This is a PREM taskSubsidies are everywhere PREM economists have
a central role in thinking about them systematicallyUnderstanding
within sectorAdding up across sectors and taxesHelping identify
tradeoffs for the govtWe have an existing set of tools that allow
us to tackle these issues
In terms of the air we breathe you can think about fuel
subsidies ranging from subsidies for oil extraction to subsidies
for consumers (not charging the full price and we can also think of
subsidies for clean air (e.g. in New Delhi, as part of the switch
to compressed natural gas as a fuel for public transport, the
conversion of engines for motorized rickshaws was subsidized)
In terms of the water we drink in high-income countries, only 50
percent of water utilities charge tariffs high enough to cover more
than operation and maintenance cost. In low-income countries,
barely 3 percent of water utilities were able to achieve this
level. Komives, et. al. (published version) pp20-22Heres the
outline for the talk:-what is a subsidy, here the main thing is
that the definition tends to be too narrow-
Politics these pictures come from subsidies related protests, on
the left is fuel subsidy protests in Indonesia (2005) when the
government announced that the subsidy would be cut and fuel prices
would rise (BBC Sat Oct 1 2005) and on the right are german farmers
protesting proposed cuts to farm subsidies Eu figure comes from
Deutsche Welle article of 6/22/2005 "The EU spends two euros a day
per cow," Britain's new minister for European affairs, Douglas
Alexander, recently summed up the situation. Egypt figures come
from IMF Country report n0 06/253, July 2006 (they are
projections)
Malawi example from Al-Samarrai and Zaman, forthcoming Education
Economics. On page 6 Primary school fess were completely abolished
in the 1994/95 school year. This led to a surge in primary
enrolment from 1.9 million students in 1993/4 to 2.9 million in
1999/00In 1990/91 the primary gross enrollment rate for the richest
quintile was almost double that of the poorest quintile. By 1997/98
this gap in enrolment had been virtually eliminated.In terms of
narrow definitions, a good example is the IMF international
financial statistics:Subsidies are current unrequited payments that
government units make to enterprises on the basis of the levels of
their production activities or the quantitiesor values of the goods
or services they produce, sell, export, or import. Subsidies may be
designed to influence levels of production, the prices at which
outputsare sold, or the remuneration of the enterprises.
Subsidies are payable to producers only, not to final consumers,
and are current transfers only, not capital transfers. Transfers
that government unitsmake directly to households as consumers and
most transfers to nonprofit institutions serving households are
treated as either social benefits (27) or miscellaneousother
expense (282) depending on the reason for the payment. Most
transfers made to general government units are included in grants
(26).10 Paymentsto enterprises to finance their capital formation,
to compensate them for damage to nonfinancial assets, or to cover
large operating deficits accumulated overtwo or more years are
miscellaneous other capital expense (2822).
Source: Government Finance Statistics Manual 2001
http://www.imf.org/external/pubs/ft/gfs/manual/pdf/ch6.pdf
Some other examples of narrow/parochial definitions:from
Princetons website: a grant paid by a government to an enterprise
that benefits the public; "a subsidy for research in artificial
intelligence" from the Customs centre in Austrailia:An economic
benefit granted by a government to producers of goods, often to
strengthen their competitive position. The subsidy may be direct (a
cash grant) or indirect (low-interest export credits guaranteed by
a government agency, for example)
On the definition point: note that the government provides the
funds but the service they subsidize may in fact be provided by the
private sector or an NGO (in addition to the government).
On the tax point an interesting example comes from the effort to
improve the air quality by switching to compressed natural gas in
New Delhi. Here the government subsidized the owners of motorized
rickshaws to convert their vehicles and fined (taxed) bus owners
who did not convert their vehicles.
Princeton ref is http://wordnet.princeton.edu/ (cognitive
science)customscentre.canberra.edu.au/glossary/glossary-S.htmlIts a
basic right, so it must be an equity issueThe hard headed economist
says no, its a market failure due to incomplete information on the
clients, or maybe a discount rate issuesThe not-so hard headed
economist says no, its an externality healthier people will be
better able to participate in society something we dont take into
account when making our individual, private health care choices
This slide presents a road map for the next section of the
discussion the why subsidize questionWhat do we do when markets are
not working right (i.e. not efficient)?Government intervenes. One
of our common tools is a tax and a subsidy is a tax with a
different sign. Here we start our discussion of what the particular
market imperfections are that motivate subsidies.
