Indian Agriculture #3: The Infamous Farm Laws
Why the repeal of the 3 farm bills by the Modi government set back Indian agriculture by decades.
This is part 3 of a series on Indian agriculture. Part 1 is on socialism in Indian Agriculture and part 2 is on the MSP regime. If you haven’t yet subscribed to The Indic Prism, here’s a button that lets you subscribe.
Covid-19 brought the world to a standstill in early 2020. The first few months were spent in lockdown with people scarcely being allowed outside their housing communities. As restrictions started easing up in the later half of 2020, a political bombshell was in the making.
Soon after Modi first got elected in 2014, he promised to double farmers’ income. Agriculture’s share of India’s GDP is about 15%, but employs 40% of the workforce. There are subsidies for electricity, fertilizers, water, credit, insurance and much more. With subsidies distorting markets, there are even more interventions introduced that end up further distorting markets.1 The end result is an ever-ballooning, unsustainable subsidy bill footed by taxpayers. Doubling farmers’ income in such an environment is a tall order and requires tremendous political will.
Ludwig Von Mises, an Austrian-American economist, put forward the theory that interventions are inherently unstable because it creates new market distortions, which in turn require more interventions. Over time, it leads to more centralization and top down planning which eventually ends in socialism. This is known as Mises’ Theory of Interventionism. Shruti Rajagopalan has an excellent paper on how this theory of interventionism applies to Indian agriculture.
With this in mind, the Modi government in September 2020, announced three crucial farm bills. The first one allowed farmers to trade freely outside Agricultural Produce Marketing Committees (APMCs), opening up alternative trade channels for farmers to market their produce. The second one introduced the concept of contract farming, where buyers and farmers could enter into agreements before farming even begins. The final bill (Essential Commodities Act) was an amendment to an existing act that repealed penalties on hoarding. Removing penalties on hoarding would enable private investors to establish and expand warehousing and cold storage infrastructure in India. These facilities have been lacking due to stringent criminal penalties that were mistakenly applied to legitimate storage and warehousing activities.
As soon as they were passed, political chaos erupted, stemming primarily from the Punjab-Haryana corridor. Farmers started out in protest from Punjab intending to choke out Delhi, the national capital. Multiple farmer groups blocked various entry points into Delhi. The implementation of the bills was stayed by the Supreme Court in early 2021. Finally, the government capitulated and repealed the laws in December 2021.
A small minority that benefits from the status quo, held hostage crucial market reforms. There were sizeable groups in Maharashtra that supported the farm laws and were against the MSP. Unfortunately, their voices lost out to those with more political muscle to flex.
The Need for Reform
The graph below depicts the share of land used for agriculture. India has the highest share of land use compared to developed nations, South Asia and even with countries that have comparable incomes. India is a lower middle income country, and other lower middle income countries use less land than we do for agriculture.
Using more land isn’t bad in itself, but expansion of agricultural land leads to ecological destruction. India’s crop yields are abysmally low, with rice yields being one-third of China’s and half those of Vietnam and Indonesia. And why would that be?
The answer is that Indian farmers aren’t incentivized to increase productivity. All the factors discussed previously, like subsidies to inputs, the minimum support price and lack of a free market introduce tremendous distortions that make price signals dysfunctional. I’ll take a quick detour to explain why price signals are so important.
Price signals are the foundation of any well-functioning sector. When the government subsidizes an input in the agricultural sector, it encourages greater use of that input. Over time, this leads to several negative consequences.
First, subsidies are based on current usage patterns, but as incentives (in the form of low prices) drive higher consumption, the subsidy bill escalates, creating ripple effects across other parts of the economy.
Second, subsidies do not increase the overall availability of an input; they simply divert it from other sectors, often at their expense. For example, subsidizing electricity for farmers likely results in reduced availability for industries, causing shortages. These shortages, in turn, drive up prices for industrial users, reducing their global competitiveness.
Third, healthy price signals communicate the value at which the transaction is a win-win for both buyers and sellers. When prices are distorted, either by setting a price floor or price ceiling, wastefulness of that commodity ensues. In fact, price ceilings don’t resolve shortages; they merely convert it into long lines at billing counter.2 Similarly, price floors incentivize wasteful production because of the guarantee that products would be bought at the price floor.
Finally, price signals incentivize producers and consumers to change their behaviour. Growing wheat and rice have caused an environmental disaster in Punjab for various reasons. In a healthy market, farmers would be faced with increasing prices for electricity to pump harder to reach water. Faced with increasing costs of input, it is a rational choice to veer away from growing wheat or rice. With subsidies in the picture, farmers don’t have this choice to make and end up damaging a delicate environmental balance.
Putting this together, it is obvious that reforms are needed to repeal subsidies, to allow farmers to trade anywhere and to open up the market for other consumers to buy directly from farmers.
How do the farm laws counter these issues?
The farm laws are going to be wordy, but bear with me for a bit. The Farmers' Produce Trade and Commerce Act did away with the requirement for farmers to sell at APMCs. I covered APMCs briefly in the first part of the series. Here’s a link for a refresher.
