Opinion | India now faces its own version of Soviet Union’s scissors crisis

Inflation numbers released by the government earlier this month tell an important story. The prices that consumers pay for food have been falling for three months in a row. Wholesale food prices have fallen for six months in a row. Roshan Kishore pointed out in Hindustan Times that this is the first time since 1990 that the prices farmers get for their produce at the farm gate have fallen for six consecutive months. Farmer incomes have taken a hit even if one assumes some amount of productivity gains in Indian agriculture.

The trend in food price inflation since the new consumer price index was introduced deserves closer attention because it throws light on one of the most important challenges in the Indian political economy. Food price inflation has been expectedly volatile since January 2012, but the overall trend has been down. Why?

Harish Damodaran has argued in The Indian Express that Indian agriculture has entered a new era of structural surpluses in many crops through the use of better seeds, as well as new technology. This is a far cry from the old belief that Indian economic growth was held back by a food constraint. It is also a very different situation from the belief among many policymakers at the beginning of this decade that Indian inflation was being driven by rising protein prices. Higher incomes were driving up protein prices since there was no adequate supply response. The production of pulses—an important source of protein in Indian diets—has soared since then.

Successive governments have struggled to deal with the terms of trade between agriculture and the rest of the economy. The United Progressive Alliance had tried to engineer a structural change in favour of the rural economy through higher minimum support prices as well as the rural jobs programme. It did spark off a rural boom. However, food inflation began to climb. It stayed in the double digits for 19 months in a row from June 2012 till December 2013.

This soon spilled over into generalized inflation. India battled an inflation crisis in the early years of this decade even as the rest of the world was facing deflationary pressures. The National Democratic Alliance went the other way. It had to quell an inflationary fire. The decision to temper the annual increases in minimum support prices helped bring down food inflation. Critics of inflation targeting have also argued that farmers have had to bear the brunt of the sharp disinflation over the past four years.

Higher food prices benefit those who are net sellers of food. Lower food prices benefit those who are net buyers of food, including rural labourers. Managing the distributional politics of food prices has foxed successive governments. However, it is not a distributional issue alone. Low nominal income growth in rural India—if not an actual decline—also hurts demand for various industrial goods. The fragile home market for industrial products plus the weak foreign demand for them is one reason why Indian production has faltered in recent years.

Many who are interested in economic history may perhaps see the parallel between what is happening in India right now with what happened in a very different country around 100 years ago. This was the Soviet Union soon after the civil war that the communists eventually won. Political stability as well as the withdrawal of draconian controls over Russian agriculture led to a huge rise in food production. The weather also cooperated. Russia saw bumper harvests.

Food prices fell. The prices of industrial goods continued to rise. A graph of these two price trends resembled the two blades of a pair of scissors. Soviet commissars began to call it the scissors crisis. Farmers who were not getting enough for their output did not have money to buy what the factories were producing. Some farmers chose not to sell the crop at all. Soviet planners—in what Friedrich Hayek later described as a fatal conceit—tried to deal with this internal terms of trade problem with price controls on industrial goods.

The rest of the historical narrative is not important right now. What is important is the fact that India could now be facing its own variant of the scissors crisis—core inflation and food inflation are moving in different directions. Managing the relative price of food in terms of industrial goods will be one of the biggest policy challenges for the new government that will take charge of the country later this year.

One important response to the Indian scissors crisis will be to remove controls on Indian farmers—be it their ability to sell directly to consumers or the freedom to export. Modern rural supply chains could also help undermine the stranglehold of middlemen. Forward markets will reduce at least some of the price risk that farmers face. Data from recent years shows that Indian farmers facing high levels of uncertainty take cropping decisions based on past price trends rather than expectations of future prices, a pattern very similar to the cobweb model taught in introductory microeconomics courses.

However, the most potent solution to rural distress continues to be outside of agriculture. India needs to create jobs in productive enterprises so as to create opportunities for millions who seek to escape farming, where they are condemned to deal with the vagaries of the weather as well as wild fluctuations in prices.

Niranjan Rajadhyaksha is research director and senior fellow at IDFC Institute. Read Niranjan’s previous Mint columns at www.livemint.com/cafeeconomics