MSP seen through the lens of the Austrian School of Economics

The Minimum Support Price(MSP) is an advisory price that the Government of India(GoI) announces for certain agricultural products before the sowing season, to procure them if open market prices are lower. In this article, we will look at MSP through the Austrian School of Economics lens.

But what is the ‘Austrian School of Economics’, you may ask? Simply put, it’s an economic school of thought that believes that an individual’s subjective choices and actions drive economic activities (methodological individualism). Based on this subjective-individualistic approach, the school regards any analysis starting with the collective as unscientific. Starting from this basic premise this school of thought has given many seminal ideas like subjectivism, marginalism, the signaling role of price, and the central role of the entrepreneur in market discovery. We will examine these ideas in the context of MSP as we go further.

The MSP is set by the GoI using the Commission for Agricultural Costs & Prices (CACP) recommendations, which factors in the cost of production, domestic and international prices, demand-supply conditions, inter-crop price parity, and terms of trade between agricultural and non-agricultural sectors. If you notice the calculation, it includes the cost of production and labour, indicating it is based on the labor theory of value. However, according to the subjective theory of value proposed by Carl Menger, the subjective perception of the individual consumers at the ‘margins’ determines the cost.  An example is a badly written book. Writing it may have been laborious. Yet it’s without value in the market.

What do we mean by the phrase ‘at the margin’ or ‘marginalism’? Imagine yourself stranded in a desert with no water. You may be willing to exchange diamonds for a bottle of water. However, having had the first bottle, you may not be willing to exchange similar quantities of the diamond for the second bottle of water. So you see how the value we assign to a product is subjective and determined by how useful we perceive the next unit of that item? That’s the basic idea behind marginalism.

Another central idea in the Austrian school is the spontaneous emergence of prices from the interaction of buyers and sellers, known as Price discovery. To understand its role in ‘signaling’ and addressing Hayek’s Knowledge Problem, let us take an example:

Around Diwali have you observed the local milkman’s reluctance to deliver extra milk on short notice, and the rising milk prices? If you investigate further, you may find that his milk was being diverted to sweet shops for the holiday season. 

Notice how the milk price ‘signaled’ both the consumer and the milkman. While the consumer economizes on milk consumption, the milkman reallocates milk to its highest valued use while carrying the circumstantial knowledge of time and place – an upsurge in demand for sweets due to an upcoming festival.

In an economy, such knowledge is distributed across time and place for every commodity. No single “central planner” can know this information in its entirety. F.A. Hayek called this the ‘Knowledge Problem.’

But luckily, as Hayek noticed, prices aggregated this precise knowledge of time and place into a single number. This economized the information people needed to process while transacting in a marketplace.

Similarly, there are many factors affecting the demand and supply of crops at any given time and place like diverse agro-climatic zones, a climatic phenomenon like a heatwave, a  pest attack, a war like the current Russia-Ukraine war, or a COVID lockdown induced disruption. It could also be the Schumpeterian creative destruction in the form of a novel GMO crop like Bt-Brinjal, Dhara Mustard Hybrid-11, or innovations in precision farming. Leveraging AIML(Artificial intelligence and machine learning), Big Data, Cloud computing, robotics, drones, and Low Earth Orbit(LEO) also affects supply.

One must note here that listing these factors exhaustively is not the point. Hayek’s Knowledge Problem makes it impossible in any case. But we should understand that freely adjusting prices arising spontaneously from the interaction of buyers and sellers will accurately convey the relevant information for the concerned crop and enable market coordination. This was Hayek’s seminal insight.

Hence, the CACP’s calculation to arrive at an MSP, is only upending and at best poorly replicating the discovery function that prices in a spontaneously ordered market transaction enable. It’s the discovery process of transacting in the market by which participants and entrepreneurs, in this case, farmers, learn and correct errors, discover novel and better ways of organizing economic activity to satisfy their desired functions optimally, and ensure the most efficient allocation of scarce resources. 

MSP  subverts the role of the entrepreneur. It’s the entrepreneur who exercises judgment through their commitment and action to bring novel solutions to the market despite the uncertainty of profits. In essence, the entrepreneur invests the capital goods at his disposal based on his best guess of the subjective value of that particular good a consumer in the future may perceive. The profits or losses in the future signal the entrepreneur about the quality of his decisions. This makes him course-correct subsequently as further knowledge is gathered by market operations. For this reason, the Austrian economists Joseph Schumpeter and Israel Kirzner regard the entrepreneur as the central hero of the Austrian school.

MSP along with subsidized inputs, and restrictions on sale/purchase completely distorts the entrepreneurial functioning of a farmer by providing incorrect ‘signaling’.A simple glance at the difference in market prices and MSP of Paddy in Chhattisgarh(Rs 300/quintal) and UP(Rs 200/quintal) in Nov 2020 indicates the problem.
 

Government-induced price distortions through MSP further lead to food inflation while excess grains rot in FCI stores and are exported as ‘aids’ due to overflowing granaries. In addition, inadequate procurement machinery limits MSP’s benefits, as seen in the case of tur dal in 2018. It wrongly encourages farmers in drought-prone areas to cultivate water-intensive crops like sugarcane and paddy], depleting the water table when substitute water-efficient crops could be grown. Price signaling aberrations also explain why protein production in India is not responding to changing consumption patterns of Indians. Entrepreneurial discovery guided by prices would have easily course-corrected these anomalies and created many other opportunities that only an entrepreneur’s discerning eye can see.

Interestingly, in 2020, the Haryana State Government launched the Mera Pani, Meri Virasat program. To address the depleting water tables in the state, farmers were offered Rs 7000/acre of diversified crops. The situation was so severe that 81 blocks were on the dark zone list with restrictions on groundwater extraction.

After all, Haryana farmers would have planted agro-climatically suitable and financially viable crops like coarse grains, cereals and pulses anyway if there was no MSP. It was a misplaced MSP policy that led to paddy cultivation in the first place. Having realized its mistake, the state government rightly wants the farmers to shift to sustainable alternatives that are easier on the water table. A higher MSP could have incentivized a switch to an alternate crop, and there were demands for that from some corners. However, the State Government wisely allowed farmers to take a call based on the market prices. The Rs.7000/acre subsidy for diversified crops was the State Government trying to counter the distortions of the Union Government’s MSP policy.

Even though distortions in the form of subsidized inputs, electricity, export restrictions, etc still plague Indian farming and Haryana farmers in particular, adherents of the Austrian school can take comfort from the fact for now that entrepreneurial discovery is being encouraged, and that prices are being honored in a limited way in this state!

Clearly, the lesson to be taken from all this is what the Indian policymaker Vijay Kelkar has succinctly stated:

“The policymaker should have no opinion on prices and should not try to control them.”

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