 right side). This will lower the open market price which may even settle at levels lower than the initial free market price, as is the case in Picture 2. Will the total quantities bought and sold expand as a result of these operations? It will since production will increase due to price support and so will consumption since people more people at lower levels could afford to buy more due to lower PDS prices.  The difference between procurement and PDS supplies will be accretion/depletion to buffer stocks.

Way Out

The production of agri commodities has been surplus to requirements for several years running. The buffer stocks with FCI is far more than norms and the credit to FCI from banking system at uncomfortable levels. One way would be to export the surpluses and not supply the same back in home markets through PDS. Or sell it to private sector for food processing. Alternatively, it can allow food processors and exporters to procure crops at MSPs and reimburse the difference between market price and MSPs to them. At least the handling/storage loss can be reduced. Simultaneously, the govt should reduce the size of PDS physical distribution and reimburse the consumers through Direct Benefit Transfers even if the consumers buy their requirement in open market.

A method to tweak the supply curve by partial rationalization of subsidies on inputs to increase the market prices and thus benefit the farmers was also explored in this paper (How the Agrarian Crisis can Be Eased, June 24, 2019).

It is time we realized the areas where MSPs and PDS can be effective and where they can’t be and not be fooled by misplaced faith and theories.

Why India’s GDP numbers may be right; but so are its doubters.

Why Arvind Subramaniam is right; but Government is not wrong.

Link to the article in Businessline: https://www.thehindubusinessline.com/opinion/gdp-both-subramanian-govt-may-be-right/article28657586.ece

The ex-CEA has argued that the figures of GDP growth are exaggerated. He may be right but equally right may be the government. The tension will ease if one recognizes that it is possible to grow for some period of time without the total amount of goods and services consumed by community not increasing at all. The reverse is also equally feasible. This can happen with increase and decrease in % terms in the domestic content in value addition, or better productivity (or fall) of natural resources, etc. The crucial bridge between the two sides may be the efficiency gains and shifts in the structure of economy in the last few years.

Let’s examine the impact from efficiency gains. Business line published a few weeks ago (GST on the Highway dtd June 4, 2019) the story of a reporter’s journey with a truck driver from Chennai to Bhiwadi. He reported reaching the destination in 42.35 hrs instead of the 4 days it used to take not so long ago. The driver saved 2 days for his owner and as a bonus pocketed the petrol he managed to save from the 400 litres allowance he was allowed for the trip.

This was confirmed to the writer by an official of a leading transport company who claimed it takes 44 hours to reach Madurai from Dharuhera (Haryana) these days instead of the 4 days previously carrying cars. Only 15% of potential savings have come from GST so far; balance has come from better roads and better driver crews who operate as a team. Let’s construct (with some lenience in calculations) the effect of such savings on GDP in different scenarios.

 

Impact on GDP from Logistics savings (of the reported case)
 

 

 

Scenario —>

Before After
1 2 3 4
Customers final bill remains same; Transport company’s profits go up. Customer takes the savings (other than Drivers bonus) Customer takes away all the savings
Petrol (assumed for illustration) Ltr 400 300 300 300
Lorry Hire (day) Days 4 2 2 2
Driver gets paid for (Days) Days 4 2 2 2
Drivers Bonus NIL Petrol savings of 100 litres (assumed) NIL
Petrol price Rs/Ltr 70 70 70 70
Driver’s wage rate Rs/day 1200 1200 1200 1200
Lorry Hire rate Rs/Day 5000 5000 5000 5000
Composition of GDP
Petrol Rs 28000 21000 21000 21000
Wages to Drivers Rs 4800 2400 2400 2400
Bonus to driver from Savings Rs 7000 7000
Lorry Hire Rs 20000 10000 10000 10000
Profits to Transport Company (say) Rs 20000 32400 20000 20000
GDP (Price Paid by Customer) Rs 72800 72800 60400 53400
Fall in GDP 0 (12400) (19400)
Fall in GDP in % 0% -17% -27%

 

The volume of final services (real GDP) has not gone down but the nominal GDP has fallen sharply. If the final price remains due to market demand and supply, both real and nominal GDP will remain same. If the consumer pays less, GDP will fall due to the efficiency gains, unless there is 50% increase in other economic activities to absorb the truck and driver’s time (unlikely) or we start measuring value of driver’s leisure as equivalent to value of wages.  Here the quantum of services enjoyed has not gone down and so the real GDP should not go down. But the real GDP this is usually measured by using deflators, even real GDP will show a decline.

