Policy Dilemmas in India – The Impact of Changes in Agricultural Prices on Rural and Urban Poverty

Trade policy reforms which lead to changes in world prices of agricultural commodities or
domestic policies aimed at affecting agricultural prices are often seen as causing a policy
dilemma: a fall in agricultural prices benefits poor urban consumers but hurts poor rural
producers, while a rise yields the converse. Poor countries have argued that they need to be
able to use import protection and/or price support policies to protect themselves against
volatility in world agricultural prices in order to dampen these effects. In this paper, we
explore this dilemma in a CGE model of India that uses a new social accounting matrix
(SAM) developed at the Indira Ghandi Institute of Development Research (IGIDR) in
Mumbai. The SAM includes extensive disaggregation of agricultural activities, commodity
markets, labor markets, and rural and urban households. This SAM includes 115
commodities, 48 labor types and 352 types of households, (classified by social group, income
class, region, and urban/rural). The CGE model based on this SAM can be used to explore
the linkages between changes in world prices of agriculture and the incomes of poor rural
and urban households, capturing rural-urban linkages in both commodity and factor
markets. The results indicate that the inclusion of linkages between rural and urban labor
markets is necessary to fully explore, and potentially eliminate, the dilemma. A fall in
agricultural prices hurts agricultural producers, lowers wages and/or employment of rural
labor, and in some cases spills over into urban labor markets, depressing wages and incomes
of poor urban households as well. In these cases both rural and urban poverty increases. The
paper explores the strength of these commodity and factor market linkages, and the potential
spillover effects of policies affecting agricultural prices.