Tuesday, February 23, 2010

Green Subsidies: India's Unfortunate Lesson

One of the focal points of the President's plan for reviving the US economy is federal subsidies for "green manufacturing" and "clean energy." Now, I've already laid out a lot of serious problems with such plans - the most important of which is America's unblemished record of utter incompetence when it comes to subsidizing products and companies to further vague environmental objectives. But another serious problem with green (and, well, pretty much all other) subsidies is the fact that they almost always lead to lots of harmful unintended consequences.

From today's Wall Street Journal comes an absolutely perfect (and sad) example in India of just how bad the unintended consequences of "green subsidies" can get:
India has been providing farmers with heavily subsidized fertilizer for more than three decades. The overuse of one type—urea—is so degrading the soil that yields on some crops are falling and import levels are rising. So are food prices, which jumped 19% last year. The country now produces less rice per hectare than its far poorer neighbors: Pakistan, Sri Lanka and Bangladesh.

Agriculture's decline is emerging as one of the hottest political issues in the world's biggest democracy.

On Thursday, Prime Minister Manmohan Singh's cabinet announced that India would adopt a new subsidy program in April, hoping to replenish the soil by giving farmers incentives to use a better mix of nutrients. But in a major compromise, the government left in place the old subsidy on urea—meaning farmers will still have a big incentive to use too much of it....

Agriculture has lagged behind other industries such as manufacturing and services, posting less than 2% growth in the latest reports on gross domestic product. And double-digit food inflation and declining yields spell less money in the pockets of rural Indians.

India spends almost twice as much on food imports today as it did in 2002, according to the Ministry of Agriculture. Wheat imports hit 1.7 million tons in 2008, up from about 1,300 tons in 2002. Food prices rose 19% last year....

Behind the worsening picture is the government's agricultural policy. In an effort to boost food production, win farmer votes and encourage the domestic fertilizer industry, the government has increased its subsidy of urea over the years, and now pays about half of the domestic industry's cost of production.

Mr. Singh's government, recognizing the policy failure, announced a year ago that it intended to drop the existing subsidy system in favor of a new plan. But allowing urea's price to increase significantly would almost certainly trigger protests in rural India, which contains 70% of the electorate, political observers say.

The ministers of fertilizers and agriculture each declined requests for interviews....

Farmers spread the rice-size urea granules by hand or from tractors. They pay so little for it that in some areas they use many times the amount recommended by scientists, throwing off the chemistry of the soil, according to multiple studies by Indian agricultural experts.

Like humans, plants need balanced diets to thrive. Too much urea oversaturates plants with nitrogen without replenishing other nutrients that are vitally important, including phosphorus, potassium, sulfur, magnesium and calcium.

The government has subsidized other fertilizers besides urea. In budget crunches, subsidies on those fertilizers have been reduced or cut, but urea's subsidy has survived. That's because urea manufacturers form a powerful lobby, and farmers are most heavily reliant on this fertilizer, making it a political hot potato to raise the price.

As the soil's fertility has declined, farmers under pressure to increase output have spread even more urea on their land....
Yikes. Be sure to read the whole thing here.  What's most interesting is the vicious cycle that developed in India because of the original, and relatively small, fertilizer subsidy program that started over 40 years ago.  The first fertilizer subsidies produced a powerful and bloated industry and millions of dependent farmers.  With all those new companies and farmers, more subsidies followed, and the cost of the subsidy program exploded - it was about $640 million in 1976 but $20 billion last year.  When the government sought to reduce or eliminate the subsidy, the industry and farmers fiercely protested and, with the help of their favorite legislators, forced the government to "compromise" in the early 1990s and only subsidize one kind of fertilizer - urea.  That decision led to even more urea production and use, and not only started harming crop yields, but also destroyed domestic manufacturers of competitive fertilizers like phosphorous.  So the government decided to subsidize those fertilizers, but the subsidy, bound by budget constraints, was too small and failed to jumpstart production of urea alternatives, thus wasting millions of taxpayer dollars and doing nothing to solve the government-caused problem.  In the end, the urea subsidy remains (mostly) in place, state budgets are buckling, crops are suffering immensely, and both the domestic fertilizer and agriculture industries are proving increasingly unprofitable (thus, imports are increasing rapidly to fill the void).  Oh, and all that fertilizer overuse has severely tainted the local water supply around many farming communities.

All in all, it's an abject disaster bordering on national tragedy.  All because of a few million dollars in "green" government fertilizer subsidies.

But I'm sure that the billions and billions of dollars that President Obama wants to provide to his favorite "green" companies won't have any of these nasty unintended consequences.  I mean, all of our other forays into the environmental market have worked out so gosh darn well, right?



Anonymous said...

Surely subsidies is a problem. But more than that the recent jump in agri prices in India is the forward trading of agri produts by the traders manipulating on the commodity exchange. Surely there is a clear nexus between the trading community as well as the politicians supporting the same. Earlier it was in the hand of the few, now it is legalized and rampant.

RickRussellTX said...

I don't think there is any evidence to indicate that commodities trading causes jumps in prices that would not have occurred due to other problems.

Indeed, with a few rare exceptions (e.g. speculative hoarding, like you saw in the rice market a couple of years ago), commodities markets with their futures and options contracts reduce volatility by allowing both buyers and sellers to hedge against sudden changes in supply due to non-economic factors like weather or pests.

It's an economic reality that "the trading community" will never be able to sell a product for more than what someone is willing to pay for it, and they will never be able to buy a product for less than what someone is willing to price it. Consequently, their long-run affect on commodities prices must be zero; the most they can do is shift variations in time and arbitrage small fractions off the trading system -- a small price to pay for a more efficient, less volatile commodities market.