The irrationality of untargeted subsidies

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Rational people maximize utility, Pakistan govt maximizes stupidity

Now more than ever, Pakistani policymakers must tackle what has become a very pressing issue for the Pakistani economy: the irrational, unregulated allocation of subsidies. There is ample and extensive research on the subject of subsidies, yet little of that seems to be making its way towards policymaking in Pakistan, especially with the present PML-N government. Untargeted subsidies, such as the infamous Sasti Roti scheme, epitomize bad policy and pose awkward questions when Rs30 billion is spent subsidizing flour in a province which has an education budget of around the same. Most countries have more or less phased out the practice of untargeted subsidies – save for perhaps Egypt, which still provides subsidies to the tune of 12 per cent of GDP on fuel and food. This practice, however, still remains and thrives in Pakistan but must be brought about to an end.

Various areas of the Pakistani economy are beset with this irrational and unfair practice. Take the Utility Stores for example. You can be well educated, have a degree from a top-tier university, earn half a million a month and you can still walk into any Utility Store, buy sugar, flour, oil and whatever else you fancy at a government mandated subsidized rate. If you are a taxpayer, you’re just getting a tax-rebate of sorts. If you do not fall in the aforementioned category, and there are many, many in Pakistan who don not, you are in effect getting a payment of sorts from the government. It’s alright if you are earning big, we will still pay you for the effort of coming in and buying something from the Utility Stores.

The magnitude of the Utility Stores subsidies pale in comparison to the electricity subsidies that the government has been forced to give to consumers, on account of a spike in oil prices post 9/11 and Iraq War (Read: Frivolity). For the year 2010-2011, the PPP government meekly budgeted Rs115 billion and ended up spending more than three times the amount at Rs372 billion. Glaring policy failure meets inept planning.

In effect, the largest share of subsidy is going to the richest sections of society. A report on Pakistan’s electricity crisis published in 2011 by the World Bank states that the biggest beneficiariesof electricity subsidies are the richest households. The same report states that nearly 90 per cent of Pakistani households are net recipients of subsidies. Rational people maximize utility, the Pakistani government maximizes stupidity.

Like mentioned above in the Utility Stores case, if you pay tax, then you’re getting a rebate. If you’re not, you’re getting an out and out discount. And really, shouldn’t the point of any subsidy be to help the disadvantaged sections of a society?

This, however, begs a small question and I digress again but the prevailing situation of unsustainable subsidies in the electricity sector is the result of policy failures and bad governance. The subsidy is in effect the government subsidizing its own failures and inefficiencies. Is it then fair, from a philosophical standpoint, to pass on that inability to govern, lack of political and governmental expertise on to the population at large, especially given that Pakistan’s political history has never been stable enough for the process of political accountability to take place?

As a matter of pragmatism and necessity, tariffs must be rationalized with high consumption consumers paying much more than low consumption consumers. In Iran, for example, consumers consuming lower than 100KWh were charged just 270 Irani Rials ($0.027) per unit while those consuming above 600KWh were charged nearly 2,100 Irani Rials per unit back in 2010 when reforms were initiated.

Subsidies when administered properly and transparently can be a great tool in the alleviation of poverty. What are needed are subsidies that do not unnecessarily subsidize the rich and reduce leakages to the undeserving and the solution to that is to have targeted subsidies. Though administratively taxing is harder to implement on account of finding the right target populace, targeted subsidies can be a great way to maximize the marginal benefit from each rupee of subsidy. Countries all over the world have successfully cut expenditures whilst increasing income transfers to the poor through ending untargeted subsidies and substituting them with targeted subsidies. Whilst not a subsidy, the BISP is an excellent example of a targeted income transfer programme and it has greatly benefitted its recipients.

Which leaves us with a very important policy question, what kind of programme would be most effective in alleviating poverty? Should it be a GST exemption? Should we transfer money balances into recipients’ accounts? Or should we subsidize the price of essential commodities for the targeted population? Each has its own merits and demerits. Research has not given its final verdict on which is the most effective mechanism for helping the more vulnerable sections of society. On the subject of targeted versus untargeted subsidies, however, there is enough research to pass judgment on the respective efficiencies of the two systems.

Such reforms have historically been difficult to implement. Also given the Pakistani population’s love for big government, the government will find it difficult to implement sweeping reforms that might take away some of the more irrational subsidies from the population. Electricity price hikes are a prime example. Whether such reforms will go through or not will depend greatly on how the government manages the media. Irrespective, reducing the size of untargeted subsidies, especially in a constrained fiscal environment is necessary and the government must act on this without hesitation.

The writer can be reached at [email protected] Twitter: @Ahshafi