Economic 11 - Copy

8/7/2019 Economic 11 - Copy

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Chanakya National Law University

Economics Project-Subsidies And Their Impact On Budget1

PATNA

A Project on:

SUBSIDIES AND THIER IMPACT ON BUDGET

ECONOMICS -II

Project submitted to: Miss. Shivani Mohan

(Faculty of Economics )

Project submitted by: SHIKHA KUMARI

Roll no.:357 [IV semester, 2nd

year]


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22.. RREESSEEAARRCCHH MMEETTHHOODDLLOOGGYY..........................................................................................................................44

33.. IINNTTRROODDUUCCTTIIOONN..................................................................................................................................................................55

44.. SSUUBBSSIIDDIIEESS ........................................................................................................................................................................................77

55.. IIMMPPAACCTT OOFF SSUUBBSSIIDDIIEESS......................................................................................................................................1111

66.. IIMMPPOORRTTAANNCCEE OOFF SSUUBBSSIIDDIIEESS................................................................................................................1155

77.. IIFF SSUUBBSSIIDDIIEESS RREEMMOOVVEEDD??............................................................................................................................1177

88.. SSUUBBSSIIDDIIEESS IINN BBUUDDGGEETT 22001111--1122 AANNDD IITTSS IIMMPPAACCTT..........................................2211

99.. CCOONNCCLLUUSSIIOONN..............................................................................................................................................................................2233

1100..BBIIBBLLIIOOGGRRAAPPHHYY........................................................................................................................................................................2244


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AACCKKNNOOWWLLEEDDGGEEMMEENNTT

II ffeeeell mmyysseellff hhiigghhllyy ddeelliigghhtteedd,, aass iitt ggiivveess mmee iinnccrreeddiibbllee pplleeaassuurree ttoo pprreesseenntt aa rreesseeaarrcchh wwoorrkkoonn

SUBSIDIES AND THIER IMPACT ON BUDGET.. II wwoouulldd lliikkee ttoo eennlliigghhtteenn mmyy rreeaaddeerrss

rreeggaarrddiinngg tthhiiss ttooppiicc aanndd II hhooppee II hhaavvee ttrriieedd mmyy bbeesstt ttoo ppaavvee tthhee wwaayy ffoorrbbrriinnggiinngg mmoorree lluummiinnoossiittyy

ttoo tthhiiss ttooppiicc..

II aamm ggrraatteeffuull ttoo mmyy ffaaccuullttyy MMiissss.. SShhiivvaannii MMoohhaann wwhhoo hhaass ggiivveenn mmee aann iiddeeaa aanndd eennccoouurraaggee

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mmee aa ggoooodd bbaacckkuupp mmaatteerriiaall

AAnndd ffiinnaallllyy yyeett iimmppoorrttaannttllyy II wwoouulldd lliikkee ttoo tthhaannkkmmyy ppaarreennttss ffoorrtthhee ffiinnaanncciiaall ssuuppppoorrtt..

SSHHIIKKHHAA KKUUMMAARRII

IIVV sseemmeesstteerr,, 22nndd

yyeeaarr::


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RREESSEEAARRCCHHMMEETTHHOODDOOLLOOGGYY

AAiimmss aanndd OObbjjeeccttiivveess::

TThhee aaiimm oofftthhee pprroojjeecctt iiss ttoo pprreesseenntt aa ddeettaaiilleedd ssttuuddyy oofftthhee ttooppiicc SSuubbssiiddiieess AAnndd TThheeiirrIImmppaacctt OOnn

TThhee BBuuddggeett

SSccooppee aanndd LLiimmiittaattiioonnss::

TThhee ffiivvee ppooiinntt oonn wwhhiicchh ssppeecciiaall eemmpphhaassiiss hhaass bbeeeenn ggiivveenn iinn tthhiiss rreesseeaarrcchh aarree::

