Association for Public Policy Analysis & Management

There is growing anecdotal and statistical evidence that modern agricultural practices have adversely affected soil quality and fresh water supplies. Policy design is key; it formulates the incentives for micro decisions made by farmers that aggregate to have a macro impact on the environment. Subsidies are a potent policy lever in agriculture, employed all over the world. They are, however, enmeshed in tradeoffs. For instance, Tilman et al. [2012] highlight that "new incentives and policies for ensuring the sustainability of agriculture and ecosystem services will be crucial if we are to meet the demands of improving yields without compromising environmental integrity or public health."

This paper seeks to provide a systematic causal link between the depletion of groundwater reserves and agricultural policy in India; the incentives offered to the farmers are making them take decisions that will have an adverse long-term environmental impact. India as a case study for this global phenomenon is important for three reasons: (i) breaking down the problem into smaller geographical regions of the world helps us understand the relationship between policy design and its environmental impact, (ii) one sixth of the world resides in India so every policy decision has a large human impact, and (iii) groundwater depletion is a particularly acute problem in India from any global standards.

The fulcrum of farming practices in many regions of India are state subsidies in their various guises. These can broadly be classified into input subsidies (free power, high yield seeds and fertilizers) and output subsidies (guaranteed procurement at set prices). Most, if not all, are well intentioned. But the externalities they have come to impose on the environment has broadly been ignored in policy design. Do these subsidies help the poor, or through the externalities they impose, end up hurting them more? Exploring the nature and extent of these externalities is the subject matter of our study.

Exploiting a policy change as a natural experiment we examine the impact of explicit procurement incentives offered by the government for water intensive crops on groundwater extraction. In the sowing season of 2007- 08, the central government announced a major increase in minimum support prices for wheat. The potency of the MSP policy is driven in large part by the procurement machinery of the state at the local level. Under this policy backdrop, we seek to measure short- to medium- term effects of procurement on groundwater levels by relying on the space-time variation in the implementation of the MSP-procurement program and exploiting policy discontinuities at state borders. Our preliminary results suggest that output subsidies that incentivize groundwater pumping can increase yields but can also cause groundwater depletion over time. By uncovering these hidden costs, this paper evaluates if in fact there exists an optimal subsidy structure in the agricultural market in India.