3 min read.Updated: 12 Jan 2018, 11:39 PM ISTLivemint
It is impossible for India to simultaneously keep farm prices high, retail food prices low, and overall inflation under control through a tight fiscal policy
Almost five years ago, this newspaper had proposed an impossible trinity of fiscal policy goals which handicaps any Indian government. The idea is worth reiterating at a time when the pattern of voting in rural Gujarat during the recent assembly elections has led to a wave of commentary on how the Narendra Modi government will have to do something for farmers in the next budget if it has to win back the rural voter.
The policy trap is as follows: It is impossible for India to simultaneously attain the three goals of keeping farm prices high, retail food prices low, and overall inflation under control through a tight fiscal policy—unless the food sector is radically reformed. This trilemma leads to three difficult policy choices.
First, the government can offer higher farm support prices as well as keep retail prices down, but only at the risk of letting inflation spiral out of control through a higher fiscal deficit. This is the trap the United Progressive Alliance walked into.
Second, the government can focus on keeping retail prices low as well as the fiscal deficit under control by limiting the increase in farm support prices. This has been what the National Democratic Alliance has done in recent years but it could now be facing a potential voter backlash in rural areas.
Third, the government can offer higher support prices to farmers and keep its fiscal policy on track, but only by making consumers pay higher food prices. This is also a risky strategy given the fact that political movements, such as the one led by Jayaprakash Narayan in the 1970s, were sparked by higher retail food prices.
Union finance minister Arun Jaitley will have to make a choice between these three imperfect alternatives when he unveils his new budget early next year; it will in all probability be the last full budget before the next general election. A further complication—and one that was not present when we first wrote about the fiscal policy trilemma in January 2013—is that India now has a central bank that is legally mandated to keep inflation near target.
The most tempting course of action would be to either increase rural subsidies or fund a farm loan waiver. The question is how this can be done under the current fiscal constraints. The Reserve Bank of India will be tempted to raise interest rates if it feels that a fiscal slippage could lead to higher inflation. Increasing rural spending while maintaining fiscal goals will necessarily mean cuts in categories that are important for other interest groups.
Trinities can sometimes be as important in policy economics as they are in religion. Think about the fact that central banks can only meet two of the three policy goals of monetary independence, flexible exchange rates and an open capital account. The economist Dani Rodrik has his own globalization trilemma: Democracy, national sovereignty and global economic integration are mutually incompatible.
The broader lesson is that the structural problems in rural India—this is arguably the third round of rural distress this century—cannot be effectively tackled with cyclical fiscal interventions. The experience of the previous government is instructive. It tried to help farmers by changing the terms of trade in their favour. That strategy only provided temporary relief.
Finding more sustainable solutions will not be easy. Among the tasks ahead will be to figure out how to raise farm productivity on the one hand as well as create non-farm jobs in rural areas on the other. It is also worth pointing out that higher real incomes in rural areas will provide the domestic demand needed to make new industrial production capacity worthwhile. A member of the Shetkari Sanghatana recently charted out a free market agenda for farmers in these pages, to mark the second death anniversary of Sharad Joshi.
The balance between town and country has always been a complicated political economy problem for Indian policymakers, right from the early days of the Mahalanobis plans, when the focus of policy was to rapidly industrialize. The early debates in Soviet Russia during the 1920s between Nikolai Bukharin and Yevgeni Preobrazhensky were in a similar vein.
This political economy challenge will remain till India completes her overdue structural transformation into a modern economy. Till then, the impossible trinity of Indian fiscal policy will have to be managed. The trinity is a good way to frame whatever choice Jaitley makes in his next budget.
How can the government relieve farmers’ distress without hurting the consumer or being fiscally profligate? Tell us at email@example.com