The definition of an externality is when the action of an agent
affect at least one other through mechanism(s) other than price.An
important thing to note about externalities is that they create a
difference between marginal social cost (benefit) and private cost
(benefit)
Public goods are an externality because individuals do not take
into account the marginal benefit (cost) to other individuals when
deciding how much of a public good to purchase. Public goods are
which are non-rivalrous and non-excludable Talk about
non-rivalrous, non-excludable hard criteria to meet, few pure
examples you might think roads are a public good, but technically
they are not (e.g. they are rivalrous look at traffic). There are a
large set of goods which have some aspects of public goods (they
are either non-rivalrous or non-excludable. Here the simple logic
for government provision breaks down (witness the debate over toll
roads). Well come back a bit to considering those types of
goods/services and how much to subsidize them towards the end of
the presentation.
On market failure due to information issues: Here the big
examples are insurance and credit markets e.g. part of the logic
for microfinance is that the information costs for very small
borrowers is often prohibitive for standard institutions and some
form of subsidy is needed. In many cases, when you include
technical assistance and the cost of funds, subsidies continue.
When the goal is equity (and not market failures) we want to
redistribute income. The best way to do this is just to give the
poor a lump sum transfer. But this may involve prohibitive
administrative costs (identification, delivery, etc) and there also
may be political obstacles (for example, its possibly a lot more
politically obvious to transfer a chunk of money to the poor than
to lower the price they pay for a given good).
Given these, we turn to subsidies as a tool for redistribution.
(Keep in mind that these subsidies can be in kind (usually altering
the price of a good or service that the poor consume) but it could
also be in cash with restrictions (e.g. PROGRESSA and other
conditional cash transfers, where there is a cash transfer
conditional on certain consumption pattern) .
Now that we have decided to subsidize, the first question (which
incidentally also applies to the lump sum case) is what we mean by
equity who gets how much. Ultimately this is about some kind of
social welfare function which will tell us what weights different
types of individuals in society have (for example, everyone, poor
or not, could be weighted equally or we might want to give more
weight to the poor). Equity is a broad and politically charged
concept and the subject for another, longer, discussion (see for
example the WDR 2006). In the end, weights in society will be
determined by the institutions and the process by which these
institutions make decisions
Having looked at equity and efficiency as logic for subsidies we
can turn to a sometimes used third reason merit goods. Merit goods
are not only used for museums but sometimes used to justify a host
of basic social services primary education, clean water and the
like. This may be the case, but we need to unpack the definition a
bit 1)individuals cannot correctly perceive their own welfare is
paternalism, the state knows best; 2) society may wish for an
equitable distribution of these goods is equity; and 3) consumption
of certain goods contribute to the formation of values upon which
society is based is an externality (e.g. in education one of the
justifications is that better educated people make better
citizens/voters and this is something we dont take into account
much when choosing education. In the end, we may decide that this
is a good reason to subsidize (e.g. most every country has
government subsidized museums) but we need to be explicit about it
and we need to clearly separate it from equity and efficiency
arguments. Too often merit goods are used as a sort of catch all
explanation.
Psacharopoulos from World Development 22 (9): 1325-1343. More
recent estimates from Knowles and Behrman (Jan 2005 HNP working
paper) find that formal schooling for youth has rates of return
that are at least as high as are those for many investments in
other sectors for the small number of cases where they can
consistently estimate this. Other fun US farm subsidy fact: what do
Scottie Pippen, Larry Flynt, and and Bernard Ebbers all have in
common? Ans: they all benefited from US farm subsidies.
Japanese data comes from Aksoy and Beghin, Global Agricultural
Trade and Developing Countries, a World Bank book.. US data comes
from Goodwin, et. al. Landowners Riches: The Distribution of
Agricultural Subsidies on the NBER website.
