Has the Modi govt finally freed farmers from the tyranny of mandis?

For the last 40 years, governments have quietly longed to do what the Modi government has now done, namely, discard the minimum support price system for farmers. 

The basic policy issue is this: How can a country afford to guarantee income and not tax it also?

The latest move is couched in terms of freeing farmers from the tyranny of mandis, but the real reason is a fiscal one—MSPs can only go up due to political exigencies and are becoming too great a burden on the exchequer. 

There’s a direct and clear relationship between whether governments are willing to cough up higher MSPs and whether they will be re-elected. Just look at the last few elections. The Vajpayee government managed only a 2.9% average increase in paddy MSPs from 2000 onwards and was promptly voted out. 

The UPA learnt its lesson and in 2007-08 and 2008-09 it increased paddy MSPs by 28.5% and 20.8%, respectively. It was re-elected in 2009. 

The aftermath of the global financial crisis and the UPA’s profligate response to it, however, meant that it didn’t have the fiscal room to repeat this before the 2014 elections. We all know what happened in that election. 

After hiking MSPs by single digits for most of its first term, the Modi government increased them by about 13% in 2018-19. Again, the farmers rewarded it with a historic win in 2019.

There were, of course, other factors at play, but time after time governments have learnt not to ignore the farmers. But now the Modi government is in the process of dismantling the entire MSP system. What’s the thinking? 

To understand that, we have to understand a little economic theory. In particular, the Cobweb model. 

In short, the Cobweb model describes the interplay between demand, supply, and prices when there is a lag between supply and demand decisions.

This applies almost perfectly to agriculture. Farmers sow this year what they will reap only next year, and so have to decide how much to sow this year based on their expectations of the price next year. 

This leads to a self-fulfilling prophecy of bad decisions. 

Say, for example, that a deficient monsoon results in a poor wheat harvest any given year. Due to the shortage, the price rises.

Based on the higher price, farmer sow more wheat this year since it was relatively more remunerative than other crops. Next year, given a normal monsoon, there is an over-supply of wheat, which drives the prices down. 

This leads farmers to sow other crops in favour of wheat, which causes a shortage next year, and so on. 

Each time, the farmer guesses what will happen next year, and because of his actions, the opposite outcome occurs. 

In the West, the answer to this conundrum was to set up forward markets. In India, the answer was the MSP system to guarantee at least a minimum income for farmers. 

The difference between the two systems is that forward markets can correct prices downwards, but governments can only move MSPs up if they want any chance of re-election. 

The move away from the MSP system is a good one, but it needs to be accompanied by the creation of a forward market in India. 

The Planning Commission of the UPA had tried to work towards that end but in the face of political opposition from vested interests the government did the opposite. It banned them!

Now that the mandi system is about to go the time has come to inaugurate forward markets. 

It’s the only way of minimising both farmers risk and fiscal pressure.