Subsidies : Burden or Necessity ?

Presenters: Abhishek Singh(13115006) Ashish Kumar Yadav(13115029)

Subsidy in simple terms can be
defined as benefit given by the
government to groups or
individuals usually in the form
of a cash payment or tax
reduction or in kind support.

It is extended to an economic
sector (or institution, business,
or individual) generally with the
aim of promoting economic and
social policy.
Subsidy : A word heard commonly understood rarely
Converse of tax
Instrument of
fiscal policy
Social security
measure
Definition of Subsidy in Indian context
It is an effort of the government to lend the
poorer sections of India a hand through
proffering subsidies so that they can deal with
the mounting expenses.
In a budgetary context, subsidies are taken as
unrecovered costs of public provision of non-
public goods.
Subsidies in India are largely seen to be
measures to ensure social security of certain
sectors.
Food Subsidy Petroleum Agriculture
Education Infrastructure Health
Products on which we enjoy subsidy
Subsidy Targeting
Subsidies can be distributed among individuals according to a set
of selected criteria, e.g. 1) merit, 2) income-level, 3)social group
etc. Two types of errors arise if proper targeting is not done, i.e.
exclusion errors and inclusion errors.
In the former case, some of those who
deserve to receive a subsidy are excluded.
In the latter case, some of those who do not
deserve to receive subsidy get included in the
subsidy programme.
and whom are the subsidies targeted to
and how much
1250 billion rupees(2013-14)
Food Subsidy
TPDS-Under this scheme, each BPL family is entitled for 35 kg of rice or wheat every month, while an APL
household is entitled to 15 kg of foodgrains on a monthly basis at subsidized prices.
AAY-one crore families out of the number of BPL families who would be provided food grains @ Rs.2/-
per Kg for wheat and Rs. 3/- per Kg for rice.
National Food Security Act-The National Food Security Act, 2013 (also Right to Food Act) is an Act of
the Parliament of India which aims to provide subsidized food grains to approximately two thirds
of India's 1.2 billion people. Pregnant women, lactating mothers, and certain categories of children are
eligible for daily free meals.
970 billion rupees
Petroleum
Kerosene and LPG are subsidized in India.
A household in India is eligible for 12 LPG cylinders at subsidized rates (Rs 414 per 14.2kg cylinder) in a
year as compared to the non-subsidized price of Rs 920.
Only 26% of subsidized kerosene directly reaches households in Maharashtra.Rest is sold to retailers and
distributors.

758 billion rupees(2013-14)
Agriculture
An agricultural subsidy is a governmental subsidy paid to farmers and agribusinesses to supplement their
income, manage the supply of agricultural commodities, and influence the cost and supply of such
commodities
Free electricity and water for irrigation purposes are provided to farmers.
The Indian Government provide subsidies to provide fertilizers to farmers at stable and affordable prices
in order to increase agricultural production through higher fertilizer use, and to encourage domestic
production by allowing fertilizer producers a reasonable return on their investments.
Crops like rice and wheat are subsidized.
Education
The Right to Education grants to every child aged between 6-14 years the right to free and compulsory
education. Students in the government and government-aided schools are provided free tuition.
The tuition fees of government-aided colleges is also subsidized. For example, under no subsidy, a B.Tech
degree from any of the IITs will cost around 16 lakhs rupees while subsidies reduce this amount to 4-5
lakhs.

Objectives of subsidies
1.
Subsidies serve as instruments for the
achievement of social policy objectives including
redistribution of income, population control, etc.
2.
To offset market imperfections
3.
Induce higher consumption/production
1.
Are budgetary subsidies being provided for the right reasons, especially in the
context of arguments like the infant industry argument which may not be valid any
more?
2.
Does over-subsidisation lead to perverse results, especially in the light of
experience regarding the damage to soil productivity by subsidy-induced
distortions in the NPK ratio and other environmentally adverse effects?
3.
Do subsidies hide and promote inefficiencies?
Subsidy related issues in India
4.
Are there subsidies which are environmentally unsustainable?
5.
Is the apparatus used to provide subsidies fatally flawed?
6.
Is there need for distinguishing between subsidies that are to be given on a
long- term basis from those that should be used on a temporary basis with a
pre- determined life?
Subsidy related issues in India
Economic effects of subsidies
Competitive equilibrium is a state of balance between buyers and suppliers,
in which the quantity demanded of a good is the quantity supplied at a
specified price. When the quantity demanded exceeds the equilibrium
quantity, price falls; conversely, a reduction in the supply of a good beyond
equilibrium quantity implies an increase in the price.


