You might find it hard to believe, but high prices of onions can trigger the fall of the government in India. In 1998, a supply side shock led to a sharp increase in onion prices in the country and most notably, in the state of Delhi. In the following elections, the ruling party was routed in large part due to its failure to control the price of onions in the capital state. Today, onion prices in India are up again, rising by over 100% in just three weeks in December. On December 20th and 21st onion prices had skyrocketed to Rs 70-85/kg in major cities of India from Rs 30-35 in early December, due to crop damage caused by abnormal rainfall in the key growing states of Maharashtra and Karnataka.
Realizing the possible political fallout as a result of the price increase, the government has moved swiftly this time to bring prices down. Apart from cracking down on hoarders, the government has lowered import duties on onions, ordered state-run trading agencies to import more onions from neighboring countries and banned the export of onions (some exceptions apply to the export ban).
For those of us accustomed to bureaucratic sluggishness, the quick response of the government is a welcoming sign. However, for others who like to sit back and take a nice long look at the rationale for policy interventions, you can’t help but wonder what is so special about onion prices, and whether the response of the government is economically justified or not. Some thoughts to consider:
The doubling of the price of onions is not a life threatening event and it is surprising that it is so politically dreaded by politicians and the government.
If voters find it so hard to live without onions (due to high onion prices) then how about clean drinking water, electricity, clean air, sanitation, crime and security and law and order? These goods are also in short supply and costly for the poor in India. I think it’s safe to say that they are more important concerns than a lack of onions. Furthermore, as one article in a leading newspaper in India put it, the panic created by the middle-class urban consumers over the price of onions must be seen in perspective. Quoting from the article:
The panic created by middle-class consumers needs to be seen in perspective. These families think nothing of buying an ice cream cone for Rs 50, a pizza for Rs 400, 1 litre sugar-flavoured water for Rs 50 - but go hysterical if onion prices shoot up to Rs 60 a kilo. This happens year after year with crop after crop - sugar, rice, wheat, cotton.
The reported measures to control the price of onions target the welfare protection of urban consumers in places such as New Delhi. Yet the farmers (onion growers) who are constantly fleeced by the middlemen see no such protection. Reports suggest that farmers receive only a small portion of the increase in onion prices and are hardly able to cover their production costs in a normal year. Does it make political and economic sense to protect the urban consumers but not the rural farmers?
High price of onions reflects that onions are in scarcity. Hence, the optimal response of the consumers should be to switch from onions to a less costly food item. Keeping onion prices at an artificially low level does not allow consumers to face the true cost of onions which leads to distorted consumption choices at the national level.
My last point relates to distortions on the production side. Production decisions are based on the prevailing price in the market and if this price is distorted (in the sense that it does not reflect the true opportunity cost of onions at the social level) then the decision of the producers will also be distorted. Of course, this can happen only in the long-run, as the production of onions is more or less fixed in the short run. If producers see that they are unlikely to benefit from high prices during times of scarcity, yet are forced to assume the full losses in times of excess supply, the incentive to invest in agriculture will diminish, lowering agricultural growth. The same can be said of the myriad restrictions on agriculture, as these tend to add to market distortions and raise the cost of doing business. As the article mentioned above further states:
Just as the corporate sector has flourished even with half-hearted doses of liberalisation and the end of licence-quota raj so also the farm sector can flourish only when the agenda of economic reforms extends to it - which means the dead hand of the government is not allowed to choke the enterprise of our farmers. The policy of restrictive quotas for farm produce export needs to be junked to help farmers earn better prices, which in turn will enable them to invest in improving production. Higher production will inevitably bring down food prices.
I hope that the points I have raised above give us some food for thought on how to properly balance the need for protecting the very poor against temporary increases in essential food items and the associated short-term and long-term cost.