EExxtteennssiivvee rreesseeaarrcchh

TThhoorroouugghh ssttuuddyy ooffbbooookkss

BBrrooaadd rreesseeaarrcchh oofftthhee ssuubbjjeecctt vviiaa iinntteerrnneett aacccceessss

CCoommpplleettee ddooccuummeennttaattiioonn

MMiinnuuttee ddeettaaiilliinngg

SSoouurrcceess ooffDDaattaa::

TThhee ffoolllloowwiinngg sseeccoonnddaarryy ssoouurrcceess ooffddaattaa hhaavvee bbeeeenn uusseedd iinn tthhee pprroojjeecctt--

11.. AArrttiicclleess22.. BBooookkss33.. WWeebbssiitteess

MMeetthhoodd ooffWWrriittiinngg::

TThhee mmeetthhoodd ooff wwrriittiinngg ffoolllloowweedd iinn tthhee ccoouurrssee ooff tthhiiss rreesseeaarrcchh ppaappeerr iiss pprriimmaarriillyy

aann

aa

llyyttiiccaall..

MMooddee ooffCCiittaattiioonn::TThhee rreesseeaarrcchheerrhhaass ffoolllloowweedd aa uunniiffoorrmm mmooddee ooffcciittaattiioonn tthhrroouugghhoouutt tthhee

ccoouurrssee oofftthhiiss rreesseeaarrcchh ppaappeerr..


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INTRODUCTION

Definition of subsidy:

Financial contribution by a government or any public body where government

Practice direct transfer of funds, potential transfer of funds

Provides goods or services other than general infrastructure

There is any form of income or price support by the government

This Contribution confers a profit

A subsidy, often viewed as the converse of a tax, is a potent welfare-augmenting instrument of

fiscal policy. Derived from the Latin word subsidium, a subsidy literally implies coming to

assistance from behind.

However, their beneficial potential is at its best when they are transparent, well targeted, and

suitably designed for practical implementation.

Definition

The Oxford English Dictionary defines subsidy as money granted by State, public body etc to

keep down the prices of commodities etc Subsidies bring out desired changes by effecting

optimal allocation of resources, stabilizing the price of essential good & services, redistributing

income in favor of poor people thus achieving the twin objective of growth & equity of nation.

Subsidies will be targeted sharply at the poor and the truly needy like small and marginal

farmers, farm labour and urban poor. Subsidies in areas such as education, health andenvironment merit justification on grounds that their benefits are spread well beyond the

immediate recipients, and are shared by the population at large, present and future. For many


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other subsidies, however the case is not so clear-cut. Arising due to extensive governmental

participation in a variety of economic activities

Subsidies, as converse of an indirect tax, constitute an important fiscal instrument for modifying

market determined outcomes. While taxes reduce disposable income, subsidies inject money into

circulation. Subsidies affect the economy through the commodity market by lowering the relative

price of the subsidised commodity, thereby generating an increase in its demand. With an

indirect tax, the price of the taxed commodity increases, and the quantity at which the market for

that commodity is cleared, falls, other things remaining the same. Taxes appear on the revenue

side of government budgets, and subsidies, on the expenditure side.


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SUBSIDIES

Although the term subsidy is widely used in economics, it is rarely defined. Often it is used as

an antonym to a tax, i.e. a government transfer of money to an entity in the private sector. This

seems, for instance, to be the case in the Oxford Online Dictionary where a subsidy is defined as:

a sum of money granted from public funds to help an industry or business keep the price of a

commodity or service low. But many would argue that tax concessions are also a form of

subsidization. Indeed, for the relevant recipients it may not make much difference whether they

are made better off by receiving money or through the reduction of their tax bill.

Both forms of assistance also represent financial transfers by the government. Border

protection, e.g. tariffs, on the other hand does not result in any such financial transfer from the

government, and instead results in fiscal revenue. Yet it could be argued that the imposition of a

tariff represents a form of subsidization for the import-competing sectors that are thereby

protected from foreign competition.

