Reforming agriculture


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BY now, it is almost certain that the agri-GDP growth for this ongoing 11th five year plan (2007-12) will remain around 3.2 per cent, way below the targeted growth rate of four per cent per annum. This is not the first time that the achievement will be short of the target by a full 20 per cent; in the last five year plan (2002-07), the situation was even worse when the actual agri-GDP growth was only 2.4 per cent against a target of four per cent, and almost similar to the performance (2.5 per cent) in the plan even before that (1997-02). This repeated failure to achieve a modest target of four per cent, plan after plan, speaks volumes of the hollowness in our policy making process, which either does not understand what drives growth in agriculture, or does not know how to design policies that can work towards attaining that target, or does not have the political will to do so.

But one thing needs to be made clear to our policy makers: unless the agri-sector takes off to a four per cent plus growth trajectory, the chances of reducing poverty in any significant manner and within a short time frame will remain dim, no matter how many freebies are doled out. The approach paper to the coming 12th five year plan (2012-17) itself recognizes that a one per cent growth emanating from the agriculture sector would be at least two to three times more effective in reducing poverty than the same growth coming from non-agriculture sectors. In the case of China, it was 3.5 times more effective and in the case of Latin American countries, especially Brazil, it was 2.7 time more effective.1 Remember that China started off its reforms with agriculture in 1978, and during 1978-84, agri-GDP increased by more than seven per cent per annum and farm incomes by more than 14 per cent per annum (due to liberating of agri-prices), halving poverty in just six years!

It should not be difficult for a country like India to recognize the importance of agriculture, where 52 per cent of the labour force is still engaged, a large mass of the poverty stricken are to be found in the rural areas and whose main occupation remains agriculture, and where an average Indian spends about half of the household expenditure on food (the bottom 30 per cent population spends 60 per cent). If this is the reality, why can’t our policy makers put agriculture on the highest agenda for the 12th five year plan, if they are in fact committed to alleviating poverty from this land?

Assuming there is a ‘political will’ to banish poverty on a sustainable basis, and not temporarily through doles (and this is a big assumption), what could be the agenda for reforms that can give us at least four per cent growth in agriculture for the next 10 years and make a significant dent on poverty?

An outline of an agenda for reforming agriculture is presented below.2 There are basically three elements (troika or trinity) needed to propel agriculture, call it the magic of three ‘I’s, namely investments, incentives and institutions. Let us discuss each of them in some detail to get a better handle on why things are not moving in agriculture at a pace they need to.


Investments and Subsidies in Agri-culture: Elementary growth theory tells us that the growth of a sector depends upon the investments made in that sector, its capital-output ratio, and the efficiency of capital in that sector. The Planning Commission assumes that the capital-output ratio in agri-culture is around 4:1, i.e, to get one per cent growth in agriculture GDP, we need to invest about four per cent of agri-GDP. That means to get four per cent growth in agriculture, investment should be around 16 per cent of agri-GDP. During much of the period from 1980-81 onwards till 2007-08, investment in agriculture (gross capital formation) from both the public and private sectors was always below this threshold mark of 16 per cent (Figure 1). One wonders then why our policy planners even expect a four per cent growth in agriculture when they are neither putting in enough resources from the government kitty nor incentivizing the private sector to do so. It is only in recent years that capital formation has crossed the 16 per cent mark, and one hopes that it will stay there for us to see some positive results on the agri-growth front.


The only consoling factor in Figure 1 is that somewhere in the middle of the 1990s, the falling trend of investment in agriculture was arrested and reversed, and this trend has continued, with some occasional hiccups. Was it the impact of overall reforms in the economy that has attracted more private investment, or was it the government’s policy choice to allocate more public resources to agriculture? The answer can perhaps be gauged from Figure 2, which gives a break-up of public and private investments in agriculture since 1980-81.


It is interesting to note that in the early 1980s, the share of public and private investment in agriculture was almost equal, but subsequently the share of public investment fell drastically. There was an attempt in the early 1990s to escalate the share of public investment, but the impetus soon petered out. It did marginally improve during 2003-07, only to fall again. By the end of the 2000 decade, the share of public investment in agriculture amounted to only about a quarter of the total investment, a drop of 50 per cent from its position in the early 1980s. So, primarily, it was the investment by the private sector, by the farming community itself, that drove growth. If one were to conjecture that the efficiency of private investment is higher than the efficiency of public investments, this result, that growth in agriculture is primarily driven by the private sector, will become even more pronounced.

