Incentives: lawmaker, get your economic craft right

Conventional economic and policy analysis give importance to studying the effect of prices in commodity and service markets across economies at different stages of economic development. An economy, as Friedrich Hayek said, can be viewed as a teacher, where prices act as information messengers reflecting the market’s ability to guide people’s choices on what, how, how much to produce and consume over a period of time.

A sharp periodic fluctuation in these information messengers (prices of goods and services) may reflect a situation where there is too much supply or demand or indicative of excessive regulation by agencies of the State that distort price-based incentive structures for both sellers and buyers.

A close look at the current state of the Indian economy from a macro-economic standpoint reflects multiple areas of our lawmakers’ poor economic craft via government regulation. Two cases in point can be discussed here — the dismal state of the agriculture sector (agri-pricing mechanism) and a poorly managed fuel-subsidy targeting mechanism.

Measures undertaken in both these areas continue to demonstrate counter-productive effects from inappropriate government intervention, distorting the incentive structures for market agents concerned — farmers and households.

Within agriculture, the idea of a single, national agriculture market, promised by the current government in its election manifesto, by introducing the e-pricing mechanism (under e-NAM), still remains a fantasy. The extent of government failure in ensuring a better, more competitive market price structure for farmers can be seen across states from the broken, operational structure of Agricultural Produce Marketing Committees (APMC).

The Agricultural Produce Marketing (Regulation) Committees (APMC) Act of 2003 was enacted under A B Vajpayee’s government and has been implemented by more than 22 states to get price-based incentives for farmers through easier access to the market for a wider basket of crops.

Facilitating easier access to the market or seeking information on market price for a diverse basket of crops is still a major concern for most farmers. This is true regardless of the recent MSP hike of 28% and 26% for medium and long-term staple fibre cotton.

While in the short term this measure may incentivise farmers to stick to cotton cultivation (and may improve farmer-government relations), in the long term, however, a high MSP for a single set of crops will set a high price floor, disincentivising farmers from shifting to other required crops across non-cotton producing states.

The e-NAM reform was proposed to address some of these agri-pricing concerns by creating a unified pricing mechanism for all APMC-regulated markets. Though, as observed from the findings of the Dalwai Committee Report (2017-18), the situation remains unchanged: “there are around 29,547 marketing points, of which 22%, or 6,615, are regulated markets under the APMC and 22,932 are regional periodical markets (RPMs). On average, a farmer gets a regulated market in the radius of about 12 km and an RPM in a radius of about 7 km…Out of these 6,615 markets, the NAM scheme aimed to bring 585 markets (9%) on the e-market platform by the end of the financial year 2017-18...”

However, these mandis include fewer than 7% of Indian farmers contributing less than 2% to the total agricultural output. Additionally, the situation on agricultural productivity worsens with other incidental costs (rental price, irrigation cost, seed and fertiliser cost, etc.) persistently rising.

Fuel subsidies

Another pressing issue for the lawmaker remains the poor fiscal management and targeting of fuel subsidies amidst volatile global crude oil prices. Subsidising consumers of petroleum (or fuel) is a common phenomenon across many developing and emerging countries, including India. If the intention is to shield consumers (particularly poor households) and producers from high costs for lighting, cooking, transport, etc., a recent IMF study shows how the current fuel-subsidy targeting mechanism is both “socially regressive” and “anti-poor”.

It has been observed how most benefits accruing from fuel price subsidies have gone to higher income groups, which consume greater amounts of fuel. The richest 10% of the households in India receive seven times more in benefits than the poorest 10%.

Further, the periodic rise in fuel prices continues to impose high indirect tax-like effects on poor households, triggering high consumer inflation levels, with negative spill-overs on agriculture production and distribution of basic essential commodities, denting average consumption levels and people’s savings. In some ways, government intervention in this case has perpetuated economic and social inequity, rather than reducing it, which is the aim of fuel subsidies.

To address this government failure, commissions constituted over the recent past have advised measures for better alignment of fiscal subsidies across fuel platforms. Some of these include: use of international fuel prices as the appropriate reference for setting fuel prices; elimination of diesel subsidies over the short term, followed by a graduated phase of full diesel price liberalisation; gradual removal of kerosene and LPG subsidies; and replacement of in-kind subsidies with cash transfers. States, however, have failed to actualise any of these.

The science of the legislator or of ‘good’ government is one that craftily aligns prices for the right set of incentives for buyers and sellers to enter into a mutually beneficial bargain, without imposing high external, social costs. At a time when the social contract between Indian citizens and the current government seems to be hitting a bottom threshold, a lot needs to be done by lawmakers in not only getting price-based incentives right but also creating an institutional environment where agents (or citizens) can put more trust in the outcome of lawmakers’ actions and not simply in the intended motives of unilateral, ad-hoc measures.

(The writer is executive director, Centre for New Economics Studies, Jindal Global University)