To define subsidies in terms of government transfers or fiscal expenditure is thus not necessarily

complete. An alternative approach is to consider that a subsidy arises any time a government

programme benefits private actors. The main difficulty with this approach is that recipients of,for instance, a cash transfer or a tax concession, are not necessarily the ultimate beneficiaries of

the policy.

For example, housing allowances, such as the German Eigenheimzulage, consist in transfers

or tax concessions to consumers who build a house. In their ultimate effect, however, they are

not unlike direct payments to construction companies.

Similarly, the main beneficiaries of subsidized intermediate goods may not be the recipients of

the subsidies, but rather downstream firms utilizing these products as inputs in their own

production. Such indirect effects may or may not be intended by the government. The more


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specifically designed a programme, the more likely it is that the intended beneficiary (objective)

and the actual beneficiary (effect) coincide. But it is not necessarily

The development of subsidy disciplines under the GAT S has been left for the built-in

negotiations that commenced in 2000 and currently forms part of the ongoing trade negotiations

under the Doha Development Agenda. Panels and the Appellate Body commonly rely on the

Oxford English Dictionary to define the ordinary meaning of words used in the Agreement.

This definition assumes that subsidies received are passed through, i.e. have an effect on sales

price. This assumption may not always hold, and pass-through may be a matter of degree, as it is

conceivable that at least part of a subsidy is put to entirely different uses.

Easy to design well targeted programs. The literature provides numerous examples of subsidy

programmes that have unintended side effects. Adams (2000), for instance, examines the

possibility that owing to improper targeting of inferior goods in the case of food subsidies to

assist the poor, part may be leaked to high-income people, where they free up funds for other

uses. Devarajan and Swaroop (1998) illustrate how official development assistance (ODA ), even

though targeted at a specific project, may indirectly finance other activities in cases where the

government would have implemented the relevant project anyway and ODA has the effect of

releasing government resources that can be spent elsewhere.

Another drawback of defining subsidies purely in terms of benefits is that such a definition

should in principle take into account the other side of the ledger the numerous government

programmes that impose costs on those same actors, either in the form of taxes or regulations

that pose a burden on private activity.

Many governmental services, such as road infrastructure, are tax-financed by users, in this case

through such levies as excise duties on cars and road tolls. The provision of road infrastructure

should thus not be seen as a subsidy in its entirety, but it may contain an element of subsidization

that is in most cases difficult to measure. Some subsidy programs even appear to be designed in


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order to counterbalance distortions created through other government interventions. In many

countries, for instance, savings beneath a certain threshold are exempt from taxes. Such tax

concessions serve in part to redress the discrimination of saving vis--vis consumption, which

may explain why the German Government in its periodic subsidy reports excludes such

tax exemptions from its subsidy calculation.

The previous paragraphs illustrate some of the difficulties in defining the concept of subsidies.

Although there appears to be agreement that subsidization involves the government and results in

benefits for somebody, approaches differ when it comes to the details. Indeed, the relevant

literature is full of references to the difficulties of defining the term subsidy, as reflected in the

frequently quoted statement by Hendrik S. Houthakker: My own starting point was also anattempt to define subsidies. But in the course of doing so, I came to the conclusion that the

concept of a subsidy is just too elusive. What Houthakker wrote several decades ago still holds

today. Rather than trying to pin down one specific definition of subsidies, this Section therefore

discusses a range of characteristics of subsidy definitions used in the literature or in policy

documents and analyses how different subsidy definitions make reference to these

characteristics.

