We know that the expenditure on food, education, and healthcare are the three major social spending for enhancing human development. It is quite simple to show that these three elements are interrelated, but food seems to be dominant in this interrelationship. Indeed, good and well balanced food is a prerequisite for good health and better educational achievements. Accordingly, policies and measures that prove to be efficient in providing people, particularly the poor and vulnerable groups, with adequate and well-balanced food are welcomed from the viewpoint of human development. To improve the standard of living of the poor and low income groups, the government implements direct and indirect subsidy programs. For example, in Malaysia, the essential food items like cooking oil, sugar and flour, healthcare, education, agriculture and fisheries, electricity, cooking gas, and the highway toll are being subsidize by the government.
For whom is the subsidy?
In general all subsidies benefit the consumers. By and large, the purpose, of providing subsidies is either to make the prices of certain goods and/or services fall within the ability of consumers to pay, or to enable inefficient producers (i.e. high cost producers like rice farmers) to continue producing rice even when the prevailing market price is less than their costs. In this case, it is the final consumers also getting benefits from the subsidy. The consumers get the benefits by buying rice a lower price because of the subsidy.
The redistribution effect of subsidies
It is widely accepted in most economies around the world that the initial distribution of income needs to be adjusted, for the purpose of ensuring equitable distribution. This is usually done through various income redistribution mechanism which includes the direct cash transfer and subsidy programs. However it is important to note that the redistribution effect is not the same for direct cash transfer and subsidies. For example, while direct cash transfer as cash rebate of RM126 a year for car owners less than 1,000cc and RM54 a year for owners of motorcycles less than 250cc represent, in their totality, a redistribution of income in favor of certain targeted beneficiaries as identified by the government. On the other hand, the redistribution effect of the indirect consumer subsidies such as fuel subsidy is usually shared by all consumers of the subsidized commodities regardless of whether they are eligible or not-eligible. Fuel subsidies are a costly approach to protecting the poor due to substantial benefit leakage to higher income groups. For example, in the case of the fuel subsidy in Malaysia, the benefits are enjoyed disproportionately by high-income households, who consume a larger amount of fuel as they are more likely to own multiple vehicles with larger engine capacities. It is estimated that the bottom 20% of households in Malaysia only receive 4% of the fuel subsidy, while the richest 20% receive 42% of the subsidy1. Therefore, subsidies received by all societies regardless of their socioeconomic status are not a suitable one to be implemented.
Subsidies and economic efficiency
The relation between subsidies and efficiency is a controversial issue. From the economic viewpoint, it is usually argued that whenever subsidies interfere with the functioning of the market price mechanism, they lead to inefficient allocation and waste of resources. Indeed, this argument holds true for the subsidies to producer, considering the purpose of this policy is to enable high cost or inefficient producers of certain commodities to continue their economics activities. Although, the argument for producer subsidies might be accepted within the context of ensuring the sustainability of the important food sector, such as rice and fishery sectors, this policy should not be a permanent policy as this would bring about negative impact in the long run.
It is quite simple to prove that direct cash transfer have no impact on the functioning of the price system given that when the government decide to make these transfers, it only provides additional purchasing power of targeted eligible individual or group to enable them to buy basic commodities at the prevailing market prices. By contrast, indirect consumer subsidies such as subsidies on food items such as cooking oil, sugar and flour may lead to inefficiency because of the price distortion associated with such subsidies. This argument is valid when low priced goods are irrationally consumed and used for purposes other than those targeted in the government subsidy scheme. For example, the consumers from Singapore and Thailand buying these subsidized food items (cooking oil, sugar and flour) from Malaysia. Similarly, industrial sectors such as cordial beverage producers and bread producers also benefit from sugar and flour subsidies. What matters in this context is the efficiency of the consumer subsidy in itself, i.e. its efficiency as a tool of targeting low-income and disadvantaged groups of the population.
