Farm support and market distortion: Evidence from India

This paper studies market distortions due to farm support policies. Using a recently implemented Price Deficiency Payments (PDP) policy in India, we examine how PDP affects farm-gate prices and crop supply. We document a new channel, the fall in reservation price of farmers under PDP, behind the decline in farm-gate prices. This impact depends on the magnitude of the deficiency payments and can lead to a supply glut and price crash. Empirically, the scheme led to a 4% decrease in farm-gate prices and a 51% increase in market arrivals for black-gram, a crop with a high magnitude of PDP. Using bid-level data on crop auctions, we rule out collusion among the market participants, another potential channel for price crash under PDP. The effects of the policy are transitory and disappear after the policy is withdrawn. In terms of welfare effects, this scheme is associated with a monetary loss of INR 1 billion. We discuss an alternate payment scheme that can reduce such losses. In summary, our results extend the current understanding of PDP schemes and contribute to the optimal design of such policies.