Among all our subsidy challenges, the most demanding and complex involves that of fertilizer subsidies to farmers. Besides the massive and rapidly getting out-of-control fiscal burden, it has created numerous incentive distortions in fertilizer use and crop-patterns, considerable environmental negative externalities, and skewed national policies on power generation and gas pricing.
Encouragingly, in the Union Budget 2009-10, the government have decided to move away from the current product-based to a nutrient-based subsidy regime. It also announced the government's commitment to move towards payment of fertilizer subsidies directly to farmers, by dispensing off with the present arrangment where fertilizer companies are forced to sell their products at artificially low prices, in return for subsidy reimbursements. It is hoped that all this would ensure balanced application of fertilizers for increasing agricultural productivity and would enable coverage of a larger basket of fertilizers with innovative fertilizer products available in the market at reasonable prices.
In this context, Freakonomics points to an interesting working paper by Esther Duflo, Michael Kremer, and Jonathan Robinson that examined the fertilizer-buying patterns of farmers in Western Kenya for three years and offers policy recommendations based on behvioural economics to optimize on fertilizer use. Invoking the "paternalistic libertarian" arguements of Richard Thaler and Cass Sunstein, they claim that "small, time-limited discounts could yield higher welfare than either laissez faire policies or heavy subsidies, by helping stochastically hyperbolic farmers commit themselves to invest in fertilizer while avoiding large distortions in fertilizer use among time-consistent farmers, and the fiscal costs of heavy subsidies". Such discounts thereby helps present-biased farmers commit to fertilizer use without inducing those with standard preferences to substantially overuse fertilizer.
They base their claim on the fact that though even poor farmers have resources available at the time of harvest, being present-biased (farmers consume all they have) and not fully aware about this bias, they procrastinate and postpone fertilizer purchases until later in the season, when they are either not left with enough money to make the purchases or become too impatient to purchase fertilizer. They find that even those who are initially planning to use fertilizer often have no money to invest in fertilizer at the time it needs to be applied, for planting or top dressing, several months later. Empirically, they also find that such discounts in the cost of purchasing fertilizer at the time of harvest induce substantial increases in fertilizer use, comparable to those induced by much larger price reductions later in the season.
Such policies have another advantage in the context of developing economies like India where the targeted group fo farmers are those with small land-holdings, who ironically benefit disproportionately less than the larger farmers, who corner the lions share of fertilizer subsidies in their present form. The smaller farmers are much more likely to be responsive to these discounts and it is therefore more likely to increase fertilizer use by them, while the market prices at all other times will act as a deterrent to over-use by the larger farmers.
Note: The study assumes that instead of applying fertilizers during sowing, a more efficient and cost-effective strategy is to use fertilizers as top dressing during transplantation, when it is clear that seeds have germinated. It increases yields and eliminates much of the downside risk (if the seed does not germinate after sowing).
Update 1 (22/3/2010)
Esther Duflo and Micheal Kremer attribute two reasons for low adoption of fertilizers - lack of information and savings difficulties. They find that "offering farmers the option to buy fertilizer (at the full market price, but with free delivery) immediately after the harvest leads to an increase of at least 33% in the proportion of farmers using fertilizer, an effect comparable to that of a 50% reduction in the price of fertilizer (in contrast, there is no impact on fertilizer adoption of offering free delivery at the time fertilizer is actually needed for top dressing). This finding seems inconsistent with the idea that low adoption is due to low returns or credit constraints, and suggests there may be a role for non-fully rational behavior in explaining production decisions."