This in turn raises two questions: (a) What happened during the 1990s and 2000s that helped propel private investments in relation to public investments in agriculture; and (b) Did the government deliberately withhold investments in agriculture and divert them elsewhere? The first question relates to the issue of incentives in agriculture during the period of economic reforms, which I will take up later in the article, but at present let us respond to the issue of public resources in agriculture. It is incorrect to say that the government deliberately withdrew resources from this sector, but if we look at the overall public resources going to agriculture through investments and subsidies, the picture becomes clearer. And it is here that the political economy of agriculture policy making rests. The overall public resources going to agriculture in the form of investments and subsidies on inputs like fertilizers, power, irrigation and credit is shown in Figure 3. The trend demonstrated in the figure is very clear: that resources going through the input subsidy route are increasing at a rate that is almost three times faster than the rate at which public investment has increased. Overall, it appears that there are sufficient public resources going to agriculture. Also, it may be noted that even public investment in agriculture has improved, especially after the drought of 2002-03. And this was a conscious policy decision. However, the fact remains that the public resources in the form of subsidies are overwhelming greater (five and half times more) than those going through public investments.


What is the problem with this type of approach where input subsidies outweigh public investments by almost five and a half times? It reflects an inherent policy preference in favour of subsidies, which seems to give quick political returns. But public investments are dominated (more than 80%) by major and medium irrigation schemes which have long gestation lags, and it is difficult to associate them with any political party, particularly when parties lose power quickly. So that is as far as the political economy works, which looks to quick political returns.


But how about the economics of investments and subsidies? An earlier study by Fan, Gulati and Thorat3 suggests that the marginal returns to public investments are at least 5 to 10 times higher than through subsidies such as on fertilizers, power, and so on, insofar as the objective function is either agricultural growth or poverty alleviation. The key results of this comprehensive study are presented in Table 1.


Returns in Growth and Poverty Reduction to Investments and Subsidies





Returns in agricultural GDP (Rs per Rs spending)









Irrigation investment




Irrigation subsidies




Fertilizer subsidies




Power subsidies




Credit subsidies




Agricultural R&D




Returns in rural poverty reduction (number of poor reduced per million Rs spending)









Irrigation investment




Irrigation subsidies




Fertilizer subsidies




Power subsidies




Credit subsidies




Agricultural R&D




Source: S. Fan, A. Gulati and S. Thorat, op cit., fn 3.

The interpretation of just a few results from this table suggests that if the public exchequer had an extra billion dollars to spend on say roads, education, irrigation investments, irrigation subsidies, power subsidies, fertilizer subsidies, credit subsidies and on agriculture R&D, and if the objective was to maximize returns in terms of agri-GDP, public expenditure on agri-R&D would have yielded returns equal to 9.5 times the expenditure, while if the same money was spent through fertilizer subsidies, the returns would have been only 0.85 times the expenditure incurred during the 1990s. This shows that investment expenditure on agri-R&D is the most powerful driver of agri-growth, followed by rural roads, education and irrigation investments during the 1990s. The returns from subsidies, particularly from fertilizer and power, are pitiably low.

If, however, the objective was to reduce the number of poor, then the returns during the 1990s were highest from investments in rural roads followed by agri-R&D, education, and credit subsidies and irrigation investments (public), and lowest from fertilizer and power subsidies. It is also interesting to note the rate of returns changed over the three decades.


The policy message for reforming agriculture is very clear: we need to rationalize and prune input subsidies and channelize those savings towards investments in agri-R&D, rural roads, rural education and irrigation. That is the way to go if we wish to put agriculture on a four per cent plus growth trajectory, and also solve the problem of poverty in rural areas. Investments may have to be doubled, even trebled and quadrupled, and this would be feasible (given the size of subsidies) provided the policy makers are bold enough to bite the bullet and prune input subsidies.

One way to contain the subsidy bill and to make it much more productive than is the case today, is to give subsidies directly to the farmers. For example, the fertilizer subsidy can be directly transferred to farmers’ accounts on a per hectare basis, thereby freeing the fertilizer sector. In this way one can avoid paying for the inflated and gold plated costs of fertilizer plants. An earlier analysis had revealed that almost half of the fertilizer subsidy shown in the budget actually goes to maintain high cost fertilizer plants, and only half reaches the farmer.4 The problem with power subsidies, which also incorporate high costs of SEBs, as well as thefts by non-agricultural sectors, is also similar. There is need for major reform in this area.


Incentives: As noted earlier, private investment in agriculture is the prime mover behind growth of agriculture, and its share has almost doubled between the early 1980s and the late 2000s. And private investment responds to incentives, both at macro level as well as at micro level. The macro-incentive environment, which earlier discriminated against agriculture through an overvalued exchange rate and high industrial tariffs, was substantially corrected and then almost eliminated during the economic liberalization process which actually started in the mid-1980s, and then got a shot in the arm in the early 1990s. This made Indian agriculture competitive in global markets, and with the opening of agri-exports in the early 1990s, agriculture got a positive response with the growth rate registering 4.8 per cent per annum during the five year plan period 1992-97.


