Subsidies: Introduction to Farm Subsidies

In any country, progressive agriculture is a powerful engine of economic growth. It aids in the beginning and continuation of the development of other economic sectors. In light of this, India’s government took a positive approach after independence, introducing specific programs such as new agricultural technology. Due to their poverty, Indian farmers were unable to purchase these costly inputs. The introduction of the HYV program in the mid-1960s necessitated a high priority on providing quality inputs to Indian farmers, such as irrigation, water, fertilizers, and electricity. All of these were identified as critical inputs for agricultural development.

To ensure that all farmers have access to these inputs at all times, the government decided to subsidize them.

Subsidies are frequently criticized for their financial burden; however, there is concern that if subsidies are reduced, agriculture production and farmer income will suffer. Instead of focusing on pleasing voters or bolstering the vote bank, the government should develop a national policy that allows small-scale farmers who are not currently receiving subsidies to receive more, while subsidies that they do not want are withdrawn.

Objectives of Subsides

Subsidies cause changes in demand/supply decisions by creating a wedge between consumer prices and producer costs. Subsidies are often aimed at-
  • Inducing higher consumption/production
  • Offsetting market imperfections including internationalization of externalities
  • Achievement of social policy objectives including redistribution of income, population control, etc.

How Subsidy Works

There are two most common ways of subsidizing agriculture;
  1. To begin with, governments may be willing to pay much higher prices for agricultural products than farmers can in a free market.
  2. Second, by providing inputs at a cost that is less than the cost of providing these inputs or less than the cost that would prevail in an open free trade environment.

Higher farm product prices can be achieved primarily by isolating domestic markets from the global economy through trade restrictions. On the other hand, vital agricultural inputs such as fertilizers, irrigation water, credit, and electricity can be provided to farmers at prices lower than the open market. As a result, the prices of these inputs do not reflect their true value, i.e., the true cost of supplying them.

Subsidies on inputs are typically preferred over the two alternatives mentioned above because it is believed that farmers can only benefit from government spending in proportion to their use of inputs. Subsidizing inputs also avoids raising food and raw material prices, which could have a negative impact on the developing world’s growing industrial sector or a large population of poor people.

Most of the time, however, it is a combination of higher output prices and lower input prices that have been used to subsidize agriculture, with goals ranging from the need to increase domestic production to the protection of farmer incomes. India tinkered with input and output prices as well, primarily to protect the poor and/or encourage the use of modern inputs.

The rationale for subsidizing Agriculture

Combine harvester on the wheat field during harvest

Benefits of Subsidies: The relative distribution of subsidy benefits among different classes or groups of beneficiaries, such as consumers and producers, as well as between different classes of consumers and producers, can be investigated. PDS suffers from significant leakage in the case of food subsidies, and aside from a low coverage of the poor, the magnitude of benefit derived by the poor is very small.

Because the unit cost of electricity has been rising faster than the relevant tariff rate, the subsidy rates for both agriculture and domestic use have been rising. Furthermore, there is significant variation in the level of per capita electricity subsidy, indicating that the per capita subsidy in the wealthier states is significantly higher than in the poorer states.

When used in conjunction with HYV of seeds, chemical fertilizers, power, and other related inputs, water has a very high marginal productivity in public irrigation. Because of their ability to use these allied inputs, the wealthier farmer may reap relatively greater benefits.

Subsidies to elementary education account for roughly half of all general education subsidies. However, this is not true for all states; in high-income states, the share of elementary education is lowest, while in low-income states, it is highest (Goa, Punjab, and West Bengal actually give higher subsidies to secondary education than primary education). As a result, there is a negative correlation between per capita income and the share of elementary education subsidies.

The majority of higher education subsidies go to the wealthier sections of society because they have an overwhelming advantage in competing against poorer candidates for admission to courses with limited seats. When it comes to healthcare subsidies, a greater emphasis on curative healthcare expenditures often reflects a bias towards the wealthy, whereas preventive healthcare expenditures with much larger externalities would clearly benefit the economically disadvantaged.

