Economics of Subsidies in India – Social Issue Essay, Article for Class 12, Graduation and Competitive Examination.

Economics of Subsidies in India

Scheme of the Essay

Exposition: The reversal of the B.J.P. government’s policy regarding the reduction of food subsidies has raised many questions.

Rising action: Economics of subsidies in simple.

Climax:

(1) Subsidies are usually bad for microeconomics.

(2) These are also bad for macroeconomics.

(3) But food subsidies are different.

(4) The entire machines of local governments may have to help in identifying the poor.

(5) The argument that subsidies increase the fiscal deficit is not so much applicable to food subsidies.

Ending: Let that growth produce equity and increase the income of the poor.

The recent reversal of government policy regarding the reduction of food subsidises-first increasing sharply the issue prices in ration shops, then partially rolling them back some questions for serious public debate. Are all subsidies bad? Are food subsidies particularly bad, so that they have to be reduced first, whether we succeed or not in reducing other subsidies? Are there no other measures of reducing fiscal deficit, raising tax revenues, or reducing public expenditure that should be tried first before raising the price of food?

These are basically political questions like which interest groups should be supported more than others. They should not be shoved under the carpet by mystifying the economic compulsions. The economics of subsidies is quite simple. Subsidies are usually bad for both micro-economic and macro-economic reasons. By reducing the prices below the cost of production of subsidised products, they encourage too much consumption and too little production. By financing them through public expenditure, subsidies tend to raise fiscal deficit and inflation.

But food subsidies are different. A part of such subsidies goes to the producers, paying them, for the amount procured by FCI, prices higher than the cost of production. That neutralises the disincentive effects of subsidies on production. Indeed the procurement prices are often fixed too high, to compensate the marginal, least productive farmers, which allows large profits to be reaped by more productive farmers in irrigated and fertile areas. The big farmers’ lobby sees to it that the procurement prices, and hence their profits, are not lowered in the name of reducing subsidies. They also make sure that subsidies on fertilisers are not reduced much even though there is ample evidence of excessive use of fertilisers from price distortions.

When food subsidies are reduced by raising the issue prices, they only affect consumers using the public distribution system. There is very little excessive consumption there, which could be reduced. For the poor, food consumption is practically inelastic. If food prices fall, they have some spare money to spend on other essentials. If they rise, they become poorer. Food prices directly affect the level of poverty, and until the poor can be given more income and purchasing power, it will be essential to give them food at affordable prices.

The decision of the government to roll back the PDS price rise of food for the ‘below the poverty line’ population was therefore fully justified. This should, of course, be complemented by policies to improve the delivery system and target the BPL population properly. The poverty line is a statistical concept and for PDS families below that line have to be identified in terms of some visible indicators, such as land holdings or ownership of assets or willingness to work for JRY and employment assurance schemes at very low wages or on food-for-work programmes.

The entire machinery of local governments or panchayats may have to work for that. Even then the targeting may not be complete and some non-poor above the poverty line may access the supply. But the heavens will not fall because these non-poor will also be quite poor by normal standards. The leakage of food from the PDS to the under-serving rich is not large, and while attempts should be made to reduce that, using it as a pretext to condemn the PDS and raise the prices is surely not conducive to reducing poverty.

The argument that subsidies increase fiscal deficit which causes inflation, and hits the poor more than others is also less applicable to the case of food subsidies for PDS. If other subsidies are infructuous public expenditures cannot be controlled and fiscal deficit is financed by inflationary money creation, an effective PDS can protect the consumption standards of the poor much better than any other measures. If PDS covers another essential item besides food grains constituting the basket of wage goods.

Maintaining the prices would help maintain real wages and prove the demand for hiking money wages leading to further cost-push inflation. If restraints on money wages are complimented by some control on other incomes, we can have an effective income policy to check inflation’s pressure. That can very much strengthen the effects of restrictions on money supply. Several developing and industrial countries have used income policy along with monetary policy to effectively curb inflation. Even India was very successful in using such policies to bring down the over-20 percent inflation after the first oil shock of 1973 to less than zero within a year.

There are many ways of controlling inflation just as there are many ways of reducing fiscal deficit. Choosing the reduction of food subsidies first betrays a particular bias–hits the poor who do not have any lobby and who are too scattered to protect their rights. You cannot reduce the procurement prices or fertiliser subsidies as that would upset the rich farmers. If you add also the power and water subsidies together with those for other inputs, the profits of these farmers can be quite high, and no government has dared to tax agricultural income. You cannot reduce public expenditure or the huge administrative structure using excessive manpower. You cannot reduce the subsidises on loss-making public enterprises, and the wasteful manner of delivering public services, both at the Centre and the states. At the same time, you cannot raise taxes. Any attempt to raise the tax rates significantly meets with tremendous opposition from vested interests. The administrative effort required to collect more revenues from the same tax rates, by expanding the tax nets and disciplining the officials, has proved to be too much for successive governments. The tax-GDP ratio today is only about 60 percent of what it was in the early 1980s. It is also one of the lowest among all developing countries.

Macro-economic stability must be maintained, fiscal deficit is curtailed, and inflation is controlled, as pre-conditions for successful reforms leading to sustained growth. Let that growth produce equity, increase the income of the poor, and remove unemployment and underemployment. Until then let us not burden the poor by raising food prices, as a shortcut to reducing food subsidies. The poor may not appear to react violently in our country, but they have an uncanny way of using their votes to teach the government in power appropriate lessons.