The transformation of NREGS

My article in Pragati which examines the transformation of the NREGS from a demand-driven unemployment insurance program to a supply-driven employment creation programme is available here.

More on the distortions around NREGS

The National Rural Employment Guarantee Scheme (NREGS), as the name suggests, is an unemployment insurance program for the rural poor. In simple terms, the government steps in as the employer of last resort, with a minimum wage guarantee, if the labourer is not able to find employment in the regular market.

However, an article in The Times of India on 18.1.2012, about an apparent lack of interest for NREGS in Warangal, is a very accurate reflection of the misconceptions about NREGS and its gradual slide from being a demand-driven to a supply-driven program.

The central government’s flagship programme MNREGS has not found many takers in Warangal. This when the district had bagged first place in the state last year in providing work to farm labourers under MNREGS and spent huge funds on works... this year Warangal has fallen to 15th position in the chart... At the recent vigilance and monitoring committee meeting, it was revealed that MNREGS implementation in 2011-12 has come a cropper... According to District Water Management Authority (DWMA) officials, the farm workers are not showing any interest to carry out the MNREGS works as the private sector is ready to pay more for their work.

In states like Andhra Pradesh, even in Warangal, NREGS can no longer be considered as not having takers because of lack of awareness or other high access barriers. In the circumstances, the low demand this year, especially in the backdrop of last year's excellent performance, is most likely to be due to reduced demand. However, instead of viewing the drop in NREGS enrollment this year as an indicator of a stronger economy and more private sector job opportunities with increased wages (say, private farm labour wages having risen, making it more attractive over NREGS), the newspaper article considers it a governance failure.

Such an understanding of the NREGS, representative of the mainstream view of the program, will come in the way of any exit strategy, even if the market is able to provide employment at higher than the NREGS wages. This conception arises when we view NREGS as an end in itself, rather than as a means to insure or protect against a market failure or deficiency. Ironically, its success may itself prove to be NREGS's greatest failing!

NREGS and mechanisation

Interference with price signals has been the bane of public policy in India. The latest example is the labour market distortions caused by wage guarantee schemes. Business Standard highlights the sharp increases in famr labour wages between January 2007 and April 2011. It is estimated that farm wages have risen by an average of 70% across the country in the past four years due to the success of the National Rural Employment Guarantee Scheme (NREGS) which has been in operation in all Indian districts since 2007.



One happy consequence of scarce and costly manual labour has been the pace of farm mechanisation, as manifested in increased use of tractors, combine harvesters, small tillers, de-weeders and small power-driven sprayers.



The BS article writes about the factors driving increasing mechanisation,

"Such high wages not only squeeze farmers’ margins, but also crimp availability of labour. Factors like MNREGA and the prevalent socio-economic conditions lead to a 30-40 per cent shortage in manpower, which, in turn, leads to escalating costs year after year... the overall harvesting cost of sugarcane in Tamil Nadu has risen from Rs 300 a tonne to Rs 500-600 over recent years. And, that it touches Rs 700 a tonne during peak harvest... a pair of bullocks cost Rs 50,000 and feeding these requires another Rs 5,000 per month. Though used only for a month, they need to be fed for the entire year... bullocks are a hugely expensive proposition in Indian farming."

Impact of cash transfers in an economy with large fiscal transfers

For its extraordinary, almost global size, India's flagship National Employment Guarantee Scheme (NREGS) remains one of the least evaluated of anti-poverty programs anywhere in the world. For example, how has the massive NREGS cash transfers to rural consumers affected wages and local price levels? More generally, what is NREGS contribution to India's persistent food inflation? Or more specifically, how is the additional disposable income generated by NREGS being spent?

Unfortunately, there is no rigorus enough empirical study of the impact of world's largest cash transfer program on rural wages and resultant inflation. In a related context, Jesse M. Cunha, Giacomo De Giorgi, and Seema Jayachandran compared the relative local price effects of cash and in-kind transfers by studying a large food assistance program in Mexico that randomly assigned villages to receive boxes of food (trucked into the village), equivalently-valued cash transfers, or no transfers and found,

"Both types of transfers increase the demand for normal goods, but only in-kind transfers also increase supply. Hence, in-kind transfers should lead to lower prices than cash transfers, which helps consumers at the expense of local producers...

