Restricting the price subsidy to coarse grains alone will not only work better from both fiscal and equity points of view but also weaken the incentives for graft
The National Food Security Act (NFSA), passed recently by Parliament, offers 5 kg per person a month of cereals at highly subsidised prices to more than the bottom two-thirds of the population. It has been rightly hailed as the largest welfare programme ever undertaken in a country to provide nutrition and food security to its poor. Passed in an election year, it is supposed to deliver rich political dividends to the party of the government of the day, but the huge bill for the subsidy (estimated to be Rs.1.15 lakh crore a year and rising) will have to be footed by future governments. Given its political message, future governments will have little option but to reform the programme and make it better targeted and fiscally less burdensome.
Since the programme covers both the extremely poor and the not-so-poor, those eligible can be divided into two groups: the not-so-poor, who, irrespective of the subsidy would consume at least 5kg a month of cereals, and the extremely poor who would consume less than 5kg a month if no subsidy was available. Such a division of the people covered is implied by the fact that cereals are a normal good, that is consumers with higher incomes consume more of the good, and thus it is the extremely poor who would consume less than 5kg a month in the absence of the subsidy.Regressive subsidy
The subsidy available under NFSA will impact the welfare and the consumption of the not-so-poor, who would consume at least 5kg a month even in the absence of the subsidy, in exactly the same way as direct, unconditional, income transfers equal to the cost of the subsidy, since they will substitute kilogram for kilogram their open market purchases of cereals with the subsidised cereals and use the cash so saved to purchase more of other goods such as edible oils, pulses and vegetables, etc. as well as some more cereals. But the impact on the extremely poor, who would consume less than 5kg a month in the absence of the subsidy, will not be the same as that of direct unconditional transfers, since they will not be able to substitute their open market purchases with subsidised cereals to the same extent as the not-so-poor and therefore may have to consume less of other goods and more of cereals than they prefer. In other words, unlike direct unconditional income transfers, the price subsidy on a limited amount of 5kg a month of cereals does not allow the extremely poor as much flexibility in choosing their consumption bundles as it allows the not-so-poor. Reports that some recipients of the subsidised rice sell it off to flour mills at below market prices only reinforce this view as they are merely attempts to purchase a more preferred consumption bundle.
Since the impact of the price subsidy on the consumption and welfare of the not-so-poor is the same as that of revenue neutral, direct, unconditional income transfer but not so in the case of the extremely poor, the price subsidy is regressive in the sense that it is equivalent to smaller, direct, unconditional income transfers for the extremely poor. This regressive nature of the price subsidy made available under NFSA seems to have escaped the attention of experts and policymakers. For instance, Drèze and Sen in their book oppose price subsidies on diesel and petrol on the ground that they are regressive, but forcefully support NFSA as if it were not.
Actually, the price subsidy should be regressive, since it is not regressive only if incomes of everyone are high enough such that everyone would consume more than 5 kg a month of cereals in the absence of the subsidy. In that case, the price subsidy would impact consumption and the welfare of everyone in exactly the same way as direct, unconditional income transfers equal to the cost of subsidy. The price subsidy, as a device for reducing hunger, would not achieve anything more than direct income transfers, but the government would unnecessarily incur huge costs of distributing cereals through the public distribution system (PDS). The case for direct unconditional income transfers in place of the price subsidy then becomes even stronger.Coarse grains
To keep the arguments simple, the discussion earlier abstracted away from the fact that the price subsidy under NFSA is available on three different varieties of cereals, namely, rice, wheat and coarse grains and one of them is not even a normal good. In fact, coarse grains, unlike wheat and rice, are an inferior good, that is consumers with lower incomes consume more of them, and consumed mostly by the extremely poor, who are habituated to an ancient diet. They are mostly cheaper than wheat and rice, but not less nutritious. In fact, a body of science asserts that some varieties of coarse grains are even more nutritious than wheat and rice. If the price subsidy were available only on an inferior good such as coarse grains, then, by the same reasoning as earlier, the subsidy would not be regressive. Thus, restricting the price subsidy to coarse grains alone will work better from both the fiscal and equity points of view without compromising on the amount of nutrition made available. Taking note of some additional facts concerning coarse grains vis-à-vis wheat and rice only reinforces this view and suggests how the programme may be reformed to make it more effective and better targeted. First, the impact of the green revolution — large increases in production and yield — seem to be now giving way to wheat and rice. In comparison, yields for coarse grains have been growing much faster. Unlike rice and wheat which require lots of water to grow, they are hardy and can flourish in relatively dry weather. Policies (support prices, procurement, and distribution) to induce greater consumption of coarse grains can raise incomes of farmers in the arid zones lacking irrigation who have remained relatively poor as they could not benefit from the green revolution. Second, the nutrient contents of some coarse grains such as jowar, bajra and ragi are not less than those of wheat and rice. In fact, they are richer in proteins, calcium and iron and many of the poor are habituated to consuming them. Their consumption in place of wheat and rice can improve health as is being gradually realised. Thus, there is every reason to promote the production and consumption of these neglected grains.Issue of reforms
Though, as reasoned earlier, replacing the price subsidy with revenue neutral direct unconditional income transfers would benefit the extremely poor more, there are significant challenges to doing that. At the minimum, the poorest must have access to bank accounts or other money solutions. Also, direct, unconditional income transfers, even if possible, may provide stronger incentives for graft and corruption as gains from that would be significantly higher than diverting subsidised cereals for resale in the illegal market. Moreover, if the poor receive a fixed sum in place of physical transfers of food, their food security could be at risk if the prices of cereals spike in certain regions and seasons. Direct, unconditional income transfers can also be criticised on the ground that there is no guarantee that they will indeed lead to higher food consumption by the poor. Given these concerns regarding direct income transfers, restricting the price subsidy to coarse grains alone will not only work better from both the fiscal and equity points of view but also weaken the incentives for graft, since pilfering and fraudulently obtaining the relatively cheaper coarse grains would be significantly less rewarding but not less risky. Such a policy would also lead to better targeting and a lower fiscal burden as many among the not-so-poor who do not really need the subsidy would voluntarily opt out of the programme. It would effectively reduce the coverage to much less than two-thirds of the population. Moreover, coarse grains, though an inferior good, are not less nutritious than wheat and rice.
Such a reform of the programme, however, may be considered too drastic and politically unwise. Moreover, the amount of coarse grains currently procured and distributed through the PDS is minuscule. Therefore, restricting the price subsidy to coarse grains alone can be done only gradually. A start can be made by raising the entitlement for coarse grains to 6kg per person a month but keeping the entitlements for wheat and rice unchanged, if not reduced, as that would be more equitable and provide more food and nutrition to the extremely poor, who need help the most and prefer to consume coarse grains, without affecting those who have strong preferences for wheat or rice. Reforming the programme in this way would not impose an additional fiscal burden as the relatively higher entitlement for coarse grains would induce many beneficiaries to voluntarily switch to consuming them in place of the more-costly-to-subsidise rice and wheat. Over time, as more people opt for coarse grains and their cultivation, procurement and distribution through the PDS rise, the price subsidy would effectively become a subsidy on coarse grains. This process can be accelerated by gradually reducing the price subsidy on wheat and rice from a suitable point of time onwards.
That would induce the not-so-poor even more to not avail the subsidy and eventually lead to a better targeted and fiscally less burdensome programme. In addition, it would indirectly reduce poverty among relatively poor farmers in arid zones engaged in the cultivation of coarse grains.
(Parkash Chander is professor, Jindal School of Government and Public Policy, and fellow of the Econometric Society.)