We study the implications of agricultural subsidies for the agricultural productivity gap, defined as the ratio of labour productivity in non-agriculture to that in agriculture, and consumer welfare. We develop a dynamic general equilibrium model with individuals heterogeneous in productivity, landholdings, and assets in the presence of mobility costs, financial frictions and incomplete asset markets. We allow for endogenous sorting between sectors: agriculture and non-agriculture, and between the production of crops: staple and cash. The benchmark economy features two tax-financed subsidy programs: input price subsidies that reduce the cost of intermediate inputs for all farmers, and a minimum support price program for the procurement of staples. The model is calibrated to match a mix of macro data and quasi-experimental evidence pertaining to the Indian economy. Our counterfactual results highlight that removing either program reduces agricultural productivity and increases the agricultural productivity gap. However, abolishing either policy boosts welfare primarily by reducing the tax burden, which disproportionately benefits the asset-poor households. Thus, we identify a tension between promoting productivity and improving welfare in the context of agricultural policy intervention.
STEG Working Paper Series
• Research Theme 3: Agricultural Productivity and Sectoral Gaps,
Cross-Cutting Issue 3: Inequality and Inclusion
The Equilibrium Impact of Agricultural Support Prices and Input Subsidies
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