The price increase caused by cash transfers, based on the point estimates, offsets the direct transfer by 6 percent for recipients who are consumers of these goods. Meanwhile, for in-kind transfers, the price effects represent an indirect benefit to consumers equal to 5 percent of the direct benefit. Thus, choosing in-kind rather than cash transfers in this setting generates extra indirect transfers to the poor equal to 11 percent of the direct transfer. Of course, the welfare implications are reversed if transfers recipients are producers rather than consumers.

We also find that agricultural profits increase in cash villages, where food prices rose, more so than in in-kind villages where prices fell. These effects are due both to the change in the price of goods sold, but also to households responding by producing more (less) when the price of what they produce increases (decreases)."

The study also finds that price effects were particularly pronounced for very geographically isolcated villages, where the most impoverished people live. This is consistent with the fact that these villages are less open to trade and have less market competition, and are therefore more likely to be supply constrained in case of cash transfers. In these cases, the in-kind transfers actually increases supply and lowers prices.

The authors point to two issues that needs to be factored in while calculating the price benefits. One, their study does not look into what kind of effect is generated in the long-term, when the higher prices would signal to increase local production, thereby easing supply constraints. In fact, its long-term benefits are far more than that arising from external in-kind supply.

More importantly, there is the issue of how much does in-kind transfers constrain households' choices or conversely how much does cash transfers increase households' choices. As the authors point out, it is quite possible that an efficient private sector would create more surplus than if the inefficient government were the supplier. So they suggest that the best alternative would a mixture of cash transfers and policies to ease supply-side constraints.

Extending this analysis to NREGS and India will yield interesting possibilities. In India, we currently have a deeply supply constrained market where inflation expectations are on the rise. In such markets, any cash transfer would do little to increase supply. It increases the cash available with consumers, without doing much to boost supply, atleast in the short- to medium-term. Increased prices are inevitable. This increase in prices affect both the specific commodity being subsidized and the general price level.

Consider a cash transfer in place of rice supply through the Public Distribution System (PDS). Assume a family requires 60 kg of rice per month and gets cash equivalent of 35 kg of rice. Let us also assume that the subsidies are calibrated to price variability. Let us assume that there is only one variant of rice available in these remote markets and its price is Rs 15 per kg before the new cash transfer scheme is introduced. In supply-constrained markets (and remote interiors are classic examples of supply-constrained markets), which also experience government fiscal spending, prices generally increase and the following two effects are observed.

1. The beneficiary gets only a portion of his rice through the PDS. He has to purchase the rest from the market at market prices. In this case, he purchases 25 kg from the open market. After the cash transfer scheme is introduced, the price of rice increases to Rs 20 per kg (since the PDS supplies, which is not an insignficant share of total supply in such small markets, is now not available and has to come from the general market supply). He still continues to get cash equivalent to 35 kg. But now he has to shell out an extra Rs 125 per month for the same amount of rice the family was consuming before the program was introduced.

In contrast, with in-kind transfer, let us assume that the price falls (or it could remain the same) by say Rs 2 per kg after its introduction. This in turn leaves the farmer with a savings of Rs 50 per month. The difference between the two programs, with these assumptions, is therefore Rs 175.

2. There is also the likely spill-over effect on the general price level due to the increase in the price of rice. Further, the additional disposable incomes generated by way of NREGS and the resultant higher rural wages, will increase the demand for other items, mainly meat and other protein foods. Econ 101 would tells us that, when supply remains the same (which is likely to be the case with most products, atleast in the medium term), additional incomes (or higher aggregate demand) will have the effect of increasing the general price level.

All this in turn increases the burden on the family by say, Rs 100. Taken together, both these effects have the effect of reducing the real income of rural household by Rs 225 per month. The combined effect of cash transfers in an NREGS context is captured in the graph below. Note that it is possible that even the actual aggregate consumption could fall, rather than increase, especially if inflationary pressures get out of hand.