Paradoxical but that’s the exact reason (but contrarian effect) why big earthquakes and natural disasters are big boosters for GDP growth.

How Arvind Subramaniam and Government may both be right

India’s new normal growth looks 7%. But there have been drop in the exports in the last 5 years of some commodities like rice, raw cotton, meat and oil cakes;  construction activities have been hit, GST and demonetization have hit some cash dependent or tax evading activities, China dumping has clipped the growth in steel and tyre industry. But these may have been made good by growth in insurance services in rural areas, banking services through Jan Dhan, massive spread of LED bulbs, construction of toilets on a massive scale, etc. These may well have compensated for the decline in other areas and the Government’s stance of 7% growth may well be true.

Revisions in the GDP calculation approach takes years and they lag changes in the structure of the economy by a considerable time. Hence it is quite likely that many new sources of growth are not captured properly. Without these services in the estimate samples, the ex-CEA’s estimates may well be true.

But the real joker in the pack may be the efficiency gains in the economy. The last few years have seen significant gains in several areas. LED bulbs have grown rapidly saving huge amounts of electricity. Industries have also invested significantly in energy and utility savings. Banking has gone largely digital  cutting down long queues and wasted time; so are airline and railway tickets. Solar energy has replaced capex with opex and led to vastly reduced levels of consumption of fossil fuel. Digital books vastly reduce the consumption of paper; Netflix reduces trips to the theatre.

As illustrated in the table, such efficiency gains have a dampening effect on the GDP. The greater the gains accrue to the final consumer lower will be the GDP and growth.

And the impact from reduction in corruption. DBT reach the beneficiaries without leakage alright. But they have also taken away the jobs of several intermediaries and fixers. This has contributed to loss of several layers of jobs, even as it resulted in convenience, reduced costs, and saved loads of time for beneficiaries.

With the impact from the above factors, the GDP may have fallen as contended by of ex-CEA.

But GDP calculation is not a perfect maths.  The entire GDP calculation of Zambia is done by a single individual. A minister in Robert Mugabe’s cabinet likened measuring GDP to “trying to use a tape measure to figure out how much Coke is in this glass.” GDP is not measured by double entry book keeping; it is based on sampling with all the deficiencies that come with it. The Ex CEA’s approach is even more remote. The rapid changes that have been observed in the last few years especially since 2008, the urbanization and formalization since GST cannot be captured or compared with static sampling approach, size or methodology.

One wishes that the ex-CEA had not adopted an alarmist approach and present India’s GDP as some kind of methodological fudge. Without an examination of reasons, chains of causation, Working Paper no 354 looks more like the statistical appendix in the Economic Survey. If he had examined the reason behind fall in electricity consumption ratio (for example) from pre 2011 period, he could perhaps have come up with appropriate suggestions for perfecting the system.

Nevertheless, assuming his figures are correct, if the 4.5% has come about due to efficiency gains, better ICORs, reduced project implementation times, cost savings, and lesser inconvenience to consumers why should we be ashamed of it. These would only improve the competitiveness of Indian industry and services.

Selective Rationalization of Subsidies might solve the Agrarian Crisis

 

Link to Businessline: https://www.thehindubusinessline.com/opinion/how-the-agrarian-crisis-can-be-eased/article28128069.ece

The current agrarian crisis in India is a product of two factors (i) failure to recognize when Green Revolution started giving diminishing returns and taking steps to come up with alternatives and (ii) economic impact of subsidies, which this article examines – both man made and policy failures.

The current crisis can be summed up as diminishing soil fertility, sinking water table, increasing costs (all effects of green revolution) and poor returns to farmers, periodic unaffordable spikes in key commodities, 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 recognizing 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 kgs the prices collapse, since not much demand is there for the excess. Contrarily, where it is supplied 75kgs only, 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 buildup 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 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 but supply curve the price line stays closer to demand and hence smaller consumer surplus and higher profits for producers.

Many people have argued for breakup of cartelization of middlemen and dismantling or reforming APMCs 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, inventory holding etc. which we forget. 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 at best 4-5 kms. How do 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 may be 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 ‘reigning in’ middlemen for tackling agrarian crisis is bound to be ineffectual.