Depending on the context, a large number of government programmes may be considered

subsidies. For simplicity, these programmes can be grouped into at least three categories: firstly,

the government may transfer funds to producers or consumers, resulting in direct or potential

budgetary expenditure, or use its power to instruct private entities to make a transfer. Direct

transfers, like re-training grants or child allowances, would fall into this category. An example of

potential expenditure is the provision of loan guarantees. The latter may or may not lead to actual

disbursements, but even if they do not, an official guarantee artificially lowers default risks of

potential buyers and stimulates consumption that otherwise would not take place. If a

government instructs a private bank to provide loans at preferential interest rates to certain

private entities, this would not result in government expenditure. Yet this can be considered to be

a government transfer as it would not have taken place without the intervention of the


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government and as it has the same effect as if the government itself had provided the loan at

preferential rates.

Secondly, the government may provide goods or services at no cost or below market price, such

as university education, public transport or food stamps. Such transfers also involve expenses for

the government, with the difference being that beneficiaries receive in-kind contributions as

opposed to funds they can freely dispose of.

Also the public provision of goods or services, e.g. electricity, can have intended or unintended

indirect effects. It can, for instance, affect competition in industries that use the relevant goods or

services as an input, as it affects producers differently depending on how intensively they use theinput.

Thirdly, regulatory policies may be seen as subsidies, if they create transfers from one group to

another. Border protection, for example, allows for price discrimination and pooling of revenues

to producers that are implicitly financed by domestic consumers (Schluep and De Gorter, 2000).

In this context, Cadot et al. (2004) point out that regulatory instruments can circumvent forms of

direct subsidization, leading to the same effects but at higher welfare costs. The authors

demonstrate that preferential rules of origin amount to export subsidies for intermediate goods

industries in the preference-providing country. This category of transfers caused but

not paid for by the government may also comprise implicit subsidies arising from the failure by

governments to internalize externalities, such as air pollution by industry, or rents associated

with untaxed exploitation by private parties of publicly-owned or managed resources.


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IMPACT OF SUBSIDIES

(A)IMPLEMENTATION OF SUBSIDY PROGRAMS

Identifying the precise cases where intervention is socially desirable is not easy. The information

requirements for appropriate interventions are extremely high, thereby making the possibility of

mis-timed and mis-targeted intervention high. These implementation issues are called

government failures. So while market failures may warrant government intervention,

government failures may exacerbate rather than alleviate the problem.

Some of the more common examples of when subsidy intervention becomes problematic include

rent-seeking on the part of beneficiaries and the political economy of the decision-making

process involved in granting subsidies. In democratic societies, electoral pressures may influence

the taxing and spending patterns of governments. Politicians, although professing to act in the

publics interest, sometimes make decisions that are in their own self interest, for instance in

order to increase the chances of re-election (Grossman and Helpman 2002, Hillman, 1989).

Even if subsidy programmes correctly identify beneficiary industries and firms, achieving the

predicted economic effect is not necessarily assured. All of the cases examined above assumethat a subsidy will generate a supply response. Sometimes, however, firms may receive the

subsidy, but may not necessarily use the subsidy commercially. Empirical studies confirm this

hypothesis. At one extreme is the possibility that instead of using funds to finance output

expansion, a firm could use the funds for a number of investment purposes that yield medium- to

long-term benefits. At the other extreme lies full pass-through where the entire subsidy is used

to develop a competitive advantage. The extent to which prices change in the subsidising

industry will depend upon a number of market factors, such as the ability of a firm to affect

prices.

(B) THE POLITICAL ECONOMY OF SUBSIDIES


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The political economy of subsidies deals with the central question of how the political process

interacts with the heterogeneity of interests in society to allocate subsidies and determine the

pace of their removal. More specifically, do the decisions of elective officials always lead to the

socially optimal use of subsidies in the manner described earlier? The conclusions of a number

of studies is that subsidization is correlated with the political influence of the beneficiaries (e.g.

retirees and the elderly in the case of social security or middle and upper class groups in the case

of educational subsidies).