Subsidies in Indian Agriculture

Subsidies in the form of cash payments to producers and consumers are easily identifiable. It does, however, take many forms that are not visible. As a result, it could be hidden in reduced tax liability, low-interest government loans, or participation in government equity. Subsidies are implied when the government purchases goods, such as good grains, at higher than market prices or sells at lower than market prices.

Subsidies and Transfers

Subsidies must be distinguished from transfers that are simply income supplements. An unconditional transfer to an individual would supplement his income and be spread across his entire range of expenses. A subsidy, on the other hand, refers to a specific good whose relative price has been reduced as a result of the subsidy, in order to shift consumption/allocation decisions in favor of the subsidized goods. Even when a subsidy is 100%, i.e. the good is provided free of charge, it should be distinguished from an income transfer (of an equivalent amount) that does not have to be spent entirely on the subsidized good.

Transfers may be preferred to subsidies on the grounds that any given state expenditure will increase welfare more if given as an income transfer rather than subsidizing the price of some commodities, and transfer payments can be better targeted at a specific income group than free or subsidized goods.

Mode of administering a subsidy

The various alternative modes of administering a subsidy are-
  1. Subsidy to producers
  2. Subsidy to consumers
  3. Subsidy to producers of inputs
  4. Production/sales through public enterprises
  5. Cross subsidization

Subsidy targeting

Individuals can receive subsidies based on a set of criteria, such as (a) merit, (2) income level, (3) social group, and so on. If proper targeting is not done, two types of errors occur exclusion errors and inclusion errors. In the first case, some people who are eligible for a subsidy are excluded, while in the second case, some people who are not eligible for a subsidy are included in the subsidy program.

Effects of Subsidies

The economic effects of subsidies can be broadly grouped into-
  1. Allocative effects: These have to do with resource allocation by sector. Subsidies assist in attracting more resources to the subsidized sector.
  2. Redistributive effects: These are influenced by the elasticity of demand for the subsidized good among the relevant groups, as well as the elasticity of supply of the same good and the mode of subsidy administration.
  3. Fiscal effects: Subsidies have obvious fiscal effects because a large portion of subsidies comes from the budget. They have a direct impact on fiscal deficits. Subsidies may also have an indirect negative impact on the budget by diverting resources away from tax-paying sectors and towards sectors with low tax revenue potential.
  4. Effects on trade: A regulated price that is significantly lower than the market-clearing price could reduce domestic supply and increase imports. Subsidies to domestic producers, on the other hand, may enable them to offer internationally competitive prices, reducing imports and increasing exports.

Types of subsidies

  • Direct subsidy
  • Indirect subsidy

Direct Farm Subsidies

Subsidies This subsidy is paid directly to farmers and is usually in the form of a direct cash subsidy. As a result, direct subsidies are critical in increasing farmers’ purchasing power and raising the standard of living of the rural poor. Direct farm subsidies are common in most developed countries, such as the United States and Europe, but India only offers them in limited forms, such as food subsidies and MSP-based procurement. Direct subsidies are in the form of cash or cash transfer subsidies, for example, a beneficiary may purchase grain from a grocery for Rs 20/kg and have Rs 18/kg credited to his or her bank account. The government has a history of increasing direct subsidies. Direct subsidies are preferred over indirect subsidies.

Indirect Farm Subsidies

These are not in form of cash but provided in the form of-
  • Irrigation Subsidy
  • Power Subsidy
  • Fertilizer Subsidy
  • Seed Subsidy
  • Credit Subsidy
  • Farm loan waivers,
  • Investments in agricultural research, environmental assistance,
  • Farmer training, etc.

Indirect Subsidies account for roughly 2% of India’s GDP. Subsidies that are given in kind are known as indirect subsidies. PDS is a well-known example because grains are available at a lower cost. For example, if the market price of grain is Rs 20/kg and the PDS price is Rs 2/kg, the beneficiary receives an in-kind subsidy of Rs 18/kg.