But just as agri-exports were on the upswing, and domestic prices for farmers started improving, the government put a ban on exports of several agri-products in 1996 and began following restrictive domestic agri-marketing policies with a view to containing food prices at home. This objective of protecting poor consumers through the tools of trade and pricing policies adversely affects incentives to the producers. This conflict needs to be resolved. The global experience in this regard is to increasingly use income policy to protect the poor, while continuing with a liberal trade and price policy as far as the producers are concerned. But India has yet to make this transition, and in the interim, the policy of restrictive trade and prices does not help either.

An argument is often made that India has a large number of small land holders, and an even larger number of poor consumers; therefore, reaching each one through an income support route is practically impossible. This may have been the case in yesteryears, but now, given that India prides itself in IT, one can use this high technology to reach each one through the UID route. This would help protect the poor in case domestic prices of agri-products go up, but will not interfere with incentives to farmers.

However, pending the above switch in the use of policy instruments – from trade and pricing to income policy – many other things can be done to improve incentives for farmers and enhance their productivity and income levels. Much of the adverse impact on incentives comes from strangulating domestic markets under the Essential Commodities Act, 1955. This law allows the states to restrict movement of agri-products across state boundaries, impose levies on processors, impose stocking limits on traders, suspend futures markets, and so on. States like Punjab also impose heavy fees and taxes, often as high as 14.5 per cent, on basic staples like wheat and rice.

The Agricultural Produce Marketing Committee Act (APMC) is another lethal instrument that goes against the interests of farmers and favours commission agents at the cost of farmers and consumers alike. For a five minute auction, e.g., in the Azadpur market in Delhi or the Vashi market in Mumbai, the commission agents charge as high as a 6-15 per cent commission on the value of output sold. This is utterly disproportionate to the services rendered. No wonder they have prospered at the cost of farmers and consumers. What is needed as a first step is a clean sweep of both the ECA and APMC Acts that can ensure the free movement of goods across India, without multiple taxes, and direct buying by organized retailers and processors from the farmer groups. With these two policy changes, India can usher in a revolution in marketing of agri-produce, improving incentives and incomes of the farmers.


Institutions: Structurally, Indian agriculture is dominated by small holdings. About 83 per cent of holdings are less than two hectares in size and together they account for a little more than 40 per cent of the cultivated area, contributing roughly half of the value of agricultural output. So in terms of productivity they are not far behind; in fact they are and can stay ahead of large farms if only they have access to modern inputs. Where they lose out is in marketing, as the top end of the value chain (organized retailing and processing) is consolidating and scaling up, while farm holdings are still fragmenting. This poses a challenge of matching the scale.


In order to scale up at the bottom end, two major institutional reforms are needed. One, small farmers need to be organized in clusters, call them cooperatives or farmer producer organizations (FPOs), and they need to link up with processors and organized retailers. This was achieved under the AMUL model in case of milk and needs to be replicated for most other high value perishable commodities such as fruits and vegetables, poultry and meat products. Second, the land lease markets need to be freed so that there can be a vibrant market for land lease without fear of anyone losing his/her land. This would involve changes in tenancy laws that at present favour the tiller and would go a long way in enabling an economically viable holding size in India.

Another critical institutional reform required is in the area of agri-R&D. We have already mentioned the need to increase investments in agri-R&D as it gives high returns in terms of agri-growth as well as poverty alleviation. But this would be even more effective if the R&D set-up undergoes a major institutional reform, where scientists are hired, say on three to five years of renewable contracts, depending upon their performance in terms of delivery. Similarly, in extension of agri-R&D, we need to create a hybrid with the private sector under a PPP model where government extension workers work with the private sector on deputation and the private sector pays them, say 25 per cent on top of their government salary. This would incentivize the whole agri-R&D system and research can move from lab to land quickly, giving high returns to the society at large.


These are some of the critical policy changes required to put Indian agriculture on a higher growth trajectory. There are many others in the area of insurance, credit, and the like that one can elucidate, which would contribute to India’s growth story in agriculture.



1. World Development Report, 2008.

2. Some of these points have been discussed in several papers written by this author, most notably in ‘Accelerating Agriculture Growth: Moving from Farming to Value Chains’ in India’s Economy: Performance and Challenges (Essays in Honour of Montek Singh Ahluwalia), edited by Shankar Acharya and Rakesh Mohan, Oxford University Press, 2010.

3. Shenggen Fan, Ashok Gulati and Sukhadeo Thorat, ‘Investments, Subsidies and Pro-Poor Growth in Rural India’, Agricultural Economics 39, 2008.

4. Ashok Gulati and Sudha Narayanan, Subsidy Syndrome in Indian Agriculture, Oxford University Press, Delhi, 2003.