Much of the political economy discussion takes place against the background of a specific

political environment, that of democracies, in which officials need to be elected by a majority of

their constituency. The simplest political model is that of the median voter. Voters are

distinguished along one dimension, for example, by the economic impact of a subsidy

programme. A voter can benefit from the programme if she becomes eligible to receive a

subsidy. But a voter will also incur a cost because taxes need to be raised to pay for the subsidy.

Clearly, those voters who are not eligible for the subsidy will only incur a cost and will not

support the programme while beneficiaries of the programme will support it. These examples

include export subsidies given to US wheat (Gardner, 1996), European subsidies to coal

(Anderson, 1995); subsidies to education (Fernandez and Rogerson, 1994; Kemnitz, 1999); and

social security spending (Mulligan and Salai- Martin, 2003).

Candidates for office win only if they get a majority of the vote. Alternatively, incumbents are

able to maintain political support if they pursue policies that the majority of voters care about.

Thus, whether the subsidy programme is implemented or not depends on the preferences of the

median voter. If the median voter is a beneficiary of the subsidy programme, then this implies

that the majority of voters are beneficiaries. In this case, politicians are able to marshal support

by implementing the programme. On the other hand, if the median voter incurs a cost from the

programme, this means that the majority of voters would lose out if the programme isimplemented. The subsidy programme would therefore not be implemented.

Perhaps the only clear prediction that can be drawn from the median voter model is that highly

targeted or specific subsidy programmes are unlikely to be implemented because only a few


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benefit. The median voter would be unlikely to favour such sector-specific subsidization,

although she would not be averse to more general subsidy schemes, the benefits of which are

more widely diffused. One can go beyond the standard median voter framework to consider

more complex political environments, where voters can form coalitions (e.g. special interest

groups). Special interest groups may arise because government policies can produce an uneven

concentration of benefits and costs. For example, giving subsidies to an industry leads to large

individual gains to the firms operating in that industry, while the costs of the subsidy

programme, which are larger in aggregate, tend to be spread over a very large number of

taxpayers. These producer groups then have strong incentives to organize and use campaign

contributions to try to influence the type of decisions taken by political incumbents. But because

the costs of the subsidy programme to taxpayers are so diffused, there is no similar urgency ontheir part to organize to oppose the programme.

Grossman and Helpman (1994) develop a model in the international context where a politicians

continuance in office is dependent not only on obtaining the support of the general electorate but

in currying favour with special interest groups. Incumbents need financial contributions for a

variety of reasons. They may need a large war chest to deter potential political rivals, or to pay

for political advertising to sway uninformed voters or to retire campaign debt. Thus politicians

are willing to offer trade and subsidy policies for sale. While they care about maximizing socialwelfare (since they need to appeal to the informed voter), they also care about the amount of

financial contributions they can generate. Given the mixed incentives of politicians (a weighted

average of social welfare and campaign contributions), the policies that are chosen in equilibrium

will deviate from the socially optimal. Compared to free trade (the socially optimum), the prices

of goods produced by lobby groups will be higher through the use of tariffs or export subsidies.

In this context, the subsidies that are provided to a specific industry are not intended to correct a

market failure, but to improve the economic standing of the special interest group, who in turn

will reward the incumbent. While this result explains why subsidies are offered when it is not

economically justifiable, it also helps explain the resistance to their removal in the domestic and

international context.


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(C) INTERNATIONAL CONSEQUENCES OF DOMESTIC SUBSIDIES

The welfare propositions spelled out in this Section have focused primarily on the impact of

subsidies on the subsidizing economy. In some instances, such as export subsidies, the welfare

effects on the non-subsidizing economy were also taken into account. Where the exports of a

country are displaced by a foreign subsidy, producers will be negatively affected, but consumers

may benefit depending upon the price effects. The only circumstance in which displacement does

not occur is when the subsidizing economy is too small to affect world price. In sum, the world

price effects of subsidies are crucial in the design of multilateral trade rules.

