The recent announcement by Prime Minister Narendra Modi withdrawing the farm bills has, predictably, generated a lot of press. Undoubtedly, there have been political winners and losers. Much more consequentially, lives have been lost in this sordid saga. Sadly, the part that has been lost in the din is the fact that the entire episode was a complete distraction from the primary goal of lifting Indian farmers out of a low-income existence. The farm bills, whether they are passed or not, were unlikely to have made any sustained difference to the life of the farmer. Let me explain.
Agriculture today employs 45 per cent of India’s workers while only producing around 10 per cent of its output. Clearly, Indian agriculture is woefully unproductive. That is the fundamental reason why the Indian farmer is poor. The problem is that there are just too many workers still trying to eke out a living from the farm. The land, despite many improvements in irrigation, seeds, fertilisers and mechanisation, just doesn’t have enough in it to sustain the sheer number of people dependent on it.
In this backdrop of vast expanses of unproductive farms, marginal changes in prices of agricultural products through tinkering with agricultural marketing laws are not going to make any appreciable long-term difference to the life of the Indian farmer and his children. Of course, small improvements in prices received would help at the margin. But they will not materially change either the low productivity of Indian agriculture or the low returns to most of its practitioners.
In that sense, the farm bills were much ado about nothing.
The problem of low agricultural productivity is not unique to India. It is an endemic feature in developing countries. Two international facts illustrate this. First, while overall labour productivity in the richest countries is almost 40-fold greater than in the poorest economies, the gap in agricultural labour productivity between these countries is 80-fold. By contrast, the gap between the labour productivity of developed and developing countries in non-agricultural sectors is just five-fold. Second, despite the abysmally low labour productivity, the poorest economies continue to allocate a huge part of their labour force to agriculture. India fits very well with these two international facts.
An implication of these facts is that in the poorest countries, labour productivity in non-agricultural sectors is massively greater than productivity in agriculture. Some of this measured sectoral productivity gap is doubtless due to factors like lower mechanisation, price differentials between rural and urban areas, worker quality and unmeasured agricultural output due to home production. However, even after adjusting for these factors, the average productivity gap between non-agriculture and agriculture remains very high.
These international patterns suggest a puzzling over-allocation of labour to agriculture in poorer countries. Why doesn’t labour in these economies just move from the relatively low-income agricultural sector to non-agricultural occupations? That, in a nutshell, is the key challenge of development.
How did the currently industrialised countries deal with this when they were at similar income levels a century ago? For one, the difference between labour productivities in the non-agricultural and agricultural sectors was much smaller, partly due to relatively few policy controls on prices and quantities. Hence, the initial misallocation of labour was smaller. Moreover, a deterioration in the agricultural terms of trade in the currently industrialised countries generated a push factor that induced labour to shift out of agriculture. Key to this was the expansion of large scale, low-tech industrial employment, which could absorb the surplus agricultural labour.
The problem in India is that the patchwork of policy measures taken over many years now lies like a smothering blanket over the entire economy. Our approach to agriculture has mostly taken a peculiar form of welfarism with measures such as minimum support prices, subsidies to cultivators and interest rate subventions on crop loans effectively acting like an ineffective balm for stressed farmers. These measures hardly do anything for long-term changes in the fortunes of farmers. Instead, it traps farmers by giving them marginally stronger incentives to remain in agriculture even though it is an activity without a future for most of them.
The need of the hour is for the non-agricultural sectors to step up and provide a viable alternative to low productivity agriculture. In India, the majority of the non-agricultural employment growth has happened in the service sector. Unfortunately, 80 per cent of this service sector employment is in very low productivity own-account enterprises that employ three or fewer people. These enterprises are mostly a refuge for people without any options.
The sector that has frustrated India’s development is the large-scale, low-tech manufacturing sector. This is the sector that typically absorbs surplus agricultural labour in bulk while also providing them with significant improvements in incomes. This sector has completely failed to grow in India.
Most Indian manufacturing units employ fewer than 50 workers, thereby failing to reap the productivity benefits of scale. At their low productivity levels, these units neither provide a good wage nor do they employ many. Even larger firms prefer to operate with many small units than a few large units. The reasons are many, but existing labour and land acquisition laws are probably up there in importance.
The need of the hour is to focus on incentivising entrepreneurs to invest in large-scale manufacturing. This will probably require the government to expend significant political capital in legislating labour reforms above all. Given the experience with the farm bills, there is unlikely to be much appetite for it though. And that is probably the biggest cost of this entire episode.
Without action, however, the costs will get larger. If India is unable to employ 10 million new workers a year over the next decade at wages that reflect aspirations, the country’s much-touted demographic dividend runs the risk of turning into a demographic curse. It is time to sound the manufacturing employment bugle. Incrementalism and ad-hoc welfarism have run their course.
This column first appeared in the print edition on November 25, 2021 under the title ‘Farm needs the factory’. The writer is Royal Bank Research Professor of Economics at University of British Columbia