Monday, March 16, 2009

Free power and market distortions

That there are no free lunches is a widely acknowledged tenet of the dismal science. It is therefore understandable that free power provided to farmers in many Indian states come with substantial costs, more medium and long term, on a number of other sectors. Here is a laundry list of possible incentive distortions and negative externalities imposed by free power to farmers.

1. Most obviously, in the absence of any price signal, there will be an inevitable over-use of electricity.
2. Since electricity availability also determines the ability to access water sources, free power will also lead to over-exploitaiton of water resources.
3. With water availability no longer a constraint, farmers will be inclined to over-exploit both surface and ground water sources. They are likely to grow more water intensive crops and go in for multiple croppings. Attendant environmental damage arising from chemicals run off and salinization are inevitable.
4. With the constraints on water availability reduced, farmers lose the incentive to optimize on their water usage. The crop patterns tend to get skewed towards more water intensive commodities and farmers have no incentive to improve their productivity (by minimizing the usage of scarce water resources).
5. Farmers will be incentivized to make one-time investments in higher than required capacity of motors and pumps to extract (and thereby over-exploit) ground water. Ground water levels will decline with calamitous impact on drinking water sources, salinization (especially in coastal belts), deforestation, and exacerbating the inequity in access to water sources (falling water table makes the water more inaccessible to poorer farmers who cannot afford the larger capacity motor pumps).
6. With no incentive to optimize usage of electricity, farmers will end up purchasing poor quality motors (with low power factors and high power consumption) which sell cheaper in the market. These poor quality motors will end up "crowding out" the good quality motors.
7. In the context of substantial power deficits, over-use of electricity by farmers will result in scarcity elsewhere - residential, commercial and industrial consumers. Industrial and commercial activity will be adversely affected. The marginal costs imposed by scarcer electricity for the later is much larger than the marginal benefits accruing to farmers from free power.
8. In the absence of any returns from distributing power to farmers, the power distribution utilities will have no incentive in ensuring quality power supply or making additional investments in delivering power to these rural areas.
9. The inability of governments to fully reimburse the distribution and transmission utilities the cost of the free power delivered (a fait accompli given the precarious fiscal situation in many states) very adversely affects their operational viability and commercial profitability. The long term costs imposed on these utilites are considerable.
10. In order to restrict agriculture supply to the promised number of hours only, distribution utilities have made massive investments in segregation of rural and agricultural feeders (Gujarat), re-configuring feeder networks to enable single phase supply (1/3 arrangements in Andhra Pradesh), or load management units. By limiting three phase supply, these initiatives go against the professed objective of promoting non-farm sector growth in rural areas. It hinders the setting up of cold storages and food processing units, besides small scale manufacturing industries. Such sectors face high up-front investment costs in dedicated three phase lines, besides suffering from poor quality of supply.

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