Another aspect of subsidies that has international consequences is the response by one country to

the subsidy of another via various forms of remedial or offsetting action. Such action can be inthe form of subsidies, countervailing duties, or a legal dispute. For example, a country that uses

import substitution subsidies to offset import competition could face counteraction by an

exporting country in the form of export subsidies, which would lower the price of the exporting

country. Countervailing duties imposed by an importing country will tend to offset the initial

subsidy in the exporting country. A legal challenge would question the legitimacy of a subsidy

policy rather than resorting to an offsetting intervention. Section F considers these issues in the

context of the Agreement on Subsidies and Countervailing Measures.


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IMPORTANCE OF SUBSIDIES

The removal of subsidies can have adverse effects on the poor in these countries and lead to

political agitation as evidenced in the 2005 demonstrations after the ruling NPP government inGhana removed the subsidy on petrol. But is there a compelling economic argument or basis for

the removal of subsidies? Will this policy necessarily improve economic performance?

Modern neoclassical economics is based on perfectly competitive markets. More than fifty years

ago, the Nobel Laureates Kenneth Arrow and the late Gerard Debreu proved the existence of

competitive prices under very restrictive conditions. Under certain conditions, a competitive

equilibrium not only exists but is also efficient (i.e., maximizes the size of the national pie or

maximizes social welfare). In this world, there can be no role for government intervention in theeconomy.

In a competitive equilibrium, the price of each commodity is equal to its cost of production.

Suppose the cost per unit of output is constant, where cost is defined to include the minimum

return on investment that an entrepreneur requires to remain in business. Since the quantity

demanded of the commodity increases as the price falls, an increase in quantity beyond the

competitive equilibrium quantity will result in a fall in the price. Given that the price is equal to

the cost of production in a competitive equilibrium, any increase in quantity beyond the

competitive equilibrium quantity implies that the price will be below the cost of production.

This clearly does not make sense.

Conversely, any reduction below the competitive equilibrium quantity implies that the price is

above the cost of production. But since price is a measure of how society or economic agents

value a commodity, the value that society places on an additional quantity exceeds the cost.

Therefore, economic welfare increases if quantity is increased when the economy is below the

competitive equilibrium quantity.

Thus, the departures from the competitive equilibrium quantity and price reduce social welfare

or do not make economic sense. If the market is in a perfectly competitive equilibrium, then a

subsidy, by reducing the price of the commodity, increases consumption of the commodity


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beyond the equilibrium competitive quantity. But since departures from the competitive

equilibrium reduce social welfare, the subsidy is not desirable. Herein lies the logic behind the

World Bank policy prescription: removal of subsidies.

In this world, subsidies are a form of market distortion which leads to a misallocation of

resources and a reduction in social welfare.

Given that the conditions required for free markets to operate efficiently are rarely met in the

real world, one is inclined to question why the World Bank recommends the removal of

subsidies to several developing countries as though this was some religious dogma or mantra.

Joseph Stiglitz of Columbia University won his 2001 Nobel prize in economics based on his

numerous works which demonstrate market inefficiencies in various contexts. Marketimperfections or distortions exist when buyers are uninformed, the number of firms is small,

public goods exist, property rights are weak, etc.

,However . market imperfections do not necessarily lead to market failures or inefficiencies. For

example, it can be shown that a market with only two firms which face no capacity constraints

could yield an efficient competitive outcome.


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IF SUBSIDIES ARE REMOVED ?

In this part two Important questions are dealt as discussed below:

y If subsidies are distortionary and reduce welfare in perfectly competitive markets, arethey necessarily so in markets which are not competitive?

y Is there a generally accepted economic argument for their removal?The answer is no for both the questions

Almost fifty years ago, Lipsey and Lancaster (1956) showed that in an economy characterized

by many market imperfections, there is no guarantee that the removal of any one such

imperfection will improve social welfare.