Problems of Indirect Subsidies

Subsidies require the most careful targeting because a poorly targeted subsidy is a complete waste of money. It creates more opportunities for corruption, such as in any indirect subsidy. Subsidized goods are available in a variety of forms. There is a financial incentive to sell subsidized food grains at every level. It leads to black marketing or PDS leakage, which prevents subsidies from reaching their intended recipients.

Indirect subsidies benefit big players more, for example, a subsidy on electricity will benefit large farmers more because they have a large land area and the financial means to purchase electric pumps. Indirect subsidies place a greater burden on the government because subsidies are provided not only for products/grain, but also for transportation, storage, and other services. Entire supervision is required to combat corruption, which will incur additional costs.

More freedom is provided by money than by kindness. It is the fundamental concept of choice freedom. For example, some farmers may require pesticides, while others may require fertilizer. They can use the money they get from subsidies, according to them. However, the problem is that there is no guarantee that subsidies will be used for anything other than the stated purpose. This issue can be resolved if proof of expenditure is required in order to receive a subsidy.

Challenges with direct subsidies

Financial inclusion- More penetration of the banking sector is the probability of getting direct subsidies. The government is aggressive on financial inclusion. E.g. NDA government Jan Dhan Yojana. But problems of Jan Dhan Yojana are- All bank accounts may not be the 1st bank account of many people. Although many new bank accounts are opened, these are not very operational. So it should be ensured that these are operations. Banking facilities to the poorest section to provide which is the biggest challenge today.  2) Unique identification of beneficiaries-
  • Penetration of Aadhar.
  • Even indirect subsidies there may be targeting problems through the presence of fake beneficiaries. E.g. in PDS, there are many fake ration cards.
  • Face beneficiaries may be more related to direct subsidies, as a face ration card is a difficult process like standing in unique getting grains, but face bank account holders can get subsidies sitting at home. So bank accounts can be linked to the unique identification of Aadhar to solve the problem.
Transfers may be preferred to subsidies on the ground that
  1. Any given expenditure of state funds will increase welfare more if it is given as an income transfer rather than via subsidizing the price of some commodities and
  2. Transfer payments can be better targeted at specified income groups as compared to free or subsidies goods.

However, this direct transfer system is based on implausible assumptions such as the world fertilizer market being perfectly competitive and India’s entry into world prices. Because there is a concentration of fertiliser producers and consumers, these assumptions are unrealistic. Mosaic (USA) and Yara (Norway) are the world’s largest fertiliser producers, accounting for more than 60% of total fertilizer production. So, what should the government do? According to the ministry of agriculture, India now spends nearly twice as much on food imports as it did in 2002. In 2008, wheat imports totaled 1.7 million tonnes, up from around 1300 tonnes in 2002.

Last year, food prices increased by 19%. In percentage terms, India spends less on education than almost every other country. This encapsulates everything. In the long run, a subsidy as an incentive is ineffective; instead, we should focus on policies that are self-implementing, such as education; invest in education today, and it will pay for itself in 50 years; invest in growth today, and it will pay for itself in ten years. A subsidy is a temporary tool that can’t be used indefinitely. There should be two things: first, there is a lot of leakage in the system, so we can’t keep using it as is.

In a country where the same good is sold at two different prices, there is a lot of room for corruption. If you’re going to subsidise a commodity, make it so that no one else can use it. DAP, for example. The addition of DAP to urea renders it unfit for commercial use while causing no harm to the field. Other recommendations-

  • Reducing the overall scale of subsidies.
  • Making subsidies as transparent as possible.
  • Using subsidies for well-defined economic objectives.
  • Focusing subsidies on final goods and services with a view to maximizing their impact on the target population at minimum cost.
  • Instituting systems for periodic review of subsidies.
  • Setting clear limits on the duration of any new subsidy scheme.
  • Reducing the overall scale of subsidies.
  • Making subsidies as transparent as possible.
  • Using subsidies for well-defined economic objectives.
  • Focusing subsidies on final goods and services with a view to maximizing their impact on the target population at minimum cost.
  • Instituting systems for periodic review of subsidies.
  • Setting clear limits on the duration of any new subsidy schemes. 
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