Tuesday, October 23, 2007

The lie called subsidy

Whenever, as a matter of public policy, goods and services are sold for a price less than what it costs to produce and deliver, with the government bearing the loss, the resulting transaction is what we would generally call a ‘subsidy’. The problem with this term is that it is a little too academic and does not fully convey what is at stake. It is somewhat like referring to a murder as a ‘homicide.’

A subsidy is, to begin with, a lie. Because it conceals the truth from both the buyer who often pays far less than what he should, and from the seller who is compensated out of state funds. The buyer believes that what he is getting for a song is only worth so much. The seller, on the other hand, loses a powerful motive to innovate, improve efficiency and cut costs. Because, thanks to the subsidy, he has an assured market. In the erstwhile USSR, the price of bread was heavily subsided as a matter of state policy befitting the workers paradise. True, there was no hunger among its people. But farmers in the country who were allowed to tend to a small plot of their own land (even while working on a collective farm) ended up feeding bread to their pigs.

In a chaotic democracy like India, there is another aspect to this issue. More than subsidies going to the poorest and therefore to those who need it and deserve it the most, they end up being cornered by those whose voices are the loudest. The prices of petrol and diesel at the pump have not budged an inch since November of last year when they were revised downwards following a dip in the international price of crude. Since then, prices have risen sharply by more than 50% (offset to some extent by the appreciation in rupee) and our oil-sector PSUs (effectively the public exchequer at the final resting point) long habituated to operating on an undemanding cost-plus basis, are bleeding. Likewise, the massive subsidy on LPG or cooking gas for domestic use is another example of an outrageously distorted sense of priorities. India has many poor people who are deprived of the most basic necessities of life. Yet, our largest subsidies are on commodities that we know for certain are not consumed by the poor.

And then, by not raising the prices of petrol and cooking gas (or better still, giving a free hand to market forces to set the prices), it is not that nobody is paying for it. On the contrary, we pay for it everyday in the form of reduced services from the government and higher taxes in other areas. Very often, the payment is by way of a debt to be paid off by the succeeding generations. When a parent does that to his child, it is called being improvident. When the government does it, it suggests responsiveness to the needs of the people.

Even as subsidies distort and corrupt, we know from experience that in the real world we have to be practical. An occasional lie here or there, hurts no one and often makes life easier. And so it is with economics. A well-targeted subsidy here and there does not hurt. Indeed, it can even do a world of good, by keeping a lid on discontent and preventing things from boiling over. But what happens when it gets totally out of hand, as happened in the centrally planned economies of Eastern Europe and the USSR, where prices were determined by fiat and seldom had any equation with cost or with market forces like demand and supply. In other words, where everything is one lie after another leading to a series of unending lies.

Well, when that happens, what we have is a work of fiction belonging to an unlikely genre called economics. Unlike the literary version, this one invariably has a nasty ending.

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