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Shreekant Sambrani: Telling good subsidies from bad

The challenge, never easy for any country, is to identify the good ones while avoiding the addictive bad ones

Shreekant Sambrani 

Shreekant Sambrani

Time was when changes in taxes, especially those on consumer goods, dominated the general speculation about annual Budgets in India. Over the last decade, that concern has given way to one about the fiscal deficit and the contribution of subsidies to it. This has come about as much because of the realisation that taxes would affect the consumer prices at the margin, as by the realisation that increasing deficits caused by mounting subsidies could potentially destabilise the entire economy. Notwithstanding the recently changed macroeconomic numbers, this is in effect what happened between 2011 and 2013. The central deficit rose to 5.2 per cent of gross domestic product (GDP) on the back of higher subsidies for petroleum products. Subsidies by themselves rose sharply to over two per cent of GDP. In broad terms, these factors together were largely responsible for the lacklustre performance of the Indian economy.

The new government has moved towards market-determined diesel prices and raised passenger rail fares, long overdue. These steps were thought of as precursors of a larger restructuring of subsidies. Yet it would be premature to expect that the forthcoming Budget will contain bold proposals in this direction, for two reasons. First, subsidies and entitlements are easy to dole out, but infinitely more difficult to reduce and nearly impossible to remove in any society. Second, the recent electoral trauma in Delhi the Bharatiya Janata Party suffered at the hands of an unabashedly populist Aam Aadmi Party despite committing to match the freebies promised by the latter would make the government extremely wary of any steps that would attract the criticism of being anti-poor.

The classic libertarian economic philosophy of Friedrich von Hayek may have gained converts and acclaim in the last four decades, but even the most capitalistic economies of the United States and Germany have deeply entrenched subsidies as major parts of key economic activities. Both the United States and the European Economic Community have elaborate farm support programmes that subsidise farm incomes. These are major bones of contention at all international trade negotiations. In addition, every major economy offers some form of protection to favoured industries and protects its export turf zealously. All Western countries have in place substantial social-welfare programmes to protect the retirees and the not-so well off without seemingly compromising their commitment to free economies. An entirely market-determined price structure for goods and services is to be found only in the fiction of Ayn Rand.

India has had a long history of subsidising virtually everything, dating back to the planned economy days of early independence. Subsidies were provided indiscriminately. For example, irrigation water has almost always been charged nominally for all users. Power tariffs, rail fares, postal charges, public health facilities and education have all been priced well below what they cost. In the early 1960s, the newly established elite Indian Institutes of Technology charged Rs 200 a year for tuition and Rs 100 a year for rooms, ridiculously low even in those days. The benefit went mostly to upper-middle-class families who could pay many multiples of those figures for quality education.

The Economic Survey 2013-14 observes, "Subsidy programmes are particularly problematic when they hamper changes in prices and the consequent shifts in resource allocation which must take place." The Prime Minister's Economic Advisory Council had said in April 2013, "The open-ended nature of petroleum subsidies resulted in an explosive increase in subsidy burden." Considerable evidence exists that continuing high subsidy for urea has caused imbalance in fertiliser application, with possible adverse consequences for yields. Similarly, free irrigation water and negligible charges for electricity for pump sets in most states have resulted in large, avoidable usage of this increasingly scarce resource. The ever present problems of misdirection of subsidies, away from those who need it most, and the enormous possibilities of leakage are too well-known for elaboration.

But not all subsidies are wasteful or uneconomic. Toward the latter part of the last decade, this writer was involved in a programme to combat malaria in Tanzania, the single largest cause of death and morbidity in most of Africa. One recommendation that met with approval of all concerned - the government, the US president's initiative, and international charities such as the Global Foundation and the Bill and Melinda Gates Foundation - was the supply of insecticide-soaked bed nets at highly subsidised prices of under $1 each. The logic that this made the bed nets affordable for even the poorest and resulted in far lower deaths and morbidity, as also improved productivity, was readily evident and accepted. Five years later, it was reported that similar programmes had been started in other African countries as well with most encouraging results.

At home, free or subsidised supply of solar panels and batteries for lighting homes would reduce the need for kerosene for this purpose and reduce the burden on the already overloaded power utilities. Solar-powered fractional horse-power pumps could lift water in areas of high water table, which covers almost the entire Gangetic plain and many parts of coastal India. That would reduce the recurring cost of energy and capital cost of drawing long, low-tension power lines.

On a larger scale, cheap and efficient urban commuter transport made possible by subsidising its capital cost reduces the much larger recurring cost of work-related travel for their users and saves fuel. It also cuts urban congestion and pollution. We may complain about the Delhi air quality and the Mumbai congestion. But they would be infinitely worse without the Delhi Metro or the Mumbai locals.

Operation Flood, among the greatest Indian development successes, followed an imaginative approach. The European Economic Community, as it then was, was planning to gift India $1 billion worth of dairy commodities in the mid-1960s. Their free or subsidised distribution in India would have depressed the local market and killed all incentive. Instead, these commodities were recombined and sold as milk at market prices. The money was then used to set up large dairy-processing plants in districts, 70 per cent as loan and 30 per cent as grant. Farmers received free extension and price benefits of modern processing marketing, but no operating subsidies. That has propelled India to be the leading milk producer in the world.

Subsidies are like cholesterol, bad for the most part, but some good ones can be greatly helpful. They are mostly for one-time expenses, rather than recurring ones. The issue, never easy for any country, is to identify the good ones while avoiding the addictive bad ones.

The writer taught at Indian Institute of Management, Ahmedabad, and helped set up Institute of Rural Management, Anand

First Published: Mon, February 23 2015. 21:50 IST