But the real problem is the supply curve‘s flatness. This is largely the result of governments ill-advised subsidy policy which makes no discrimination whatsoever on the various input subsidies to agriculture. When everything from electricity, water, seeds, fertilizer, interest, MSPs, are given free or subsidized without any limits of land holding or size, it leads to similar cost structures for most suppliers and hence the supply curve becomes flat as shown in Graph (Before segment). 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 rationalizing 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, it is possible in the current scenario. Or it can be graded like 100% of current levels for 2-3 acres, 50% 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).

Rationalization of Subsidies

Effect of rationalizing subsidies

The prices as is seen in the graph will raise (in the illustration from Rs 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% of people get a share of 15% 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 food grains 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 may be without much pains (other than a onetime 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 rationalization 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 unsubsidized products will also start moving up. Larger farmers would gravitate towards such products.

Macro Imbalance and the need for a new framework agreement

My article in Businessline today.

The chorus for reduction of Real interest rates as the panacea for the current economic stall is getting louder. From commentators to administrators to economists that seems the only item in the menu these days.

Interest rates (nominal and real), Inflation, Forex rates and Reserves, Investments, Capital Account convertibility and Foreign Investment Flows (all from the input or causative side) and Growth, Output and Employment on the resultant side are all intricately interconnected. There seems a need to look at things comprehensively and evolve a framework agreement between RBI and the Government reflecting this reality.

Illustration of Inter connectedness and imbalance

People buy things in advance if either it is likely to be costlier in the future when they need it or for de-risking (like Gold and Real estate). But what if the realized prices later consistently prove to be less? Would people still buy upfront or would it indicate some discrepancy? Lets see it in the context of forex rates.

The actual rates post facto have consistently been lower (far lower) than the Forward rates (rates quoted today for $ that will be delivered say 3, 6 months later).

The first one is determined based on the difference in inflation rates and the second one based on difference in nominal interest rates. If the Real Interest Rates are deducted from nominal, then the movement in both should be determined by difference in inflation. This should hold but for changes in outlook and situational factors and the policy induced difference in Real interest rates.

The persistence of actual rate being way less than Forward rate represents a serious imbalance and causes plenty of problems in domestic competitiveness, flow of foreign currency, investment absorptive capacity, etc. For example, if apples (representative of a basket of goods) are selling at Rs 50 in India and $1 overseas, then exchange rate should be ideally 1$ = Rs 50. Say, next year Indian apples have suffered an inflation of 10 per cent and have gone up to Rs 55. But apples overseas have suffered an inflation of 2 per cent and gone up to $1.02. Then the exchange rate should be Rs 55/1.02 = 53.93. But if the exchange rate is kept at say Rs 51, then the Indian exporter will get 1.02$ X 51 = 52.02 Rs /apple while he is able to get Rs 55 selling it domestically. Why would he export? To overcome this, we should allow the Re to correct. This will happen if we match the $ supplies into India with its net imports

Contours of a new framework agreement 

The framework agreement between the Government and RBI should cover all the essential variables not just one or two in isolation. Such an agreement should cover the following.

Limits on Forex Inflows: The inflows should be calibrated to match the absorptive capacity of the economy and its investment needs.  While Capital account convertibility can remain, RBI has to limit the quantum either at total levels or under each major sources of inflow. Reserves are a costly loss making insurance asset (much like Gold in individuals’ hands) whose cost are far more than the difference between interest earned and paid. It has effect on the real economy. The limits can be +/- 1-2% of what is required to plug the CAD or 6 months imports +/- 2 weeks.

Maintenance of Competitiveness: Competitiveness comprises two elements – the physical and the currency. Physical competitiveness comes from technology, scale, skills, IPRs, and natural resource endowments over which neither RBI nor Government may have control. Currency needs to stay competitive which can be achieved only if it floats freely to reflect the inflation differential.

Forex rates: RBI should be mandated to maintain the REER values within 2/3% of Re’s REER value after correcting the massive divergence now on a one-time basis.

Recalibrating REER Values: Again instead of using the general inflation numbers of the countries it should be the inflation of major input costs (including interest costs) of goods and services traded between India and its major trading partners. This basket may keep changing but there are real dangers of monolithic baskets or even currencies as a whole which are governed by many factors other than what determines competitiveness.

Real interest rates – Real interest rates should be mandated to be within 5-10 bps spread over interest rates in competing countries and those investing into India. High real interest rates and overvalued currency may encourage debt flows more than investments in real assets and FDIs.