The effect of a subsidy is to shift the supply or demand curve to the right (i.e. increases
the supply or demand) by the amount of the subsidy. If a consumer is receiving the
subsidy, a lower price of a good resulting from the marginal subsidy on consumption
increases demand, shifting the demand curve to the right. If a supplier is receiving the
subsidy, an increase in the price (revenue) resulting from the marginal subsidy on
production results increases supply, shifting the supply curve to the right.
Economic effects of subsidies
Economic effects of subsidies


Assuming the market is in a perfectly competitive equilibrium, a subsidy increases
the supply of the good beyond the equilibrium competitive quantity. The
imbalance creates deadweight loss. Deadweight loss from a subsidy is the amount
by which the cost of the subsidy exceeds the gains of the subsidy. The magnitude
of the deadweight loss is dependent on the size of the subsidy. This is considered
a market failure, or inefficiency.
Economic effects of subsidies
CRITICISM OF SUBSIDIES
CONS
Many subsidies can cause unintended issues threatening environment
sustainability
1.An increase in irrigation has helped the nation feed itself, it has also led to a
groundwater crisis. As groundwater tables drop, the pumping of groundwater from
deeper and deeper wells requires an ever-increasing amount of electricity. Because
electricity for agriculture is subsidized, there is little incentive for farmers to adopt
water-saving techniques, creating a vicious circle of water and energy consumption.
2. By subsidizing inputs and outputs through such schemes as yield based
subsidization, farmers are encouraged to: over-produce using intensive methods
including using more fertilizers and pesticides; grow high-yielding monocultures;
reduce crop rotation; shorten fallow periods; and promote exploitative land use
change from forests, rainforests and wetlands to agricultural land. These all lead to
severe environmental degradation including adverse effects on: soil quality and
productivity including erosion, nutrient supply and salinity which in turn affects carbon
storage and cycling, water retention and drought resistance; water quality including
pollution, nutrient deposition and eutrophication of waterways, and lowering of water
tables; diversity of flora and fauna including indigenous species both directly and
indirectly through the destruction of habitats, resulting in a genetic wipe-out.
CONS
Absence of an effective apparatus to disperse subsidies may lead to perverse
effects
Most of the domestic maids, helpers, cleaners, drivers and a host of other blue-collar
workers who live in our cities and towns dont have access to LPG connections,
basically because they cannot produce an identity proof or give residence proof
without which their neighborhood gas agency would not even countenance their
application. Many are itinerant workers and even those that are not rarely have a lease
document for their rented homes. So, they end up procuring 5 kilo empty cylinders
from the market which they fill illegally (and dangerously) every few days from their
friendly gas shop in the same neighborhood. And they pay at least five times the price
of a subsidized LPG cylinder.
CONS
Subsidies-agents of crony Protectionism
Due to the Farm Bill of 2002,cotton growers in the US receive half their income from
the government. The subsidy payments stimulated overproduction and resulted in a
record cotton harvest in 2002,which had to be sold in the global market. So, African
farmers received 35 to 40 cents per pound for cotton, while US cotton growers, backed
by government agricultural payments, received 75 cents per pound.
CONS
Inefficient Transfer to Recipients

The money from government subsidies does not always make its way to the intended
recipients. Although some of the money is likely to make a difference in peoples lives,
a sizable amount tends to go to other places. In a 2010 report by the Organization for
Economic Co-operation and Development called The Use of Input Subsidies in
Developing Countries, OECD analysts found that less than half the value of an input
subsidy in developing countries actually translates into any improvement in net
incomes for agricultural households. The majority of the money is instead transferred
to suppliers or lost due to inefficiency, according to the analysts.
CONS
Subsidies tend to benefit rich more than the poor
A paper published by the International Monetary Fund (IMF) had concluded that 'the
top 20% of the households in India get six times more benefits from fuel subsidies
than the poorest 20%' . This is because the richer households tend to consume a lot
more fuel based products as compared to the poor. This makes sense right? The rich
drive more cars, most of which are large SUVs or sedans. These are powered by diesel.
And the fuel being subsidized is mostly diesel and kerosene.