Examples of these kind of subsidies arent confined to developed
countries. Take the case of electricity in Andhra Pradesh. Getting
rid of this subsidy would, arguably, be both efficiency and equity
enhancing. Efficiency enhancing because due to subsidies the
government has to roster the electricity (i.e. give farmers
electricity at pre-announced and restricted hours). But due to
energy shortages the quality, amount and voltage of electricity is
unreliable. This leads to unpredictability of supply which can
cripple yields and periodic blow outs of pump motors and
transformers. Furthermore, since farmers are charged a flat rate on
electricity, the marginal cost of pumping more water is 0. This
leads to over use of groundwater. This is critical in AP,
especially in the drought prone areas. This flat rate also
indicates the equity improvement this is a regressive subsidy.
The reasons we see these kinds of subsidies persisting are
political and thus we now turn to take a closer look at political
economy issues.
We now will see the illustration of the first three of these
points in an example from Sri Lanka. The subsidy focuses on rice (a
staple) but also, at one point or another, covered wheat, flour,
sugar, and powdered milk. Also, there were significant balance of
payments implications as during most of the universal period, over
50% of food was imported One thing to note is that this government
was elected as a liberalizing government, so the initial push for
the mandate (reform, overcome the short run view) was there. The
means test was a household monthly income threshold (with some
marginal allowance for household size) and cut the number of
beneficiaries to half the population. In the shift to food stamps,
the number of beneficiaries did not fall, but actually started
rising. In response the govt fixed the number of beneficiaries and
fixed the nominal amount allocated to the food stamp program in the
budgetThe government spending on total food (and kerosene)
subsidies fell from 15% of govt expenditure (5% of GNP) in the mid
1970s to 5% of govt expenditure (2% of GNP) by 1982. The protection
for wage earners came through govt and parastatal wage increases.
Note this co-opts one of the powerful interest groups that had been
at the heart of earlier protests.An important thing to keep in mind
when we talk about tax and redistribution for subsidies is that
taxes themselves entail some efficiency cost. In some contexts this
can be quite high.
The national health insurance is mostly payroll deductions so a
tax, but has some other sources (returns on assets, etc).
Health is a significant part of government spending, accounting
for 25% of municipal budgets and health, welfare and social
security account for about 20% of national government
expenditure.
According to a survey published by the European Commission in
2000, Finland has the highest number of people satisfied with their
health care system in the EU: more than 80% of Finnish respondents
were satisfied compared with the EU average of 41.3%. These figures
come from a WHO Europe report. Finnish tax and spending figures
come from the same report. Keep in mind that while a government may
face separate fiscal and political economy constraints, they are
likely to interact. One such example comes from Sri Lanka:-Early
1950s saw inflationary pressure as rice prices rose.-The government
then had overenthusiastic adherence to IMF program subsidies
cut-Riots, labor heavily involved-Partial reversal, PM resigns,
govt falls, new government and subsidies return fullyNote for the
last point that one factor that enabled the new government to
return the level of subsidies was the fact that rice prices fell.
Keep in mind that this is only one case, but throughout the
universal period of the subsidy there was a number of clear cases
of fiscal constraints leading to political turnover/turmoil around
this subsidy program.
In terms of tax costs, there may be a bunch of different ways to
measure them. Basically, you have to consider the counterfactual to
raising the tax, and then cost out the tax (which will include not
only the induced changes in behavior but also leakages and
administrative costs).
In terms of cross subsidization, an example of this going awry
in Cote dIvoire during 80s:-Put in place free water connections for
urban and rural customers-Subsidized by few hundred industrial
customers (large surcharges)-Fell apart when industrial customers
exited public network
These data (and the health that follow) come from a review of
the 20 PERs done for the last two years (plus an old Cambodia one
to get another picture of longitudinal change). Note that only 10
had education expenditure incidence.
Here we can see that with the exception of Cambodia (in 1997,
not 2002) and Madagascar, that primary and preschool spending is
progressive. The results at the higher levels, however, show the
opposite. In almost all cases secondary and tertiary education are
regressive. The exception to this is secondary expenditure in
Ecuador and Jamaica where the middle quintiles capture a
disproportionate share of the spending relative to the poor and the
rich (and hence the distribution has a bell curve shape). Note that
the years in parentheses are not necessarily the year of the PER
but rather the year that the data used are from. Only five of our
20 PERS had any data on health programs. Here the evidence is
mixed, often in ways that are possibly counterintuitive. Take the
last three rows which show the data from Jamaica. We can see that
outpatient care and hospital care are progressive, while primary
care is regressive. On the other hand, in El Salvador we see a
pattern similar to education where the higher level care is
regressive.