Inflation: Divergence between estimated actuals and realized actuals after the end of period is difficult to control even for items like Forex rates where almost all participants are educated, trained and hence rational. It becomes even more hazardous in inflationary expectation. It’s time we move on to inflation targets for 3-4 major groups. Food inflation is far more politically sensitive and socially damaging than perhaps white goods or real estate.

Stability of Laws:  The last 4-5 years have seen sudden sharp changes in rules governing provisioning, NPAs, default status, etc. and levels of support to distressed assets even those which are clean but facing stretched cash flows. Changes should factor in reasonable adjustment period.

Quid Pro Quo

If these are corrected, governments should undertake to do the following:

  • To stay within the 3-4% fiscal deficit targets,
  • To smoothen MSP increases based on fundamentals rather than subject to political whims and fancies,
  • To curtail interest declared on mandated savings like PF, PPF etc.,and
  • Not to announce arbitrary minimum wages.

The current economic impasse is arising out of highly overvalued currency, uncompetitive real interest rates, inflows far in excess of absorptive capacity and inflation which looks more western and 1st world’s. The entire burden of causing growth and employment hence falls on the elected Government which has to substitute for the private sector which has been rendered uncompetitive due to these imbalances.

A comprehensive agreement on the above lines would go very far in kick starting growth and employment once again.

Flexibility and Agility are Virtues

Ironically almost a century ago, as the noted economist Irving Fisher in his The Money Illusion quotes Reginald McKenna, Chancellor of Ex-chequer UK as follows: “Since the War, central bank reforms have been instituted in Albania, Austria, Chile, Colombia, Germany, Hungary, …India, Russia, South Africa. In all these countries, except India, not one central bank has copied the Bank Act of England; but with that exception, all have adopted some system which is similar to the Federal Reserve Act” which provides for an ‘elastic currency’… the greater elasticity of the Federal Reserve System (is) the main reason for the higher prosperity of America”.

What was true then of America is true today of China which has proved far more nimble footed and what was true of Bank of England is true of RBI, which treats cast in stone monolithic approach as a virtue.

(The writer is the author of Making Growth Happen in India, Sage Publications).

 

Time to shed excessive fixation over inflationary expectation in Monetary Policy Making