In fact the same paper of IMF states that in per capita terms the top 10% of the
households spend 20 times as much on fuel as compared to the poorest 10%. And we
subsidize fuel for these bottom 10%. This makes no sense to us at least. In essence
the fuel subsidy is helping the rich save more. While the benefits to the poor are
limited. And think of the burden that these subsidies are placing on our fiscal deficit.
As the deficit has worsened over the years, the problems caused in our economy are
something we are seeing in the bad macro numbers.
CONS
Fiscal deficit
When a government's total expenditures exceed the revenue that it generates
(excluding money from borrowings),it is termed fiscal deficit.


Subsidies are a major contributor to the fiscal deficit.
CONS
Economic inefficiency
Because total surplus in a market is lower under a subsidy than in a free market, we
can conclude that subsidies create economic inefficiency, known as deadweight loss.
Economic inefficiency is created by a subsidy because it costs a government more to
enact a subsidy than the subsidy creates in additional benefits to consumers and
producers.

Critics often point to the economic distortions created by subsidies, especially
subsidies that are used to promote specific sectors or industries. Generally, such
subsidies tend to divert resources from more productive to less productive uses, thus
reducing economic efficiency.

Those who take a more benign view argue that subsidies can serve redistributive goals,
or can help to correct market failures. But, as the public-finance economist Ronald
Gerritse once warned, subsides defended on such grounds "may have externalities
that we did not bargain for." Indeed it is such second-order effects that have come
under attack by environmental economists in recent years.

CONS
The opportunity cost of subsidies
Economists refer to the value of an expenditure in its highest alternative use as its
"opportunity cost." The concept of opportunity cost is reasonably intuitive. At the
household level, if a person spends $100 on a night on the town, that $100 is no
longer available to buy necessities, like food. Similarly, if a government spends
$100,000 on a bridge that few people will use, that money is not available to be spent
on education, or health care, or any other government priority. Because of taxes and
other feedback mechanism in an economy, the analogy between the government and
a household is not perfect. But in the presence of a budget constraint, all spending
decisions, at the margin, imply trade-offs.
Consider a hydro-electric project that also provides water to irrigate adjacent
farmland. A cubic metre of water from its reservoir has a high value when it passes
through turbines and generates electricity, but also to a farmer growing thirsty crops.
Nevertheless, the incremental value of an additional cubic metre of water may well be
much higher when used to generate electricity than to irrigate the farmer's crops.
Policies - such as subsidies that allow the farmer to pump out the water from the
reservoir at a very low cost, or that artificially increase the profitability of farming - will
result in some of the water being diverted to its lower-value use. In that case, the
economy as a whole generates a smaller surplus.
CONS
Generation of black markets
Subsidies may lead to unintended or perverse economic effects. A price control may
lead to lower production and shortages and thus generate black markets resulting in
profits to operators in in such markets and economic rents to privileged people who
have access to the distribution of the good concerned at the controlled price.
CONS
Subsidies tend to get locked in society
Perverse subsidies are not tackled as robustly as they should. Principally this because
they become locked into society, causing bureaucratic roadblocks and institutional
inertia. When cuts are suggested many argue (most fervently by those entitled,
special interest groups and political lobbyists) that it will disrupt and harm the lives of
people who receive them, distort domestic competitiveness curbing trade
opportunities, and increase unemployment. Individual governments recognize this as a
prisoners dilemma - inasmuch that even if they wanted to adopt subsidy reform, by
acting unilaterally they fear only negative effects will ensue if others do not
follow. Furthermore, cutting subsidies, however perverse they may be, is considered a
vote-losing policy.
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