9 October 2020

To lift India’s farmers out of poverty, Modi must embrace the market

By Jairaj Devadiga

Before taking office in 2014, Narendra Modi promised to double farmers’ incomes by 2022. For six years, his administration has done next to nothing to achieve that goal. Now he’s belatedly introduced two new laws to open up the market and boost incomes. Better late than never.

Indian farmers are among the poorest people in the world. More than 86% own less than two hectares of land. With a plot this small it’s impossible to benefit from economies of scale or new technology. Instead of tractors and combine harvesters, smallholders are stuck using primitive, back-breaking methods which strangle productivity. At the same time rigid, protectionist laws funnel Rupees into the pockets of wealthy larger land-owners.

Modi’s new reforms are a step in the right direction. Previously, farmers were only able to sell their produce to traders who had a licence to operate in government approved marketplaces, called Agriculture Produce Marketing Committees or mandis. These traders formed cartels and forced farmers to accept lower prices for their crops. After these reforms farmers will be able to sell their produce directly to wholesalers, retail outlets, food processing companies, restaurants or individual consumers.

State governments also levied fees on traders, which were inevitably passed on to farmers via lower prices. Now buyers must compete for the produce, and offer better prices to farmers. Nor will state governments be able to levy any fee or cess on transactions outside the mandis.

The second law provides a framework for contract farming, which will let farmers and buyers agree on a specific quantity of produce to be delivered in the future at a fixed price, even if market prices are lower at the time. That will reduce the risk farmers face due to volatile prices. Both are welcome reforms. Of course, the mandi-based traders are understandably protesting against these reforms since they will lose their market power.

But why are farmers protesting too?

As the Indian Express explains, farmers are not protesting against the current reforms. Rather, they fear that it will be a slippery slope to abolishing Minimum Support Prices (MSPs), and move to market based prices. Right now, if the market price is lower than the MSPs, the government steps in and buys crops from farmers at a fixed price. The rationale is that poor farmers should be protected from the vagaries of market forces, and receive an assured price for their produce.

In practice, however, the scheme does little to help poor farmers. How much money a farmer receives from this price support scheme depends on the amount of crops he sells to the government. The rich farmer, who owns a lot of land, grows and sells the most produce and gets the most money. The poor farmer, with his tiny plot of land, grows little and receives little aid. It is no surprise that farmers from mainly Punjab and Haryana, who have large landholdings, are protesting the loudest.

Price supports end up funneling billions of tax Rupees to wealthy farmers, while doing little for those who really need help. They should be abolished, but sadly, Modi has promised not to do so, in order to appease these wealthy farmers.

Instead of price supports, more structural reforms are needed to get farmers out of poverty. In India, more than 40% of the workforce is still employed in agriculture. Contrast this with 1.3% in the US, and 4.2% in the EU. The US and Europe also had majority of their populations in agriculture at one point. They got rich by leaving farming for more lucrative jobs in the manufacturing sector.

Small farms are not very productive, since they can’t benefit from modern technology and  economies of scale. For instance, on a small piece of land, it would make no sense to use a tractor or a combine harvester. Small farmers are thus stuck using more primitive methods which hobble productivity. The vast majority of those farmers, with their tiny plots, would be far better off if they had factory jobs.

The answer is reducing their barriers to exit. As it stands, farmers are in the absurd position that they can only sell their land to other farmers. Selling farmland for non-agricultural use requires government permission, which is costly and difficult to obtain. Small farmers should be free to sell their land to the highest bidder, which will make it easier for them to quit farming.

Next, there are not enough manufacturing jobs in India, due to burdensome regulations on the sector. As Vivek Kaul has pointed out, Indian manufacturing firms need to comply with 6,796 different regulations, which imposes a high cost of compliance. India’s inefficient legal system poses another challenge. It takes on average 1445 days to enforce a contract, at a cost of 31% of the claim value. Few firms find it profitable to do business in such an environment.

India’s tax system has been another deterrent for investors. Toyota said that they would not expand operations in India due to high taxes, claiming that they felt “unwanted”. Ford ended independent operations in the country last year, and General Motors quit entirely in 2017.

Only the manufacturing sector can create jobs on the scale needed for people leaving agriculture, offering them a way out of poverty. The government urgently needs to bring in widespread judicial, regulatory and tax reforms in order to make investments in manufacturing more profitable.

And this is just scratching the surface. Another obvious reform would be getting rid of the law outlawing sale of farm land for non-farm purposes, and allow manufacturers to use some of that land more productively.

India’s notoriously inflexible labour market is also ripe for reform. Fortunately, some progress has begun on that front. A new law now lets firms with up to 300 workers lay off employees without prior government permission, which wasn’t possible before

That change, along with the two new agricultural laws are certainly welcome, but they are just baby steps. If the Modi government is serious about helping poor farmers, it needs to truly embrace the market and have the guts to stand up to the vested interests.

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Jairaj Devadiga is an economist whose work mainly deals with public policy and economic history.

Columns are the author's own opinion and do not necessarily reflect the views of CapX.