The Last 3-4 years inflation control has become the dominant theme of our monetary policy making with just a lip service to growth and even lesser concern for what is needed most by the democracy – employment. Inflationary expectations have become the mascot of inflation and taming it has become a near exclusive fixation. the current approach fails to incorprate lessons from the recent advances in behavioural economics
Inflationary expectations have stayed stubborn and unrelenting at 8-10% even while CPI inflation has been has been drifting downwards to around 3-4% for several months.
There are some fundamental issues with expectations of individuals.
Firstly, do retail consumers (unlike equity investors) from whom data is gathered for consumer inflationary expectations have sufficient information and expertise to predict inflation even if they are the ones who are affected? People dislike risks and as Daniel Kahneman theorises people dislike losses twice as much as they like profits. There is hence a tendency to overestimate risks and the losses especially the non insurable ones. Even RBI itself has been consistently overestimating inflation.
Secondly, mind comprehends or estimates prices more based on purchase cycle. For example, a vegetable or fruit purchaser might think or worry about what will it be in the next two weeks. But it will be futile to ask him for an estimate of prices 26 or 48 weeks hence. RBI data gathering does not reckon the purchase cycle.
Thirdly, the nature of human mathematical comprehension itself and translation thereof into annual numbers. Even if they knew rightly that the weekly inflation of two different items are 0.2% and 0.5%, they will most likely come up with annual numbers in the region of 6-10% (instead of 11-30%). RBI’s data on various class wise inflation expectation figures reveal how the expectations are in a significantly narrower band than the experience of the preceding few weeks or months which should have had a significant influence on their expectations. Vegetables prices vary by as much as 40% between March and September (RBI’s Mint Street memo 19), yet this is never captured in the expectations reported which stays flat at 8-10% for most of the times.
How much do expectations drive actual behaviour.
This is the most crucial question that would govern the success or failure of the current approach. Unless it can be demonstrated that people’s behaviour (in direction as well as quantum) is consistent with their inflationary expectation using it will be as perilous as a trap shooter shooting before the bell and hoping that somehow the clay pigeon will show up where the shotshell goes.
How much inflationary expectations will affect consumers buying behaviour depends on several factors like the life cycle of the product itself, per transaction costs, costs of advancing or postponing buying decision and the alternative (even if short term) investment avenues and cost of funds (borrowing costs).
A 15% annual inflationary expectation in real estate might make many to advance their purchase of house sooner than later more so if the financing costs are lower and perhaps even reallocate from other items to beat the market. But the same inflation expectations for petrol and diesel prices (roughly 1.12% on monthly cycle basis) may not make a car or 2 wheeler owner to tank up on empty cans to cover his next purchase. The same rate (0.264% on weekly cumulation basis) would not make anyone to stock up on vegetables especially given the cost of preservation and possible deterioration.
The House owner will most definitely compare his cost of borrowing with his expected price increase in house prices to make his purchase decision. But for articles of daily consumption or even white goods the household consumers are unlikely to be swayed by inflations of the range one is talking of in India. This can be gauged by the discount quantum announced during festive seasons or season end sales in India – upwards of 15-20% of sale and in some items 40% or one free for every one purchased and so on. One does not hear of 1-2% off on discount sales open only for 1-2 days (a 2% discount ending in 2 days translates to a cumulative 3500% p.a.) even for ‘definite to be purchased’ articles of consumption like clothing, household supplies etc. It does not have any impact. Even the pensioners may not be influenced to stock up even when their savings may be earning just 6-8% annual interest rates.
Unless inflationary expectations translate to rational choices by consumers, the current approach will on most occasions result on excessive action. And as RBI’s data clearly proves that as far as India is concerned, inflationary expectations are not necessarily rational expectations.
Only when inflation becomes high (say 20-25% for India) and the interest rates are way lower in comparison or in a hyper inflation (like in Venezuela now), would people be driven to rush their purchases fuelling the price increase further. The current approach at inflation levels of 4-6% seems like having a foot firmly on the brake pedal as a precautionary measure while driving at 1 kmph. Actually many end products in agri and manufacturing sector are crying for a better inflation to neutralise their cost increases.
A case for differentiated approach
There is good case for junking our inflation control focus of monetary policy making. If our economists have faith in their own icon, Philips (after whom the curve linking inflation and unemployment is named), even in short run they would be forced to conceed that a low inflation is a leading likely cause of the current unemployment crisis. We can just use the last 2 months or quarters inflation to decide what to do and should it be necessary convene the review meetings at closer intervals whenever necessary.
Rather than a single objective whatever the inflation, we should move a into differentiated approach depending on levels of inflation. Upto 4-6% inflation we should focus on job creation, between 5-8% may be on growth and employment and thereafter inflation control can take primacy.
Our industrial capacity utilisation is stuck at about 75% for a long time now. The lowest hanging fruit to be harvested for employment and growth is to put the unutilised 25% to use. It would take a bold approach to identify the more viable ones amongst these and provide them with 4-6% working capital, which could make them chugging again. A growth of an additional 2% will deliver more goods and services to the consumers and tame inflation and create employment far better. But such a sensible approach would be blasphemous to our orthodox theorists.

Income Transfers – is it the most effective solution.

Link to Businessline Article: https://www.thehindubusinessline.com/opinion/are-unconditional-cash-transfers-desirable/article26762792.ece

Just recently Congress has announced its promise of income transfer of Rs 72,000 for the poorest 5 cr families costing the Central Government Rs 360,000 cr., potentially becoming bigger than our Defence Budget.

One side of evaluation is the feasibility of mopping this amount without fiscal stress. But the other side to look at is whether this is the most optimal solution to bring about the desired impact on the target,  which is what we will focus on.

Inequalities of Income arise from three other forms of inequality (i) inequalities in human capital (levels of health, literacy, skills, etc.), (ii) Inequalities in Opportunities (in education, jobs, etc.), and (iii) inequalities in living conditions.

In the long term, these can be corrected only by better healthcare, education and skilling, creating sustainable jobs and the industrial competitiveness to create jobs, housing and medical infrastructure for poorer sections, etc.

But in the short to medium term (say 3-5 years) the inequalities can be more urgently addressed by ‘redistribution’ of wealth, income, reservations etc.

Thomas Piketty, the renowned French economist classifies the redistributions into two categories – Direct and Fiscal. Some examples of direct redistribution to labour are fixation of minimum wages more than required to compensate for inflation and gains in productivity, prescribing social contributions, ESIC, etc. This increases the cost of labour for employers who may shift to mechanization and thus has a negative fallout in terms of jobs created for the target.

