Strategies for Agricultural Liberalisation: Consequences for Growth, Welfare and

Distribution
Author(s): Kirit S. Parikh, N. S. S. Narayana, Manoj Panda and A. Ganesh Kumar
Source: Economic and Political Weekly, Vol. 30, No. 39 (Sep. 30, 1995), pp. A90-A92
Published by: Economic and Political Weekly
Stable URL: http://www.jstor.org/stable/4403270
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 Strategies for Agricultural Liberalisation
Consequences for Growth, Welfare and Distribution
Kirit S Parikh
N S S Narayana
Manoj Panda
A Ganesh Kumar

This note summarises the results of a recenttly completed stud) which examined the impacts of trade
agricultural input subsidy reductions and safety net programntes for India with an applied general equil
with nine agricultural sectors, one non-tradeable non-agriculture sector and one tradeable non-agriculture sect
five rural and five urban income classes. Thle study demitonstrates the importanice of accounting for large co
in rice trade and estimates the optimal tariff/lquota for rice exports for India - which is found to be just
tonnes of net export of rice. The results show that non-agricultural trade liberalisationi is even more im1portan
than even agricultural trade liberalisation, both of which help accelerate growth. The study concludes that
involving trade liberalisation with moderate residual taiffas permitted unider GAlTanidagricilttural input.s su
accompanied by targeted safety net programmes along with stepped up investment in irrigation, with the exp
foreign inflows materialising, produces a scenario that is superior fronm the point of growth, welfare and
that this can be financed without raising taxes.

I expenditure classes in both rural and We use the Agriculture, Growth and
Introduction and Issues urban areas? Redistribution of Incomes Model (AGRIM)
(4) What would be the impact of removal of Narayana, Parikh and Srinivasan (1990).
THE Indian economy has not grown rapidly of subsidies on agricultural inputs? This is a sequential general equilibrium model
in the past in a command and control type (5) How to offset welfare loss, if any? What that computes equilibrium price and output
of environment that offered little incentive would be the net impact of liberalisation for each year in succession. Many of the
for efficient use of resources. The economic and such offsetting measures? supply and demand relations in the model
reforms initiated in June 1991 aimed at The study adopts the normal small countryhave been econometrically estimated. It
putting the economy on a high growth pathassumption for most of Indian agricultural considers nine agricultural sectors and one
through improvements in efficiency in the produce. But the case of rice appears to be composite non-agricultural sector. There are
industrial sector by bringing in competition. different. India is a major producer of rice. three sets of agents: producers, consumers
Unlike industries, agriculture has The buffer stock of rice with the government(classified into five expenditure groups in
functioned more or less, in a competitive (18 million tonnes in January 1995) is itself each of rural and urban areas), and
environment all along. Nevertheless, more than the world trade volume of this government. Produccrbehaviourdetermines
inefficiencies in resource use in agriculture commodity. Given such market power there commodity supplies and incomes. Consumer
arose due to trade restrictions, inappropriate is a need to study the large country effects behaviour generates commodity demands
pricing of inputs and outputs, and the while considering the trade liberalisation of and household savings. The government
prevailing macro-environment. Trade rice. In particular one may look into the sets policies such as investment targets, taxes,
restrictions take various forms like, totalquestionban of adopting asocially optimal tariffs/ tariffs, quotas, rations, price supports and
on exports, export licensing/ceilings, export quota policy. ceilings. Finally, equilibrium is achieved
canalisation through governmental agencies, through exchange in which domestic
as well as restrictions on export prices. II demands, together with export demand by
Distortions in input prices arise mainly due Methodology the rest of the world for each sector's output,
to subsidies on farm inputs such as fertiliser, is equated to the sum of domestic supply
irrigation, power and credit. A combination Agricultural reform is likely to affect (emerging from previous year's production
of the trade restrictions and government almost every mne. Trade liberalisation would net of changes in stocks) and imports.
intervention in commodity markets result in affect domestic prices of different The base/reference run is a business-as-
distortions in farm output prices. It is time commodities differently. Changcs in relative usual scenario in which past policy regimes
that the reforms address to these inefficiencies prices would cause farmers to change their continue. Any policy changes relative to the
in agriculture so that gains from industrial cropping pattern and allocation of inputs reference scenario have been introduced
reforms are enhanced further. such as fertiliser to ditfferent crops. This willbeginning 1993 and their impacts studied
This note summarises a study that examines result in changes in output levels and farm over the period 1993-2000. Comparison of
a number of issues that arise in the context incomes. The trade pattern will also change. the outcomes of the reference run and the
of agricultural liberalisation. The study Changes in relative prices also affect policy scenario for the indicators reflecting
addresses the following specific questions: consumers and their welfare. All these would the various objectives of the society show
(I) Should agricultural trade be liberalised? have implication for government's tax the impact of the policy change.
If yes, should we liberalise all revenues and expenditures for subsidies andIn the reference run, it is assumed that the
commodities or only selected ones? In anti-poverty programmes. The macro- policies with respect to procurement and
particular should we liberalise rice trade economic consequences for the economy public distribution of foodgrains, public
as its global market is thin? can be significant. consumption and investment, foreign trade
(2) What would be the impact of Thus to answer the questions posed above and aid, etc, would correspond to those
liberalisation on the growth of the satisfactorily, we need to account for all these prevalent in the recent past. Trade quotas on
economy, sectoral outputs, trade and interdependencies and feedbacks. We have different agricultural commodities range
prices? done this through policy simulation using an from 5 per cent to 15 per cent of domestic
(3) How would it affect welfare of different applied general equilibrium (AGE) model. supplies. For rice, an export quota of half