This is the theory of the second-best. As the development economist Paul Mosley (1991: 227)

observed any structural adjustment programme i.e., programme to remove a cluster of

such imperfections is therefore not an application of economic principles but rather an

improvisation, a gamble

Let me present an illustration of second-best theory. Suppose there is a market imperfection, for

example, there is only one firm or very few firms in the market. Typically, the equilibrium

quantity in this market will be below the perfectly competitive equilibrium quantity. For

example, the equilibrium quantity when the seller is a monopolist is lower relative to the quantity

in a perfectly competitive market since monopolies charge higher prices. Therefore, a subsidy,

by reducing the price of the commodity, may increase the consumption of the commodity

towards the equilibrium (perfectly) competitive quantity, given that output was initially too low.

Indeed, an appropriately chosen subsidy will move the economy towards the perfectly

competitive equilibrium quantity. This increases social welfare. This benefit must be balanced

against the cost of the subsidy, which also includes the cost of financing the subsidy through

distortionary taxation. But the main point is that we cannot necessarily conclude that the subsidy

will reduce social welfare unless we know the relative magnitudes of the costs and benefits. The


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theory of the second-best suggests that if there are irremovable distortions in some sectors of

the economy, then economic performance or social welfare may be higher if free-market pricing

principles are deliberately violated in other sectors of the economy.

There is yet another reason why the removal of subsidies may not enhance economic

performance. Subsidies may be used by governments to redistribute income from the rich to the

poor. For example, subsidies on kerosene in Ghana serve this purpose, since kerosene is

typically used by the poor. Indeed, redistribution can enhance economic efficiency in certain

situations. Harvard economists Alberto Alesina and Dani Rodrik (1994) showed that income

inequality had an adverse effect on growth. They argued that in more unequal societies,

economic growth is lower because the demand for fiscal redistribution financed by distortionary

taxation is higher. Income inequality also fuels social discontent and increases socio-political

instability. The uncertainty in the politico economic environment reduces investment which

reduces growth.

Here is another example, of how redistribution or less inequality can enhance efficiency.

Consider a winnertake-all society where being first comes with everything and being second,

third, etc comes with nothing.


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RELATIONSHIP BETWEEN SUBSIDIES AND BUDGET

There is a Keynesian view of macroeconomic policy management where subsidies could be

used to boost expenditure or aggregate demand. Hence, the removal of subsidies might dampeneconomic activity. But this depends on ones view of the budget balance. If we appreciate the

fact that subsidies must be financed through taxation, then the removal of subsidies might also

imply the reduction of taxes. The reduction of taxes could stimulate the economy. In reality,

taxes are not reduced when subsidies are removed nor is there necessarily a strong connection

between subsidies and taxes. Governments, indeed, run budget deficits.

Of course, if the continual use of subsidies widens the government's budget deficit, then this is

clearly a cost of subsidies which must be taken into account since bigger budget deficits implyhigher interest rates which also dampen economic performance.

Also, the political economy of subsidies depends on the perception of economic agents. If

economic agents do not trust their governments and believe their most of their taxes are used for

the private gain of politicians, then they might agitate for subsidies on certain commodities as a

way of getting a piece of the national pie. Subsidies, no matter how inefficient, may then be

used by the electorate as a way of getting politicians to commit to some form of credible

redistribution.

The main argument is that since there is no compelling theory to support the removal of

subsidies, the World Bank and governments in developing countries should implement this

policy cautiously and should do so on a case-by-case basis. Indeed, the World Bank does not

impose these conditions on the developed nations. Why? Clearly, there is a double standard. The

removal of subsidies should not be a one-size-fits-all policy prescription for developing

economies because there is nothing in economic theory which unequivocably supports this

policy.


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The public must be educated and informed about the pros and cons of this policy on a case-by-

case basis including the alternative uses of tax revenue if the subsidy on a specific commodity is

removed. For example, the removal of subsidies on health may have entirely different

implications than the removal of subsidies on petrol.