Fiscal transfers tax the richer through income taxes or a wider cross section through indirect taxes like GST. This has the beneficial effect of not increasing direct cost of labour thus not decreasing demand for labour. The scheme in discussion falls in this category. Let’s see the demerits.

Firstly, this form of income transfer is addictive. The amount is too huge to be spent on short term measures without measures to set right the structural defects of human capital inequality. Once started the political system especially in India simply lacks the will to withdraw it even when the purpose is achieved. But more importantly the political system forgets its duty to address the long term issues feeling absolved with quick fixes. We have seen this in reservations, free electricity, etc. A scheme of this magnitude simply cannot ignore the need for balance between the short and the long term. The scheme should spend at least 60-70% in addressing inequality of human capital and the balance in income transfers.

Even if it is not able to take any steps for long term correction, it can make the 60-70% as conditional entitlements like attend adult education and dinner will be free, attend prenatal counselling and child delivery and all inoculations will be free, acquire a skill and one year’s apprenticeship is free, have and use toilets and get one gas refill free, etc. Unconditional entitlements are prone to Chakma Baboon syndrome – any sign of withdrawal can result in attack and even killing – in this case political suicide and hence no political party will dare withdraw.

Secondly in the words of Piketty, ‘the cost of substantial fiscal redistribution would be considerable, because it would decrease the return on investments (for individuals) in human capital and thus decrease the incentives for individuals to make such investments …’. Illustrating, if wages earned by a 8th std pass is Rs 60,000 on average and that of a 12th std pass Rs 90,000 per annum, his family will decide on sending their wards to school based on these incremental returns on investments. However, if Rs 72,000 is guaranteed, the incremental returns to investment upto 8th std and 12th std becomes Rs (-) 12,000 and Rs 18,000 per annum respectively.  If in the neighborhood it is not shameful to be uneducated, the family might conclude why educate anyone upto 8th std to earn Rs 60,000 when he can sit at home and get Rs 72,000. This will save them their investments. This outcome will seriously dent our ability to address the long term issues.

Thirdly, researches on the impact of neighborhood, family status and social settings have led to conclusions like, ’inequality of educational opportunity is reproduced from generation to generation’, ‘students from modest background are less motivated to pursue lengthy courses of study’, ‘(it is) the immediate social environment that inequality inevitably originates’. The surroundings have a huge inertial impact on perpetuation of inequalities and need far greater and immediate attention to get the basics right. Widespread initiatives like sending some bright students to different settings so that they have demonstrative impact, forcibly setting toilets in the poorest 10-15% of families in poor neighborhoods so that it creates peer pressure on others to follow suit, setting up model farms with improved agricultural practices, model houses in slums, etc. should be initiated to tackle this highly underappreciated impediment on equalizing inequality.

To give credit where due, given the labour market conditions (high levels of unemployment), fiscal transfers are a far more effective tool than increments in minimum wages and other mandated payments by employers. Given high possibilities of mechanization, minimum wages would have driven more enterprises away from labour and worsened the problem.

One way perhaps to strike a balance may be to issue equivalent value coupons eligible for exchange in areas we desire them to consume – education, purchase of food, clothing, building materials for housing, use in public toilets, buying medical services, payment of insurance premiums for crops, life, cattle etc.

A succession of poverty band aids starting with loan write offs, educational loan write offs, transfer of Rs 6000 per family and now this Rs 72,000 to the bottom 5 cr people is a clear sign and admission of failure of our reforms to address the concerns of the poorest sections of our society.

Income transfer looks not the most optimal solution at present. Even so, one wishes that if it gets implemented the information does percolate properly and every one of the families take due advantage of it to get out of poverty for sure, without leakages plaguing this initiative as well.

(The writer is author of Making Growth Happen in India)

Contrarian Ways to tackle Agrarian Crisis

https://www.thehindubusinessline.com/opinion/tackling-the-agrarian-crisis-differently/article26501142.ece

Article link in Businessline 11 March 2019

Agrarian crisis is staring on our face and as usual a flood of familiar suggestions have resurfaced. The political responses have been on expected lines.

