Monday, June 9, 2008

Sensible Subsidies?

Well-conceived subsidies, e.g. for food and fuel, can be in the public interest.

Shyam Ponappa / New Delhi June 05, 2008

Subsidies are controversial and easy to condemn. Yet, subsidies abound in the real world. Despite theoretical arguments to the contrary, we have to live with the manifestations of national or territorial interests. This is where subsidies come in.

There appears to be general acceptance of subsidies for basic food needs, i.e., in subsidising needy buyers. Subsidies for growing food are more problematic. Some argue that market processes provide self-correction, e.g., reduced consumption as prices rise, substitutes, imports to counter shortages. This reasoning ignores the facts. First, people who spend more than half their income on food do not switch staples; such rice-eaters don't switch to wheat, nor do such wheat-eaters switch to rice. Second, traditional exporters like Thailand and Vietnam have restricted exports at this time. Third, India's needs are so large that even a small proportion is massive relative to world rice exports. Fourth, food subsidies are used worldwide including in America and the EU as an instrument of policy, and cannot be wished away.

Another sector where subsidies abound despite being controversial is energy/fuel. Morgan Stanley estimates that half the world enjoys fuel subsidies.* As with food, we would be well advised to structure energy subsidies in a way that is beneficial to the public interest.

Food Subsidies

A possible approach to rice and wheat subsidies in India is as follows:

a) Give farmers access to market prices.

b) Replace the PDS with direct subsidies at retail linked to income for needy buyers.

c) Provide comprehensive, integrated, end-to-end solutions. Read: think through, develop, and put in place every piece of this system (avoid patchy implementation).

The underlying principles are: avoid distorting producer prices, subsidise needy users directly, and plan each step and integrate the processes we need into a coherent system, with prioritisation (don't assume it will just happen).

Production support too is essential, especially (i) timely inputs, (ii) finance, and (iii) insurance. These services are not even designed properly — forget delivery. But we have to make a prioritised beginning. The first steps are market access and terms.

Many consider low food prices to be an unqualified benefit. This is not true for farmers, who are exploited by such prices which are out of sync with overall prices, and have been for decades. To be sustainable, benefits and costs must be equitable. While farmers do not pay income tax and get other breaks, these have to be compared with benefits to other sectors, e.g. tax breaks to IPL investors, or lawyers being exempt from service tax.

Growing food grains has to be made profitable, and getting farmers market prices is a start. Farm prices are way below market because procurement prices are low, and smaller farmers need to sell when they harvest. The fact that procurement works at low prices is itself the problem. Therefore, organisation, logistics, and finance need to be developed and instituted so that market prices flow through to farms. (Large farmers who can store produce often opt out of rice cultivation, as in Kerala and Karnataka, because they find even market prices unattractive compared with cash crops.) Buyers need retail access through smart cards scaled to income, with a cutoff.

The difficulties in budgetary resolution and in execution are bound to be legion. Like "good roads", these things are easier said than done; but as with good roads — ah, good roads — so difficult, yet so necessary.

Several benefits can accrue from such market organisation. Farming will become more effective and efficient, with incentives built into prices, and less distortions. Besides actualising the professed concern for small farmers, there may be greater benefits from an improved polity with less scope for populist giveaways — "free" electricity, rice at Rs 2/kg (although it may need the Election Commission to work hard to extirpate such practices…) — and for dipping into the till.

Extension to other sectors: energy/fuel

The above approach can be extended to inputs like fertilisers, as also to other sectors like energy, with the induction of appropriate domain-specific concepts like windfall taxes. Economists advise against energy subsidies, and the Commission on Growth and Development** does so, too. But there are two good reasons for India to try to develop and implement a sound program:

- Fuel prices cascade with a burgeoning ripple effect throughout the economy. Whatever the levels of efficiency and energy intensity, the consequences of increasing fuel costs are staggering. Perhaps advanced economies can be left to self-correct — in reality, they are not. Emerging economies certainly need intervention because of their early stage of development.

- Most governments do provide energy subsidies. Take America: in 2007, Federal energy-specific subsidies were estimated at $16.6 billion. Of this, oil and gas received $2.37 billion. Further, state and local taxes were estimated at an additional $4 billion, funding of oil and automotive infrastructure at over $40 billion, and environmental cleanup at over $230 billion (about Rs 10,000 crore).# This in an advanced economy, which results in Exxon being able to pay taxes of $30 billion. In other words, subsidies are used to make the economy productive, and add to government revenues.

A well-conceived programme for India, if it were possible to develop, could be very beneficial to the public interest. For example, it would remove the absurdities of cheap diesel for cars, with smaller subsidies for petrol — perhaps linked to 2- and 4-wheelers with less subsidy for the latter, high disincentive charges for SUVs on urban roads (again through smart cards), no LPG subsidies at higher income levels, with support for cooking fuel/kerosene linked to income, and more incentives for solar power, for instance.

This is what our government can do: apply itself to devising what works for us, and make it happen. E.g., use subsidies for:

- Market access for farmers and needy buyers, and

- The creation of efficient, responsible giants among our energy companies, instead of emasculating them, or subjecting them to state-sponsored plunder, or lackadaisical neglect.
With careful structuring for each domain and proper integration, this approach could perhaps be extended to other sectors, such as pharmaceuticals, metals, IT, telecommunications (broadband), automotive and transport, and dairy and agricultural products.



# Federal Financial Interventions and Subsidies in Energy Markets 2007: andUnion of Concerned Scientists' report:

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