Energy subsidies and sustainable development

Wealthy countries support their farmers through a host of different measures, such as direct payments, price incentives and export subsidies, which artificially reduce world prices below the cost of production and inhibit the ability of farmers in poorer countries to compete in the world market. Despite some major policy initiatives in recent years, such as the European Union’s reform of its Common Agricultural Policy (CAP), production-linked measures still dominate producer support in most OECD countries, encouraging output, distorting trade and lowering world prices.

It is widely argued that removing domestic support would raise world prices for agricultural commodities, making way for more competitive countries to export their produce in the world market. Indeed, the World Trade Organization’s Doha Round negotiations, billed as a ‘development round’, are currently stuck, as developing countries wait to see the magnitude of the reduction that developed countries are ready to offer on agricultural subsidies before moving forward on commitments on industrial tariffs.

Agriculture is a crucial sector for India, and a reduction in wealthy country subsidies is widely expected to be a boon for our farmers and our economy. Yet research undertaken by this author suggests that India is not well positioned to benefit from improved world market conditions. Even if trade-distorting subsidies are completely eliminated, poor price transmission from border to farm gate leads to very minimal impact on production enhancement and exports.

A simulation exercise undertaken by the Indian Council for Research on International Economic Relations (ICRIER) shows that eliminating trade-distorting product specific subsidies in OECD countries would raise world prices by 1.1- 4.9 percent for rice, 2.6-7.4 percent for wheat, 6.5-20.8 percent for cotton and 7.5-26.4 percent for sugar, under different supply and demand scenarios. These results confirm that depressed world prices can be corrected by the removal of agricultural subsidies from OECD countries. But the key question for India remains: How much would these price corrections benefit Indian farmers?

The answer is not promising. ICRIER research reveals that, in reply to this change in world prices, India’s domestic price response would only be an increase of 0.1-0.3 percent for rice and 0.5-1.5 percent for wheat. For cotton and sugar the price response is better: a rise of 4.8-15.2 percent and 7.9-28.1 percent respectively. Thus a 10 percent rise in world prices leads to only 0.5 percent, 2.0 percent, 7.3 percent and 8.7 percent rise in domestic prices for rice, wheat, cotton and sugar.

India is poorly placed to take advantage of improved market conditions because of government policies like minimum support and procurement prices. These provide stability for Indian farmers, shielding producers against unexpected price fluctuations. Yet these institutional rigidities also affect the ability of domestic prices to adjust to world market prices, with poor price transmission leading to poor supply responses.
Moreover, India’s intensive regulations, supply constraints, productivity issues, land scarcity and huge domestic demands make it even more difficult for Indian farmers to compete with other exporting nations on the world market.

If India wants to cash in on a future opportunity to enhance exports then there is a need to work on domestic policies along with negotiations on the multilateral front. Instruments like forward trading and futures markets, for example, could be used to stabilise prices, while encouraging farmers to be more responsive to the futures prices. These instruments could also provide insurance to farmers against future price instability.

While delays in reaching a multilateral deal in the WTO trade negotiations may be lamentable for other reasons, it has at least given India some time to do away with its domestic inefficiencies, so that in the long run a WTO agreement on agriculture would bring about more significant gains.

*The views expressed in this commentary belong to the author, and do not necessarily reflect those of the ICRIER, nor the GSI.