Those who wish to play politics with this piece will only see one side of the story. On the

contrary, this piece calls for pragmatism, balance, and common sense. Finally and perhaps, more

importantly, the World Bank will not be able to tell developing countries what do if they put

their house in order. For the sake of their children, grandchildren, and their own pride,

developing countries ought to get rid of any canker of corruption, nepotism, misgovernance,

incompetence, and apathy in their house. That way, they wouldnt have to depend on the World

Bank.


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SUBSIDIES IN BUDGET 2011-2012 AND ITS IMPACT

Last year our Finance minister experimented with the direct transfer of subsidies for a few

agricultural fertilizers excluding urea.This has been found to be very successful in ensuring thatthe benefits are accrued by the actual farmer who ultimately uses the fertilizers and not the

intermediaries.Emboldened by the success of the experiment, the Finance Minister has extended

the concept to a few more products.

Subsidy Proposal This Budget

Budget 2011-12 proposes to include urea which is the most consumed fertilizer by volume,

under the direct subsidy route under the Nutrient Based Subsidy (NBS) scheme.

There is also a proposal to shift kerosene & LPG to the direct transfer system for the below

poverty line people. This is a welcome measure.

The reason is that today in the name cross subsidy everyone kerosene & LPG are fixed at a lower

price for all consumers. This in turn forces the price up for the commonly used fuel petrol.

For the common man of India the money spent on petrol is more that the benefit from the

subsidy on kerosene of LPG.

The scenario also leads to a lot of kerosene being used by commercial establishments by

manipulating the distribution system.

Going the direct subsidy route, the prices of kerosene and LPG will go up in the market, but the

extent of rise will not be as high as when the subsidy is given to everyone.

HOUSING LOAN INTEREST SUBVENTION

The finance minister has extended the limit for the interest rate subsidy for housing loans from

Rs.10 lakhs to Rs.15 lakhs for properties worth upto Rs.25 lakhs. This again is a welcome

measure. The interest subsidy remains at the same 1%.The possibility to own a house is

increased now for the common man.


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AGRICULTURAL LOANS INTEREST SUBVENTION

The last budget had given a provision for 2% interest subvention to farmers who borrow shortterm crop loans and pay back on time. The response has been good during this year.

Based on this the Finance Minister has not only extended the scheme but has increased the

interest subvention to 3%.This trend is a sharp and welcome shift from foregoing / writing-off

farm loans, which created a wrong precedence and did not motivate even farmers who had the

money to repay the loan.

OVERALL SUBSIDY BUDGET

The Finance Minister has fixed a limit of Rs.23,000 crores for the fuel subsidy which is lesser

than the previous year. But with the crude prices rising to US$120/gallon, this will not be

enough.

However the extend of benefit (actual reduction in the subsidy paid out) due to the

implementation of the direct payout of the subsidies needs to be seen. Overall the shift in system

by going for direct transfer of subsidy is a step in the right direction for the entire society


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CONCLUSION

The project mainly revolves around subsidy provided by government and its impact on budget. It

however answered many question on how absence of subsidy will affect the economy at large.

Also to make the project live as the subject of economics is the subsidies provided by the

Government of India in the Union Budget of India 2011-2012 has been given.

In this context, the subsidies that are provided to a specific industry are not intended to correct a

market failure, but to improve the economic standing of the special interest group, who in turn

will reward the incumbent. While this result explains why subsidies are offered when it is not

economically justifiable, it also helps explain the resistance to their removal in the domestic and

international context.


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BIBLIOGRAPHY

BOOKS :

1) ECOMOMICS FOR LAW, Wadwa publication2) Introductory Economics , K.L. Verma3) Macro Economics , G.S. Mittal

WEBSITES:

1)reuters.com

http://in.reuters.com/article/2011/02/28/idINIndia-55216320110228

2) wikipedia.org

en.wikipedia.org/wiki/Subsidy

Documents

Economic 11 - Copy