Today is a sad day for economics in India because the government may repeal the farm laws in the parliament. The laws were meant to help the farmers increase their incomes while lowering the cost of food for consumers. However, this game changing reform got entangled with politics and has come to a premature end. Thought I’d share a few thoughts on this.

First, a brief overview of the law of supply and demand from microeconomics. The law says:

• Demand is inversely proportional to prices. Higher the prices, lower the demand. And lower the prices, higher the demand. (see demand curve)
• Supply is directly proportional to prices. Higher the prices, higher the supply. And lower the prices, lower the supply. (see supply curve)
• The point at which the supply and demand curve meet is the equilibrium point. This determines the price and the quantity that would get traded.

A few other nuances of the law are:

• If the supply is constant and demand increases then the price would increase too. For example, software engineers are highly in demand but their supply is constrained by the number of colleges. And therefore, the salaries (price) of software engineers are on a rise.
• If the demand is constant and the supply increases the price would fall. For example, pubs have happy hours when the supply (seats) is constant but demand is very low. And therefore they offer lower prices (happy hours) to attract some demand.

A free market is one where there is no regulation. And therefore the forces of supply and demand would guide the pricing in the market.

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Farming in India is not a free market. For example, grains such as wheat are procured by the government at MSP (minimum support price). The price is artificially set high by the government so that the farmers benefit. As the law above states, at higher prices the supply would be higher. And therefore, the farmers tend to produce more wheat and sell it to the government at the MSP. However the volume produced is far more than the demand and therefore the surplus tends to go waste. However, the farm laws did not aim to do away with the MSP.

Instead, some of things that the farms did try to do were to bring in a more free market.

Currently farmers are forced to sell produce like fruits and vegetables at their local mandi (market) only. And the mandi has licensed buyers. In a free market, a seller can sell to anybody she wants and a buyer can buy from anybody he wants. But if you force the farmers to sell only to a select set of licensed buyers, what is likely to happen? The buyers are likely to collude to keep the prices artificially low. It’s in their interest to do so.

So, the buyers would buy from the farmers at this artificially low prices and sell the same produce to factories or supermarkets at a much higher price. Price arbitrage exists between what the farmer is selling at and what the supermarkets are buying at and the middlemen (licensed buyers) continued to exploit this.

If the farm laws had been implemented, it would have allowed the farmer to sell to whomever he wants. And the rational farmer would have sold his produce to the one who paid her the most. This would have eliminated the middlemen. In the long run, the farmers would have received a higher profits and the supermarkets lower prices for the same produce.

If you were Sherlock Holmes, who would you say had the motive for making sure the farm laws never got implemented?

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I was just searching for who runs the local mandis? And no surprises, the local politicians do. And they are the ones giving out licenses (blank checks) to the buyers. Very likely some of those checks would be written for the politicians by the politicians.

The mandis were themselves established in the 50s to protect and benefit the farmer. But like Charlie Munger would say “show me the incentives and I’ll show you the outcome“. By having a limited set of buyers the mandis were incentivizing collusion among the buyers. On the other hand, in a free market system, it becomes extremely hard for price collusion and therefore the prices tend to be true.

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Free markets are also not perfect. They are just far better than regulated markets. Even in a free market, sometimes there could be price collusion if there are limited set of buyers or sellers. For example, since there are only 3 telecom operators, if one raises the prices the others will too.

I also came across an example of a financial services company that operates in a niche where there are only a handful of such service providers. I was shocked to see what the management said on the earnings call. If the regulator had been paying attention, the management could be in trouble for openly suggesting collusion.

Our competition is the NBFC. And the NBFC’s, the pain points are common, where at some point of time, we have to come to some sort of informal understanding below that pricing, nobody can go.

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Last year, a friend recommended “Basic Economics” by Dr. Thomas Sowell. It’s probably one of the best books to read and I’d recommend you do too.

Cheers!