A-90 Economic and Political Weekly September 30, 1995

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a million tonne is imposed to reflect the FIGURE: INDIA'S RICE TRADE, WORLD PRICE AND PROTECrnON LEVEl.
thinness of the world market. Domestic price
policy sets target prices in a way that provides
the estimated degree of protection to that Domestic Supply
particular commodity. price (Pd) pd - _ _ ,
An important assumption in the reference
scenario and most policy scenarios is that
total (= public + private) investment follows
a specified investment-GDP relationship. pd
This is accomplished by requiring that
government savings adjust through Domestic demand
adjustment of tax rate to supplement private
savings. This requirement is relaxed in some
- -~~~~~~~~~ ~Quantity
scenarios where tax rate is kept fixed and
public investmcnt adjusts. World price
Free trade implies removal of all price
distortions including trade quotas. The model * i j ' ~~~(P*)o
captures this by removing the prevailing
protection/disprotection for the different
sectors. Thus, domestic consumer price for .Pw?
an exported (imported) commodity is set as
world market price minus (plus) international I Apparent
trade and transport margins in the policy - 7 True protection
scenarios. The prevailing protection rates
used in the model are: wheat -0.12, rice Exports E, E, Imports
-0.34, coarse grains 0.10, bovine and ovine E, EI
meat -0.15, dairy products -0.15, other India's rice trade
animal products -0.15, protein feed -0.30,
other foods 0.40, non-food agriculture -0. 10, allocative efficiency. However,
effect of itnon-
trade liberalisation on should
tradeable non-agriculture 0.35. The noted that potential gains due to better agricultural output is weak due to prevailing
protection rates for the agricultural sectors allocative efficiency within non-agricultural capacity constraint, leading a big jump in
are based on Gulati et al (1993). These sector as also within some of the commodity non-agricultural imports. Over time, as
protection rates are derived by comparing groups (e g, Other food sector) are not capacity is created non-agricultural output
existing world market price with domestic captured in the model in its present form. expands and imports stabilise.
price. Ideally, one should estimate it by com- Subject to these limitations, this implies that In the long run, liberalisation leads to
paring domestic price with what the world investment goods liberalisation has a greaterhigher volume of exports of all agricultural
market price would be when India removes impact on growth, even agricultural growth,goods, except coarse grains. Particularly,
its protection. For a small country these two than agricultural liberalisation. Agriculturalexports of wheat, rice, dairy products and
estimates should not be very different. While trade liberalisation beginning 1994 results non-food products could expand
in the reference scenario these (dis)protection in a growth of I per cent by the year 2000substantially. Prices of several agricultural
rates are used, in the trade liberalisation in agricultural GDP, whereas when non- sectors, which are disprotected now, would
scenarios these rates are set to zero and trade agricultural sector is also liberalised, rise with trade liberalisation, while prices o
quotas are removed. An exception is rice for agricultural GDP grows by more than 3 per industry and some agricultural sectors (coars
which an export quota is imposed to reflect cent. The terms of trade moves in favourgrain of and other foods), which are protected
the limitation of the world market to absorb agriculture by 27 per cent when non- now, would fall. The only exception to thi
it (as discussed below). agriculture is liberalised whereas it is lesspattern is the case of rice the price of which
than 2 per cent when only agriculture is falls despite prevailing disprotection. Thi
III liberalised. The terms of trade effects counter-intuitive result is explained through
Results and Conclusions dominate the scenario outcomes. Thus, a the large country effects and associated expor
very important conclusion emerges. Non- quotas, as discussed later.
Various policy scenarios have been agricultural trade liberalisation is even more
developed to analyse the impact of trade important for Indian agriculture than How DOES AGRICULTURAL TRADE
liberalisation, optimal rice export quotas/ agricultural trade liberalisation. This also LIBERALISATION AFFEcr WELFARE?
tariffi retaining moderate protective tariffs, means that the process of liberalisation which The average welfare indicators such as
capital inflows, agricultural inputs subsidy has so far only reduced non-agricultural average calorie intake, average equivalent
removal and safety net programmes. The protection cannot be said to have bypassed income and rural-urban income parity show
main conclusions emerging from the study agriculture. improvement under agricultural trade
are summarised below. In the long run, agricultural liberalisation liberalisation. This is because the welfare
increases output of all agricultural effects of trade liberalisation differs across
TRAE LiBERALISATnON:
commodities excepting coarse grains and different expenditure classes in the rural and
DOES IT HELP ECONOMIC GRowTH?
'other foods' (which includes sugar, oils, urban areas. Agricultural liberalisation by
Trade liberalisation helps to accelerate etc), the sectors for which our estimates of itself improves the welfare of the poor in
economic growth in the medium run by the nominal protection rates were positive. both rural and urban areas. The marginal
increasing allocative efficiency within However, when non-agriculture is also increase in terms of trade for agriculture and
agricultural sectors and between agriculture liberalised, the outputs of these two sectorsthe decline in prices of rice, coarse grains
and non-agriculture, and by increasing real also increase. In the short run, however,and other food together result in different
investment due to terms of trade effects. In agricultural trade liberalisation by itself impacts on consumer price indices for
fact, in seven years after liberalisation in disrupts agricultural production, mainly in different expenditure classes. The adverse
2000, the GDP is larger by 4.5 per cent and the 'other foods' sector by as much as 8 per income effect associated with the increase
agricultural GDP larger by 4.1 per cent cent. But if non-agricultural trade is in terms of trade is more than adequately
compared to the reference scenario. liberalised agricultural output, includingthat
compensated by the gains to the poor as
The impact of increase in investment is of 'other foods', picks immediately by about consumers due to fall in rice, coarse grains
much stronger than that of increases in 4 per cent by 1995. The short run growth and other food prices. The rural rich who

