Arbitrage and Corruption in Food Subsidy Programs: Evidence from India’s Public Distribution System

Would the households get to buy more of subsidized grains from a food safety-net program if the difference between the price of grains in the program and the open market were to increase? This is an important question for social safety-net programs everywhere in the world, but even more so for the Public Distribution System (PDS) of India—the largest food-based safety-net program in the world. The standard economic intuition suggests that price controls distort price signals and create incentives for unintended transactions and the unintended transactions increase in magnitude as the incentive (the arbitrage) increases. However, Dreze and Sen have argued that the increase in arbitrage between PDS and open market prices of grains increased the value of PDS entitlement, giving people much greater stake in the system leading to increased accountability and increase in household purchase of grains from PDS. We test these two opposing arguments empirically in this study using repeated cross sections of consumer expenditure surveys by National Sample Survey Organization (NSSO) and panel datasets from India Human Development Survey (IHDS) and Village Dynamics in South Asia (VDSA) and find evidence for both arguments. Our analysis shows that whether more subsidy in a food safety net program benefits the households or leads to higher diversion, depends on how well the system is managed. In states where PDS is better governed, households get to buy more rice from the PDS when the arbitrage increases. However, in states like Bihar and Jharkhand where PDS is poorly run, household purchase of subsidized grains goes down as the arbitrage goes up.