This highlights the importance of easing supply-side constraints in ensuring the effectiveness of any cash transfer scheme. In fact, taken together with NREGS, cash transfers could, without policies to increase supply, exacerbate inflationary pressures. Whatever the analysis, India's biggest obstacle to growth and successful implementation of process reforms that can increase growth, is a deeply supply-constrained economy. Its inflation problems too are just a symptom of supply bottlenecks.

The downward spiral with public policy?

Consider the following news stories

1. The MGNREGA moves from being an unemployment insurance program to becoming a market wage jobs entitlement program. The pressure to raise wages every year is increasingly driven by populist considerations,

"The wage rates for workers under the Mahatma Gandhi National Rural Employment Guarantee Act (MGNREGA) have been increased. According to the rates revised by the Ministry of Rural Development with effect from January 1, 2011, the wages will go up by 17-30 per cent."

2. In fact, if ever a government wanted to design a policy that boosts aggregate wages across all sectors, there could not have been anything better than MGNREGA. Businessline has these latest Labour Bureau figures,

"Andhra Pradesh, for instance, has seen farm wage rates – the average taken for ploughing, sowing, weeding, transplanting and harvesting operations – going up 40.3 per cent in 2009 and 27.8 per cent in 2010. It is no different in other States, where, in the last year alone, the price of agricultural labour surged 15 to 20 per cent in Haryana, Bihar, West Bengal and Assam, 32 per cent in Punjab, and 43 per cent in Orissa."

(Given the concerns about the low wage rates in China and its impact on structural imbalances there, it may be worthwhile for the Chinese government to embrace its version of an employment guarantee scheme!)

3. To square the circle, the wage boost coupled with the upward movement of fertilizer prices (thanks to this), means higher cost of agriculture production, which naturally generates pressure for higher Minimum Support Price (MSP). This was therefore inevitable,

"The Centre is set to announce significant hikes, ranging from 15 to 17 per cent, in the minimum support prices (MSP) of most crops to be planted during the ensuing kharif season. The higher MSPs, while expected to further fuel inflationary pressures, are meant to compensate farmers for the surge in cultivation costs experienced by them in the last couple of years".

4. And high MSP also leads the way to record procurement, with all its attendant storage problems and carrying costs. Going by current trends, wheat procurement during the ongoing 2011-12 rabi marketing season (April-June) is set to cross 27 mt (of a total wheat crop of 84.27 mt), well beyond the target of 26 mt and the previous record high of 25.38 mt in 2009-10,

"At the start of the current marketing season on April 1, wheat stocks in the Central pool were placed at 15.36 mt against the minimum buffer and strategic reserve requirement of seven mt for that date. By July 1, the stocks are likely to be in the region of 40 mt or twice the corresponding required level of 20.1 mt."

So we appear to have this vicious spiral - higher farm wages leads to higher agriculture input costs begets higher MSP begets higher food prices.... Not to speak of the impact of higher farm wages on non-farm wages and the larger economy itself. See this, this, and this.

It is really unfortunate that our vast academic community has made virtually no serious attempt to assess the economic and social impact of the most important poverty eradication strategy of the times. It is impossible to tease out the magnitude effects of the aforementioned chain of events, without rigorous field surveys, pain-staking data collection over a period of time and from different areas, and comprehensive analysis of this data. In the absence of such research, we are forced to rely on official aggregate data to draw broad, un-quantified, and often vague inferences.

Tailpiece

And as if all the aggregate wage boost was not enough, here is more sage expert advise to increase the productivity of NREGA spending,

"Why cannot we have a system, where rural labourers are paid Rs 250 for working eight hours on farmers' fields? Out of the Rs 250, Rs 125 can be underwritten by NREGA, with the balance coming from farmers. We are, then, able to dovetail welfare schemes with productive activity and raise the latter component to 70-80 per cent."

Where and when will all this end?

Update 1 (14/6/2011)

Reuters report points to labor shortages across the country and the role of NREGS in causing it. It also points to the steep increase in farm wages and its impact on food prices.