Economic and Political Weekly September 30, 1995 A-91

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get income from both agriculture and non- million tonnes by India. For exports beyond input subsidies, with other government
agriculture are, however, worse off due to 4 million tonnes, the world price falls below expenditures being constant, would result in
liberalisation in terms of their equivalent the domestic price and the run would be the release of substantial amounts of
income. This is because, as government loses inconsistent in the sense that we force the resources. These resources can be used in
tariff revenue due to liberalisation it has to model to export rice when we should be in several alternative ways such as for tax reliefs,
raise taxes, which are stipulated to be only fact importing. for enhancing investments and/or for welfare
on non-agricultural income. Therein lies the The results of this exercise indicates that programmes.
dilemma of agricultural trade liberalisation. as rice exports rise, domestic rice price If the savings from subsidy removal, along
The rich farmers would oppose it even thoughincreases. The production structure shifts in with trade liberalisation, are used merely to
the rural poor and urban population stand favour of both rice and wheat and there is provide tax reliefs, it results in a loss in GDP
to gain from it. a gain in real GDP. For optimal tariff policy, by about 1.5 per cent in the year 2000 with
Non-agricultural trade liberalisation results however, we should go beyond the GDP agricultural GDP falling by about 3.5 per
in a deterioration in the average welfare effects. We consider welfare level in terms cent. This aggravates rural poverty though
indicators. This is largely due to the fall in of equivalent income of different classes. the rural rich and urban population gain
equivalent income of the rural rich and whole Equivalent income is defined as the income from tax reliefs. However, when such savings
of urban population due to increase in tax required to provide a consumer at a reference are used for increasing investment, especially
rates on non-agricultural incomes. The set of prices the same utility as provided by irrigation investment, the adverse effects on
equivalent incomes of urban population falls consumption in policy change scenario. Thus, growth and distribution are more than offset
in spite of growth in real non-agricultural we can compare equivalent incomes in resulting in higher growth of about 1.3 per
GDP because of the terms of trade effects. different scenarios. To comparedistributions cent. There is virtually no loss in agricultural
of equivalent incomes across different groups GDP and distribution is also more equitable.
LARGE CouNTRY EFFEr7rs: WHAT Is THE we use the Willig-Bailey (1981) criteria Thus the conclusion that emerges is that, if
OPTIMAL TARIFF ON INDIA'S RICE EXPORTS? which compares average equivalent incomes agriculture is to be subsidised it is better to
of different cumulative population subsidise investment in irrigation rather than
Taking into consideration the large country proportions for rural and urban areas and use of current inputs.
effects in the case of rice as discussed earlier, looks for stochastic dominance. These Expansion of safety net programmes such
the study concludes that if India were to indicate that the export tariff for rice as would
targeted rationing or public works
export rice freely, the world market price ofbe socially optimal at a level such that rice programmes (like the Employment
rice is likely to fall. When we consider such exports are around half a million tonne. Guarantee Scheme (EGS) orJawaharRozgar
effects, rice sector is not disprotected to the Yojana (JRY)) when financed through
SHOULD WE RETAIN PROTECTIVE TARIFFS?
extent implied by the present world prices. savings from agricultural input subsidy
In commodities where India has market Retaining (imposition) of moderate removal can fully protect the poor from
power, the non-linearity in world prices in protective tariffs as permissible underGATT adverse welfare effects of trade liberalisation
response to India's trade of the commodity reduces the GDP gains and welfare impacts and input subsidy removal. In fact, such
should be accounted for. A correct measure arising from trade liberalisation. If protective measures can substantially improve their
