The Equilibrium Impact of Agricultural Support Prices and Input Subsidies

We study the implications of agricultural price support programs, which offer a minimum price predominantly to farmers of staple crops, and farm input price subsidies for consumer welfare and misallocation, measured as the productivity gap between agriculture and non-agriculture. We develop a dynamic general equilibrium model with heterogeneous agents, financial frictions and endogenous occupational sorting between two sectors: agriculture and non-agriculture, and two crops: staples and cash crops. The government procures staple crops at predetermined prices and distributes them as free rations while also subsidising farm inputs. The model is calibrated to match a mix of moments and quasi-experimental evidence pertaining to the Indian economy. Our results suggest that in the absence of the minimum support price policy, labour reallocates from the agriculture to the non-agriculture sector, slightly raising aggregate output and reducing misallocation. A reduction of the input price subsidy lowers agricultural and non-agricultural output and exacerbates misallocation. Policies that replace the support price or input subsidy programs with budget-equivalent income transfers improve welfare.