Distortionary Public Policy

Bad public policy creates severe distortions in the economy, can lead to macroeconomic imbalances, and often has large societal costs.

Badly designed public policy can cause a lot of harm. It can cause severe distortion in the economy, misalign incentives, and finally produce bad outcomes in the economy and society at large. Take one example of a large US federal scheme that is worsening the drought conditions in the West coast.

The US states of California and Arizona are facing one of the worst droughts in recent history. It has received sparse rainfall in the past four years, less than 34% of expected rainfall, and there is a severe water shortage in the desert land. With experts claiming that the drought like situation could last for a few more years to come, this has already been termed as a ‘megadrought’.

California Drought: Before and After

California Drought: Before and After

Exacerbating the natural crisis is the pattern of agricultural land use. The preference of most farmers in the region is to grow cotton, which is one of the thirstiest crops, in a desert landscape. Each acre of cotton planted here demands six times as much water as lettuce and sixty percent more than wheat. That precious liquid is pulled from a nearby federal reservoir, siphoned from beleaguered underground aquifers and pumped in from the Colorado River hundreds of miles away. Ironically, billions of dollars have been spent on building reservoirs, aqueducts, and power stations to push water from the Colorado river to the dry states of Arizona and California. Similarly in California, production of almonds, another exceedingly thirsty crop, is expanding and it now accounts for nearly 80% of global production. However, it also consumes more than 10% of the state’s annual agricultural water use – or more than what the entire population of Los Angeles and San Francisco use in a year.

The reason that farmers are growing water thirsty crops in the middle of the desert during a harsh drought like situation is basically misdirected government policy. A relict from the dust bowl era in the 1930s, the US Farm Bill, provides misdirected incentives to farmers to grow certain crops, though it may not be in the societal interest at large. No American law has more influence on what, where and when farmers decide to plant. And by extension, no federal policy has a greater ability to directly influence how water resources are consumed in the American West.

The Bill offers monetary incentives to farmers planting cotton seeds in the ground; it also provides heavily discounted loans, which they do not have to repay in case the crop fails. Further, the government provides insurance cover on the entire cotton crop, guaranteeing that the farmers will be financially protected even when natural disasters like drought prevents a good harvest. In total, farmers in Arizona and California have received $4.1 billion in cotton aid.

The subsidies are bad enough in creating a fiscal strain and in creating incentives that draw farmers away from growing other crops. Also, due to the implicit government guarantee on the crops, banks are more willing to lend to farmers growing cotton than any other crop. However, the bigger damage it does is in distorting water usage and providing incentives to use more water than would be used in an open market. The final push comes in the form of providing water all the way from the Colorado River, a distance of 230 miles, for a minimal price. The government is also considering building a billion dollar desalination plant to purify ocean water and feed the crops.

If farmers were charged for the water, as well as for the cost of transporting water (using generators to pump the water, cost of building the infrastructure, etc), no farmer would even consider planting a water intensive crop.

In their textbook, Tyler and Alex Tabarrok dwell on this subject:

Farmers use the subsidized water to transform desert into prime agricultural land. But turning a California desert into cropland makes about as much sense as building greenhouses in Alaska! America already has plenty of land on which cotton can be grown cheaply.  Spending billions of dollars to dam rivers and transport water hundreds of miles to grow a crop which can be grown more cheaply in Georgia is a waste of resources, a deadweight loss. The water used to grow California cotton, for example, has much higher value producing silicon chips in San Jose or as drinking water in Los Angeles than it does as irrigation water.

Closer to home, there are several governmental agricultural policies in India that have similarly changed the incentive structure for crop choice. The Minimum Support Price, the minimum price paid by the government to the farmers for their produce, has introduced severe economic distortions. Rice and wheat have a higher MSP than most other crops, which naturally tilt the preference of farmers towards them; rice is a fairly water intensive crop and despite this, it is grown in arid areas across India. Pulses, which do not get much support from the government, are not grown in adequate quantities. There is a chronic shortage of pulses on the Indian market, prices have risen and it has to be imported in large quantities.

As the example of Farm Bill and MSP show, bad public policy and unnecessary government intervention creates severe distortions in the economy, which leads to macroeconomic imbalances and often has large societal costs.

Anupam Manur is a Policy Analyst at Takshashila Institution. He tweets @anupammanur