The case of Mexico is interesting because here we have a fund
which is financed by contributions by formal sector employees and
their employers. If we net this out, the *net* distribution is
neutral, but more on Mexico in a few minutes.
For Bolivia: Government expenditure is mainly wages and
salaries. (central government controls 80 percent of public health
expenditure). Municipalities account for around 18percent, which
include variable costs of the public health insurance. The
remaining 2 percent is managed by Social Investment Fund (FPS) and
other public entities. Pg. 107. The public sector also gives an
annual subsidy from the public sector to the Health Insurance Funds
(which is about 0.2% of GDP), which I believe is the social
insurance. (pg. 103)This table is for quantity-based infrastructure
subsidies. The targeted performance indicator is share of subsidies
that go to the poor over the population share of the poor. So 1 is
a neutral subsidy (money dropped from the plane), >1 is
progressive, and PSIA on the World Bank website). Willingness to
pay/accept (WTP) and contingent valuation studies are key in cases
such as determining the right amount of a public good to
provide.
Underlying all of these tools is data. In some cases additional
data may need to be collected, in others it is already there. A
good place to start for seeing what data is out there is to type
data into your browser (if you work in the bank). Not only does
this site give you access to some micro and macro data online, it
also has Country Statistical Information pages which list the
surveys which have been done.
So weve talked about the main justifications around equity and
efficiency and how to approach these. But remember that we have two
other factors that shape what is feasible. How do we deal with
these in designing subsidies?
Understanding the political situation is key to understanding
what is possible. Ideally, a good PSIA should bring political
considerations into the analysis. There will also be a fair amount
of informal, unwritten understanding that goes into this analysis.
Its important to keep in mind that the political situation can
present opportunities as well as problems for example, as we saw
earlier in the example of Sri Lanka, there was a significant
opportunity to reform a subsidy with the election of a new
government.
Obviously, we have to be able to afford whatever subsidy we are
thinking of. So on one level this constraint brings in the issues
of knowing your budget envelope and identifying the funding
mechanism. This will true for all subsidies. But when we consider
equity-justified subsidies, we have to think carefully about
targeting which among the poor will get it, and which among the
non-poor will get it. (To those of you familiar with the targeting
literature, these are the errors of inclusion/exclusion). The
budget constraint will dictate how many poor and non-poor can
receive this subsidy and this leads to the choice of targeting
mechanism. Note that including the non-poor is not always a bad
idea for example it can lead to critical political support to
continue a subsidy in some cases on the other hand it can also
allow for a coarser (and usually cheaper) way of targeting (e.g.
target a region rather than individuals).
On inclusion/exclusion: Recall the earlier slide where we saw
that all of the quantity based water and electricity subsidies
shown here were regressive. A big contributor to that result is
exclusion in many cases the poor (as well as a chunk of the
non-poor) are not connected to the water and power grids, and hence
cannot receive a tariff subsidy. This points to the fact that you
have to consider the exclusion of poor/inclusion of non-poor in
light of your budget constraint but adds the twist that in this
case it suggests that the intervention is misguided if we want to
alleviate poverty we are better off focusing on connection, rather
than usage charge subsidies.
Keep in mind too that the inclusion/exclusion, fiscal constraint
and political economy are intertwined. Going back to earlier
example of our sri lanka subsidies there was significant leakage in
the early 1980s recall it covered 50% of the population but 30% of
the lower half of the pop did not get it, while a fair number of
those in the upper half did (Edirisinghe p 260. Reforms proposed to
fix this in 1985 met with significant protests from current
beneficiaries and their elected representatives (Edirinsinghe +
Sahn 46)
To wrap up our discussion of how to implement effective
subsidies we need to take a quick look at why subsidies fail. There
are two groups here: badly designed subsidies (a lot of which
should be avoided with careful thought to the issues we have
discussed) and those which were well designed but still went awry.
To take a closer look at the badly designed subsidies, we can
separate out a few common problems.
First, we have bad information within the market of concern. We
saw that in the case of Cote dIvoire there was an underestimation
of the price elasticity of demand of industrial users. As a result,
they exited the market when the cross-subsidy surcharge was put in
place (for the benefit of poorer households).
