By Jayashree Jakhade

Evidence shows that in many countries the expenditure on subsidies remains at a very high percentage of GDP. In India too, the incidence of the subsidy to GDP ratio is very high and the government is trying its best to scale down this figure.Subsidisation on such a large scale implies substantial opportunity costs.

Subsidies have to be viewed from both a micro as well as a macro perspective.Today, subsidies account for a major chunk of the government expenditure if not properly administered.

On the domestic front, they can lead to large-scale misallocation of resources, income distribution can get skewed and structural and distributional problems can lead to an overall reduction in the efficiency of the economy.

On the international front also, increased international integration through trade and multilateral and bilateral arrangements can also cause distortions in international resource allocation if not handled in a proper manner, thus affecting competitiveness.

The world over there have been a series of discussions on how one justifies a subsidy and how one quantifies it . Broadly, any government intervention where the consumer benefits by paying a lower price and the producer enhances his income is referred to as subsidy.It is here that the government bears the cost burden upon itself.

Measurement of subsidies can have varied problems .Subsidies are not homogeneous, they can fall under several categories and this leaves ample room for ambiguity and quantification problems.

It is here that the government should try and justify the extent of the subsidy so that there is no room for wastage and it does not add to the fiscal burden.

Over the years, in India, it will be seen that the level of subsidies has been growing year after year, reflecting in the higher budgetary allocations.

In many cases this is not justifiable as mismanagement of the entire exercise results in the rich fending for the poor. As the government is politically bound, it cannot be harsh on the poorer sections. So, what option is it left with but to tax the rich to fill its coffers?

The opaque picture
Whether the budget provides us with the right picture of subsidies is the issue of a debate that has been going on for years.In the budget category, all subsidies are not accounted for.It is only cash subsidies that get reflected. The remaining subsidies fall under different heads.

What about those subsidies that fall outside the purview of the budget? More transparency is required. Very often, the government's fiscal accounts do not capture most operations that create subsidies.Regulatory subsidies, controlled consumer prices, subsidisation operations provided by international organisations are all off-budget documents.

Fiscal accounts do not show the full economic impact of current subsidy practices.Some subsidies may not have an immediate impact but can reflect after a time lag. How does one account for these?

Therefore, subsidies when measured on the basis of government fiscal accounts typically comprise but a fraction of the full extent of subsidisation that exist in an economy at any point of time.Since it is impossible to know the full extent of subsidisation, the available data has usually been confined to what can readily be observed and quantified.

Theoretically, subsidies are justifiable as they have a welfare element involved in them and are aimed at targeting the poor sections of society to bring about an equitable distribution of resources and reduce the income disparity gap.But mostly, subsidies are a tool to win vote banks and are readily used when elections are approaching or there is political instability.

Especially, at a time when India is opening up to foreign investment, the government has to play a pivotal role to enhance large scale economies of scale as this would help Indian firms compete with multinationals.The profits that accrue can be diverted to enhance the competitiveness of Indian firms further. Overall, the micro and macroeconomic effects of subsidies are closely linked to how they are provided.

Off at a tangent
Subsidies should be viewed from a long term perspective if the full effect of the subsidy has to be properly understood.If subsidies are given in an uncompetitive market mechanism, they may result in inefficient allocation of resources and deadweight losses.Many a time it is noticed that subsidisation leads to over production of the commodity and it may outweigh demand .

This may result in a marginal social benefit being far less than the marginal cost.

Today, why the government is not opening up the market to consumer items, especially food stuffs, is that if allowed this would drain out a lot of precious foreign exchange leading to pressures to reduce other imports or depreciate the exchange rate which may distort the domestic market functioning.

Subsidies should be well looked into as domestic consumers can end up paying prices that are much higher than in the neighbouring countries. This could lead to large-scale smuggling of goods to that country which will result in only traders benefiting at the cost of consumers.

Thus, if the government has to make the subsidy programme cent per cent effective, it will have to focus on making it more transparent, thereby enhancing the cost effectiveness, limiting the duration of the programme, and strengthening cost control. It would also have to select a pragmatic approach where it matches the institutional and administrative capabilities of the government.

So, if the government has to justify subsidies, it should see to it that subsidies do not only benefit the well-placed groups. This would distort incentives which would put the desired distribution and resource allocation effects into doubt.

Today there is a heated debate on whether the whole exercise is serving any purpose. Despite the government making a conscious effort to target the subsidies to the rural and pro poor groups it has failed miserably in its endeavour.

Even today more than 70 per cent of the subsidies do not benefit directly the masses for whom they have been allocated. They still flow into either producer/distributor channels or they go to the rich urban consumers.This has resulted in the PDS system becoming defunct and malpractices creeping in both at distribution and retail system.

Despite the government setting up a administrative body, there is no significant improvement.

Foodgrains do not reach the ration outlets but either are rotting in the godowns or are being redistributed to more profitable channels.This is all at the knowledge of the government and no one can do a thing as producer lobbies are very strong voting banks and financial suppliers.

Despite such a large chunk of the subsidy going towards this group, still there is a huge shortage felt in the market and people below the poverty line for whom the subsidy is meant suffer from starvation and non availability. Often it is argued that subsidisation leads to over demand for the commodity which adds to the financial burden of the government.

Many states have announced heavy subsidisation for food through the public distribution system. But distribution channels are still primitive and it is here that malfunctioning takes place.Despite having huge coffers of food grains the poor classes still have to access the open market and pay a price which is higher than the existing PDS price.

The government is conscious of the irregularities that are prevailing in the system but not much seems to be happening.Strong recommendations are made but year after year they seem to be remaining only on paper.Although the percentage growth in the subsidies has been declining over the years it will be a while till mass targeting is achieved. For this efficiency will have to be installed at each and every stage of the distributive system.

Today, the government has realised that there is a huge wastage of precious resources. Despite huge buffer stocks in food grains, ration shops are still running dry. Also, despite the government resorting to imports of sugar and kerosene there is a massive shortage.This trend is especially noticeable at festival times when the demand for food grains is slightly high that shops run dry and open market prices are at their peaks.

For subsidies to hit the target masses, the government will have to check blackmarketing and see to it that ubsidies are well channelled so that they are productive in nature and help improve the tax base.

This will also help in bringing the necessary revenue that can be chanelled into more fruitful and productive projects like infrastructure which has an inbuilt potential to generate growth.