ECONOMIC HIGHLIGHTS

New Delhi, 23 February 2006

Robbing Peter To Pay Paul

Rationalize Subsidies and Cut WASTE

By Dr. Vinod Mehta

Almost a decade ago it was decided to phase out subsidy on cooking gas.  Banking on this decision, a few private sector companies entered the cooking gas distribution business, thinking that there would be level playing field in a few years.  But the Government has not been able to phase out subsidy, and the few private companies that entered the gas distribution sector had to close down, as they could not compete with the subsidized gas distribution network of public sector undertakings.  Similarly, subsidy on Kerosene and diesel is affecting the price of petrol. 

All kinds of Central and State subsidies (open as well as hidden) are reported to account for 15 per cent of the GDP.  About 90 per cent of subsidies go for "non-merit goods and services" -- the non-merit goods and services as identified in one of the budgets include milk, power, transport, irrigation, education etc.

Take, for instance, the subsidy on fertilizer.  As per the available data the amount of subsidy being paid on fertilizers is very high.  This is expected to keep the price of fertilizer low for the farmers; but nearly 50 per cent of the fertilizer subsidy actually goes to the producers/suppliers rather than to the farmers.  In fact, subsidy paid out on food rarely percolates down to the consumer but gets absorbed in costs of handling and storing food grains.  Similarly, a significant portion of subsidies in higher education is appropriated by middle to high-income groups.

Unnecessary subsidies are leading to wastage of scarce resources.  For instance it has been mentioned that extremely low recovery rates in sectors like irrigation, water, electricity and diesel lead to their wasteful use as these have been withdrawn from some other sectors in which these could have been very useful.  Provision of free electricity to farmers is a big drain on resources.

Except for petrol all other petroleum products like diesel, domestic gas, wax, naphtha, etc. are being subsidized in a big way.  Of the total subsidies paid on the petroleum products nearly half of it goes to diesel, kerosene and domestic gas in that order.  As per the Rangarajan Committee Report on petroleum prices, the current -subsidy on cooking gas is still whopping Rs.171 per cylinder.

Similarly, the Railways are providing huge subsidy every year on movement of passengers and low cost goods.  The subsidy goes to ensure lower freight rate on essential items and second-class travel.  One could go on and on but it is sufficient to say that the nation cannot afford to go on paying subsidies on every conceivable  product  and service.   Subsidies beyond a certain level are  harmful to the economy in various ways. 

Firstly, it leads to wasteful use of resources.   If a farmer is getting diesel or electricity at a very cheap rate he would not bother about economizing on the use of these two inputs.  Moreover, who knows that the electricity and diesel is also being used by farmers for non-agricultural purposes?  The wasteful use of electricity and diesel by the agricultural sector implies that some other important sector of the economy like industry is being denied the optimum use of these inputs. 

Secondly, subsidies lead to distortion of relative prices in the country and send wrong signals to business units.  For instance, the Railways are known to be the cheapest mode of transport as far as bulk commodities are concerned.  But by subsidizing diesel we are artificially propping up the  motor transport sector and at the same time forcing the railways also to keep their freight rates relatively lower from those of the motor transport etc.  None of these two sub-sectors have any incentives to economize on the use of diesel, coal and electricity or to improve their efficiency by reducing their operational expenses. 

Thirdly, subsidies beyond a certain level also imply that either the country resorts to deficit financing or imposes higher taxes on the people.  Subsidies are not produced out of thin air; somebody has to pay for it. Subsidies are essentially, what economists call transfer of incomes.  Subsidies are in fact, a modern version of the old saying:  "Robbing Peter to pay Paul".  Therefore, at one level the choice boils down to either having more subsidies and more taxes or fewer subsidies and fewer taxes. 

Fourthly, the subsidies are also inimical to the export sector.  They make the cost of export lower to the foreign buyers; to that extent the domestic population is aiding the consumption of foreign buyers.  One cannot afford to support export sector on the basis of subsidized inputs for all times to come.  Subsidies only reflect the uncompetitiveness of the domestic production and hence there is no incentive for the exporters to improve their efficiency by reducing production costs. 

Therefore, what the country needs is to have a dispassionate  look at all kinds of subsidies and decide as to which subsidies need to be continued, which subsidies need to be reduced and which subsidies need to be discarded.  This cannot be a one-time affair but a continuous process in the sense that the effects of subsidies need to be reviewed every three to four years to see if they are fulfilling their role and a decision taken as to whether it needs to be continued, reduced or discarded. 

Apart from downsizing, the Government can also save funds by introducing a kind of contractual employment at a higher level where the services of specialists are needed for a specific purpose and for a specific period.  For instance, it may be less expensive to employ a doctor or a health specialist or two to prepare the health policy than to allow a non-specialist bureaucrat to develop a health policy with the help of a specialists committee.  This will also help save lots of money which currently goes into meeting the expenditure related to the organization of committee meetings which includes cost of air travel, daily maintenance, honorarium or sitting fee and so on.

At the moment a large part of administrative expenditure goes into maintenance of law and order especially in disturbed areas as in Northeast, J & K etc.  If these problems could be settled politically, a lot of money, which is being today spent on military and para-military forces in these areas, could be saved.          

It is high time that along with pruning subsidies, the Centre comes out with appropriate policies and takes appropriate steps to reduce the size of bulging bureaucracy, cut down expenditure on stationery, telephones, electricity etc., cut down expenditure on maintenance of law and order and thus reduce the cost of administration and divert the funds so saved to more purposeful activities like education, health, housing, food etc. 

The reduction of subsidies is a politically sensitive issue as many interest groups would not6 like them to be curtailed, but at least the Finance Minster can initiate the process of streamlining the subsidies and curbing the wasteful expenditure in the budgetary proposals.---INFA

(Copyright, India News and Feature Alliance)