Second, when seeking to remedy a market failure the designer has
to pay careful attention to complementary markets. India subsidized
water and power for farmers with the goal of increasing
agricultural growth (presumably on some logic of credit constraints
or equity) but neglected issues of distortions in the land and
agricultural output markets. One of the interesting lessons to
observe here is that of the political economy circle -- these
subsidies have benefited an increasingly entrenched powerful
political constituencies that make them hard to reverse. This is an
important lesson: a subsidy mistake can be very hard to undo.
Finally, one area of design in which subsidies may fail (despite
having a sound justification and underlying analysis) is in
delivery. As we know from our work on leakages and public service
delivery, the government may not all be the best provider of a
service look at studies of doctor/teacher abseentism, etc in the
public sector. Keep in mind that with subsidies the first question
is whether the government should pay for it. Then we ask the
question as to whom should deliver this: the govt, NGOs or the
private sector. This is basically about inflexibility. Once you set
up a subsidy, you create a group of beneficiaries who have a clear
stake in the continuation of that subsidy. The budget may change
and political conditions may change and these will impact the
Throughout this presentation we have seen the travails of the Sri
Lanka food subsidy and they embody these problems. At one point in
time, the budget constraints tightened, this provided an
opportunity for narrowing down the targeting, but at other points
in time the real value of benefits eroded as budget constraints,
combined with political economy factors prevented changes. This
program was initiated by the Government of Bangladesh with World
Bank support to boost female enrollment. Its primary component was
the Stipend and Tuition Subsidy, which provided monthly stipends to
girl students from Grade 6 to Grade 10 for female students 11 to 15
years old. The stipends covered nearly half of a girl's annual
direct educational costs, including tuition, textbooks, supplies,
uniforms, and transportation during rainy season.*
To start our wrap up, lets revisit the three big questions
In a fair number of discussions you hear subsidies as justified
as good for the poor. Well, as we have seen, that isnt always the
case (remember education primary education subsidies are usually
good for the poor, secondary not so much). But even if we accept
this justification of good for the poor the question is how are
they good for the poor are they good for the efficiency of the
markets the poor face or good for redistribution? As we saw this
makes a big difference in how we will go about things and how we
will ultimately judge a subsidy so understanding WHY is key.
We need to know who is supposed to be getting it, who is getting
it and who is not to begin to understand how we should target a
subsidy and then the impacts, intended or not.
How is where the rubber meets the road we need to seek out a
subsidy that does what we intended and not a lot of what we did not
intend. We need to identify the best possible mechanism to achieve
what the justification mandates. We know economies are complex
systems and tweaking one price can have repercussions in many other
markets.
In the end we have to weigh this logic and the potential options
against the ways things are now subsidies can make things much
better (look at the results we are getting on the results of
Mexicos PROGRESA/Opportunidades) but in some cases it may be better
to do nothing. Since one of the goals of this discussion is to
think systematically about subsidizes, lets recap the logic. We
start with the basic question is this subsidy (chiefly) by equity
or efficiency concerns? This then takes us down 2 separate pathsFor
equity, we have to ask if a lump sum transfer will work first. If
not, we move to designing a subsidy. The next question is who we
need to know who the poor are. Then we decide how to do it do we
need access (e.g. building health centers, connecting households to
water) or affordability (do we change user fees for health or water
tariffs). We have to figure out how we will target people, what are
our political constraints (and/or political opportunities) and what
we have to work with on the budget side.In an efficiency justified
subsidy we are going to look primarily at changing behavior or
reducing market distortions. In the realm of changing behavior, we
have to know how much people are going to react to the subsidy, so
we need to know the relevant elasticities (these include cross
elasticities). We want to find the policy handle that imposes the
minimum amount of distortion (lest we end up in the worst choice
among second best situations) and the one that is as close as
possible to the behavior we want to change.
In reducing market distortions, it is useful to make a
distinction between externalities and other market failures and
public goods. For public goods the task is straightforward, figure
out how much is needed and figure out how to pay for it there is a
clear justification for the government paying for these. But these
are rare, we are more likely to find ourselves faced with other
types of externalities, including quasi-public goods and
information failures (as well as those garden variety
externalities). Here we have to know the markets and get the policy
handle right. In all of these cases we have to figure out how this
will be paid for is it a cross-subsidy, government spending, how?
Putting the cost of the various subsidies in perspective will help
identify tradeoffs across areas.