Fixing MSPs at 50% over costs is as disastrous as it can get. There is no inherent incentive for cutting down the bill on Government or the rest of society. It may be possible in Western societies where 2-10% farmers depend upon the rest 90% but not in India where 50% are in agriculture. The sinking water table without a care, due to free electricity even in the land of five rivers (Punjab) is an example of such a sink hole. On the contrary, when West Bengal used to charge farm electricity same as residential, it held its water table since the farmers used the expensive resource judiciously.

The basic problem is that our agri sector is producing more than the demand, even when its productivity is way below world standards. The Kcal value of just the top 8 food items produced is approx. 2250 just about what an average Indian requires. And we have compromised the soil health massively in the last 4 decades, so the costs are increasing way beyond productivity gains.

The main impediment in tackling the crisis is the wrong formulation of the problem. Instead of seeking to double the farmers ‘gross’ income, we should seek to raise his “net, net income” – net of costs but more importantly net of soil health loss and depreciation. Let’s see how this cab ne achieved.

First the wastes in our cultivation. Our flood irrigation system which has evolved to cut off oxygen to weeds and thus control their sprouting, has had adverse consequences on plant health also. The excess water washes nutrients, costly chemicals and fertilizers along with it, more than half of these never coming in contact with the plant or root aura. These unutilized chemicals have long term consequences on soil quality.

SRI (System of Rice Intensification) farmers who have consistently reported higher yields, have direct- planted or planted single seedlings with gaps of 20-25 cm (instead of clumps) and shunned flood irrigation for just retaining enough moisture and reported 80% savings in seeds besides saving 50% water.

Next the soil health. Excessive chemical application has killed the earthworms so necessary for aeration and microbes and fungus which break down vegetable matter and carbon into essential inputs for plant growth. These chemicals solidify soil causing easy run-offs. Stronger osmotic pressure of the chemical solution outside the root systems promote reverse osmosis causing the water to flow from roots to soil rather than the other way around causing withering and dryness in some crops.

We need to get a lot more humus into our soil to boost its water retention (without run offs) to achieve the above and enable stronger roots that can to go deeper and wider and sponge more nutrients besides being naturally more disease resistant.

We need to rotate the crops judiciously with nitrogen fixing legumes/plants, so that the artificial life support of chemicals get replaced with natural manures and supplements in a far more balanced way.

Sir Howard the author of the Indore experiment, had demonstrated that with just the organic material available within the village – the foliage, crop residues, and animal residues,  it is possible to generate all the humus and compost and within it all the chemical required in a more balanced manner at much lesser costs. It might require some reinventing the natural and traditional methods and some re-training.

Trapping more incomes within village ecosystem: The Indore experiment cited above reported that a pair of oxen can help generate 1350 cft of compost i.e approximately 27 tons of manure containing a balanced mixture of essential chemical ingredients. The market price of equivalent weight of Urea is about Rs 1.45 lac. Even if one were to offset the cost of animal keep and downscale the value, it would still leave a net Rs 30-40,000 of commercial value in the hands of the farmer and village community. Instead, villagers are driving away these to graze unyoked and spending a fortune in ‘importing’ costly fertilizers. A better balance should be attempted.

Rice production is reported to be contributing nearly 15% of world’s methane emission annually. Long term research should focus on harvesting this thinly spread greenhouse gas like we have done with Sunlight. It is also possible to sequester carbon by traditional methods as modern agriculture is one of the biggest contributory to carbon emission.

If these incomes are trapped within the village ecosystem it could lead to better secondary cycle of incomes and enable our villages to make more investments in housing, electricity, healthcare and education, the other social necessities.

Employment potential: Adoption of natural or semi traditional methods of farming like manual composting and weed control, controlled water charge, focused pest control, recharge of crop residues are reported by Joel Bourne in his book The End of Plenty to absorb 27% higher labour. That may be a huge boon by itself for India which desperately needs to create employment.

‘Open sourcing’ research: The current system of research excessively serves only certain sections or links to the compromise of overall health. It is focused on maximizing chemical or insecticide sales far beyond optimal levels. So much so that insecticide companies do not even train the applicators on optimal volumes or safe methods of application. Today, more people may be dying out of their harmful effects besides those who consume it as poison, than out of farm loan distress.

There is a compelling case for ‘open sourcing’ all agricultural and allied research even if necessary by Government setting up more facilities under its control as well as opening up trade at least in commodities where we have surplus.

In conclusion, it is possible to more than double the net farm incomes just with better seeds and package of farm practices, cutting down heavily on the artificial ‘boosters’ even while preserving or promoting soil health.