of disprotection of rice would be the tariffs are maintained at 25 per cent ad wel fare over and above even the base scenario
difference between present domestic price valorem on non-agricultural trade, GDP in which reflects the pre-liberalisation policies.
and the world market price that would year 2000 would be lower bv about 0.8 per Thus a policy package involving trade
prevail if India were to have free trade incent than under trade liberalisation with no liberalisation with moderate residual tariff
rice. The Figure shows this correct measure protective tariffs. This suggests that these as per GATT and agricultural inputs subsidies
of (dis)protection. tariffs should be imposed only after careful removal accompanied by targeted safety net
The top part of the figure shows domestic consideration of benefits and costs. It may programmes along with stepped up
demand curve. Given a fixed supply (the be noted that our model does not account investment in irrigation, with the expected
argument is valid even if supply is made to for potential benefits (if any), of dynamic additional foreign inflows materialising,
respond to price) the export level will vary improvement in efficiency due to (infant produces.a scenario that is superior from the
with domestic price. Thus, at price PI,, theindustry) protection. In any case, a case for point of growth, welfare and distribution
export will be SE, and at Pk, it will be SE2.protection has to be made before it is granted. and this can be financed without raising
In the bottom part of the figure is shown the This should be particularly so for capital taxes.
world market price's response to India's rice goods sectors because of the real investment
trade. At an export level of SE world price benefits from trade liberalisation noted References
would be Pw, and at a level of ?E2 it would earlier.
Gulati, A, J Hanson and G Purcell (1993):
be Pw,.
WHAT WOULD BE THE IMPACT OF CAPITAL 'Effective Incentives in India's Agriculture:
In a situation where a domestic price of
INFLOWS? Cotton, Groundnuts, Wheat and Rice', WPS
Pd, prevails an apparent estimate of nominal
332, World Bank, Washington, DC.
protection rate would be (P`, - P' )/PW) If liberalisation results in additional inflow
Narayana, N S,S, K S Parikh and T N Srinivasan
Now suppose under no export restriction tie of foreign capital which is used for increasing
(1990): Agricutture. Growth ahd
domestic price is P",, exports SE, and investment then it helps in both accelerating
Redistribution of Income: Policy Analysis
world market price P`2 = P",. The 'true' growth and reducing adverse welfare effects.
with a General Equilibrium Model of India,
nominal protection rate is now estimatedIf to the capital inflows rise from 1.5 per cent
North Holland/Allied Publishers, New Delhi.
be (Pw2 - I"I)/P-2). in 1993 (base scenario) to about 4 per cent
Parikh, K S, G Fischer, K Frohberg and 0
Given its market power in world riceby 1996 and maintained thereafter, GDP in
trade, Gulbrandsen (1987): Towards Free Trade in
India could think of imposing tariff year 2000 would be higher by 2.6 per cent
on rice Agriculture, Maritinus Nijhoff Publishers,
exports. To determine the level of optimal over and above the improvements due to Dordrecht.
tariff, we need to analyse the impact of trade liberalisation. Parikh, K S, N S.S Narayana, Panda Manoj and
Indias exports on world market price of rice, A Ganesh Kumar (1995): 'Strategies for
AGRICULTURAL INPUT SIJBSIDIES REMOVAL,
which is a major task in itself. Based on Agri-cultural Liberalisation: Consequences
INCREASED INVESTMENTS AND SAFETY NET
estimates made by Parikh et al (1987) and forGrowth, Welfare and Distribution', report
PROGRAMMES: Is THERE A PARETO-
suggestions of the World Bank, we used a submitted to the World Bank, Washington,
SUPERIOR WIN-WIN POLICY PACKAGE?
rice demand elasticity of 0.1 and a supply DC.
elasticity of 0.4 for the rest of the,world to Removal of input subsidies is often Willig, R D and E E Bailey (1981): 'Incone
determine the world market price that would advocated as a part of the reforms measuresDistribution Concerns in Regulatory Policy
prevail corresponding to different quotas on Tequired to eliminate the distortions in Making' in G Fromm (ed), Studies in Public
rice export varying between 0.5 and 4.0 agricultural prices. Removal of agricultural Regulation, University of Chicago Press.

A-92 Economic and Political Weekly September 30, 1995

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