Managing subsidies

The delivery of subsidies by governments has been shoddy and enables siphoning off of vast portions of the funds.

Indian governments have got us used to the idea of subsidies and cross-subsidies. Central and state governments have over the years offered goods and services to specific groups, free of or below cost. They have also compelled providers of these services to pay the cost by charging extra to other customers.

Companies making or selling many products or services sometimes sell one or more below cost. They use some of the profit from the other goods and services to support the loss-making ones. However this is done for a limited period and the subsidised item has to be self-sufficient in a given time. Thus ITC diversified from cigarettes when the writing was on the wall that cigarettes would be subject to increasing restrictions and taxes. However, the cigarette business produced big profits and some of the profits went to subsidise new ventures.

 ITC’s diversifications into hospitality, biscuits and personal care products took time and considerable financial support to become successful in market shares. ITC spent heavily on product development, advertising and distribution. No new venture in any of these items had the deep pockets that ITC had from their cigarette business. The cigarette business subsidised the new diversifications.

The Competition Commission can penalise ‘penetration pricing’, i.e., introducing a product for a time at especially low prices so that it can penetrate to many consumers. However, a multi-product company can have accounting policies that enable a new product or service to get services (administration, accounting, common sales force, etc) at no cost, enabling its prices to remain lower than they would otherwise be. Corporate enterprises have a justification for incurring subsidies to build new ventures, with defined time limits, ultimate elimination and the ability then to pay for all expenses from its sales revenues. If it cannot, it is abandoned.

Unfortunately, subsidies given to consumers by our governments do not appear to follow any of these principles (defined period, clear identification of the costs, outcome targets). In India government subsidies have tended to be on commodities and services important for weak and vulnerable sections of the population. But there is considerable leakage in all of them. They have not remained confined to the poor.

The delivery of subsidies by governments has been shoddy and sometimes deliberately enables siphoning off of vast portions of the subsidy amounts. (Surveys of the public distribution system, kerosene for the poor, subsidized LPG gas, electricity for agriculture, rural employment guarantee scheme, etc, have estimated the leakages as being over 40 per cent, are many examples). Most subsidies do not get eliminated over time or modified for better efficiency.

Economic downturn

Governments like companies, also cross-subsidise payments for subsidies. One group of consumers pays more for the benefit of others. In the 1950s and 1960s cheap and rough ‘controlled’ cloth was sold at low prices to benefit the poor. Textile mills were expected to recoup the cost by charging higher prices for the other textiles they manufactured. This recouping depended on the markets accepting the higher prices. When there was an economic downturn and a slump in demand for the expensive textiles, the mill was paying for the subsidies.

Petroleum companies have supplied kerosene to identified poor at specially low prices. But over 40 per cent was actually diverted to lorry owners who used it to adulterate diesel and so bring down their fuel costs. The kerosene subsidy was not borne by government but by the petroleum companies. Other products were priced higher to cross-subsidise kerosene. As crude prices flared up and also became very volatile, populist Central governments kept the prices of petrol and diesel at earlier lower levels.

The gap between cost and price was to be reimbursed to the petroleum companies but for many years it was never fully returned, adversely affecting the financial standings of the oil companies. They now had to bear the cross-subsidy cost on kerosene and the un-reimbursed subsidy on petrol and diesel. An unfortunate consequence of cross-subsidy was the complicated mess in corporate accounts so that the real efficiency and profit of each product could not be known.

Electricity tariffs were kept low for the poor. The better-off consumers paid for them. Then governments declared below-cost or free power to farmers. There was no control on the efficiency of the farm pumps and motors run on electricity, no metering to measure the quantity of power used, no determination of how many pump sets were in a household, how much of the power used was for other non-farm purposes, and what crops were grown. Reimbursement to electricity enterprises by the state government was rarely done in full or in time. The distribution companies accumulated losses, adversely affecting maintenance of equipment, their renovation and modernisation.

Cross-subsidies lead to messy accounting, are not easily quantified, especially when demand varies over time, distorts price signals, demand and markets. The enterprise pays for government policies. The cost does not go to government budgets. Direct subsidies as with food grains do not identify target beneficiaries. Such subsidies benefit over 50 per cent or more of those who were not intended beneficiaries.

Governments make policy to help groups of citizens. But the enterprise making or distributing the product or service should not bear the cost. Government should directly pay for it. Importantly, the subsidy should not be in kind, involving massive transfers of goods and services. They should be in cash to identified people so that there is no misuse.

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