This allows farmers to trade goods beyond the physical premises of APMCs and prevents state governments from levying cess or market fee outside of APMCs on trade. It also allows farmers to trade produce across the country, which was prohibited previously, in the interests of protecting farmers.
The second act, Farmers Agreement on Price Assurance and Farm Services Act, legalises contract farming. Contract farming is essentially a mechanism allowing buyers to directly get into an agreement with farmers. Farmers agree to raise crop or livestock according to the buyers’ specification and on their part, buyers agree to buy the whole produce at a predetermined price. It enables farmers to plan production in advance, gives them access to new markets, reduces costs, increases sales and can even be used as a tool for skill transfer.3
Contract farming was opposed by farmer groups. They claimed that it would put farmers at the mercy of corporates. This takes the form of various fallacious arguments. The most common argument put forward is that corporates would exploit farmers by suppressing prices. In a free market, the farmer could always decline the contract or enter into a contract with a corporation offering favorable prices. Unless cartelisation takes place, corporations can’t suppress prices. The correct way to go forward would be to ask the government for protection against cartelisation. In fact, a few months ago, the government itself turned to contract farming to reduce import dependency for pulses. Unfortunately, the government will procure this at the higher of MSP or market rates, distorting markets again.
The third act was an amendment to the Essential Commodities Act. This act penalized any hoarding, the unintended effect of which was to also penalize investments into storage facilities. Coupled with strong criminal penalties, this deterred almost all private investment into the sector. The amendment repealed stocking limits except in case of steep price rises.
India has more than enough buffer stocks to tide over any short term disruptions to supply. The collective agricultural mindset has been living in the 1960s when India was facing problems with hoarding and wasn’t producing enough to feed its own population.
Taken together, the three acts would be helpful in introducing free markets to agriculture. Let me paint a picture.
Almost half of the crop area under cultivation is split into parcels of less than 2 hectares in size. One such farmer who owns and cultivates a small piece of land, sees input costs rising for wheat. The water table is sinking every year, causing him to use more electricity to pump out the water from more depth. The soil has lost its quality, being used to grow the same crop over the years, necessitating the use of even more fertilizer. The MSP that the government guarantees hasn’t increased as much and even if it does increase, it just keeps pace with inflation. Living standards haven’t increased much. All produce isn’t bought by the government at MSP anyway.4 Selling at the local APMC isn’t very profitable because the traders form a cartel. Selling to others is done through the traders as well and the traders capture much of the increased sell price.
One day, the impediments to selling are done away with. Suddenly, there are multiple options at disposal to a farmer. He doesn’t need to go to an APMC to sell his produce. He can directly sell to others without middlemen.5 Companies can approach him and ask him to grow directly for their needs. Companies like BigBasket that need produce in large amounts can directly work with farmers to get it. It ends up being a win-win because it reduces costs for companies too. The free market introduces competition that modernises agriculture. Companies could help in modernisation too. The farmer could be contracted for crops other than wheat. That drastically reduces fertilizer bills because the soil quality could probably use less fertilizer for crops other than wheat. Crops using less water would also reduce electricity bills.
There are multiple such streams of revenue that open once markets are allowed to work unimpeded. The limiting factor is creativity of the farmers and buyers. As I have stated multiple times before, free markets are a powerful resource. 6
So, what next?
With the laws being repealed, agriculture will have to go through piecemeal reforms again. Agriculture is split between State, Union and Concurrent lists. That means depending on what part of agriculture is concerned, both the states and the Centre can make laws.
The way forward lies in states themselves reforming agriculture. For example, Maharashtra has dismantled the monopoly of the APMCs. Madhya Pradesh and Gujarat have also followed suit.
With the magnitude of protests that the government saw over the farm laws, I wonder if it will again have the appetite for such bold reforms. I hope it does, absent which, the farm subsidy model is doomed to fail.
For more detail, refer to Shruti Rajagopalan’s paper on how interventions into agriculture, resulted in the need for even more interventions.
Without a price ceiling, only those consumers would buy a product who really need it at the current price. The price acts as a barrier against inefficient usage. When a price ceiling is implemented, the demand for the product goes up, but since the quantity is the same, long lines result for the product. In essence, consumers are buying the product with their time instead of money.
Sometimes companies can take extra steps to train farmers in new production methods or provide them with new technology. Some buyers might also provide inputs to farmers at reduced cost, helping them keep costs low.
And before anyone says that this is why we need a legalised MSP, let me point them to my post on it and why that’s a bad idea.
Of course, transitioning to a free market model from a socialistic model needs support from the government.
Before someone puts words in my mouth, I am not claiming that free markets are a panacea to everything that ails agriculture. But taking significant steps towards free markets reduces distortions and improves price signals which helps makes better economically rational decisions.
https://gurhaal.com/%e0%a4%b0%e0%a4%9c%e0%a4%95%e0%a4%b0%e0%a4%a3/farms-act-2020-%e0%a4%95%e0%a5%83%e0%a4%b7%e0%a5%80-%e0%a4%95%e0%a4%be%e0%a4%af%e0%a4%a6%e0%a5%87-2020/
This is link for articles.
Good one.
I too wrote a 5 article series on these acts, In Marathi. It is intended for those who are blindly opposing the Farm laws without understanding what is there in it?