In general Malaysia is among the major countries that implementing subsidies policy to help reduce the cost of living of its people. In year 2013, government expenditure on subsidies equated to nearly 16 per cent of its operating expenditure, which is about 5.1 per cent of the total Gross Domestic Product2. This figure also does not account for the cost of implicit subsidies in terms of revenue foregone by public enterprises and the Government under price controls, such as the provision of natural gas below market prices to electricity generation companies to enable lower electricity tariffs. Ultimately, this reduces the funds available for the Government to spend on other key development areas that would significantly benefit the nation over the long term, such as infrastructure, health, education and social protection3. The authorities took vital steps to shore up fiscal management and policy in the second half of 2013, and signaled their commitment to secure medium-term fiscal targets in the 2014 Budget. Fiscal management and institutions were strengthened substantially by the establishment of a high-level Fiscal Policy Control. In addition, subsidies on fuel, electricity, and sugar are being rationalized, and a GST has been introduced in April 20154.
How successful is the food subsidy policy?
Three criteria are used to assess how successful is the subsidy system in targeting the low-income people in Malaysia. Those criteria are: the level of necessity of the subsidized commodities as consumer goods(since subsidy should be directed to necessary commodities); the relative share of the subsidized commodities to the overall budget of the low income groups, since the higher is the relative share of the household budget spent on those commodities, the more the poor are benefiting from the subsidy; and how efficient is the subsidy system in reaching the low-income people in Malaysia. In Malaysia, the four subsidized food commodities (flour, rice, sugar, and cooking oil) are present in the consumption patterns of almost all socioeconomic groups. Based on several studies conducted using the Household, Income and Expenditure Surveys for different years, the findings showed that these four food items are considered necessary commodities regardless of the socioeconomic groups and location (i.e. either rural or urban). According to the most recent Households Expenditure and Income Survey, households in rural areas spent around 30 per cent of their expenditure on food, while this percentage falls to about 20 per cent in urban areas5. In addition, the same surveys showed that the four subsidized food items are relatively more important for the lower income group as compared to the higher one.
Based on the statistics, for the last 10 years, Malaysia has been running a fiscal deficit, which has been growing progressively from RM5 billion in 1998, to a record high of RM43.1 billion in 20176. The escalating government expenditures including subsidies which do not keep pace with the growth of government’s revenue explains this phenomenon. The dependency of the Malaysian economy on tax revenue from petroleum production and petroleum royalty affects the ability of the government to spend when the revenue from Petroleum declined from RM66.27 billion in 2014 to only RM43.87 billion in 2015. As to counter the problem of declining revenue from petroleum, the government has however introduced GST. Through GST the government was able to collect around RM34.64 billion as oppose to sales tax for the year 2014 which was only RM17.22 billion.
A subsidy serves as an important tool to ensure social equality and help the poor to have the chance to live a respectable life. Nonetheless, too much allocation for subsidies may give an adverse impact to the economy especially when the deficit is getting larger. As mentioned earlier, subsidy will create price distortion and thus lead to inefficiency. In essence, balancing between efficiency and equity objective is rather tricky and proper implementation and monitoring must be put in place as to ensure that the cost of subsidy can be minimized.
As Malaysia embarked on the initiative to gradually reduce the subsidy through the subsidy rationalization policy, it is important for the government to properly evaluate the impact of such move. While subsidy rationalization may improve the government’s balance sheet, the impact to the poor and middle income group may be substantial. In summary, it is agreeable that subsidy should not be a long term solution and selective subsidy that targeting the poor should not be completely abolished but the improvement on its implementation need to be carried out.
1 Malaysia, Household Income and Basic Amenities Surveys (2012), Department of Statistics, Malaysia.
2 Malaysia, Economic Planning Unit (2016), the Malaysian Economy in Figures.
3International Monetary Fund (2013), Energy Subsidy Reform: Lessons and Implications. https://www.imf.org/en/Publications/Books/Issues/2016/12/31/Energy-Subsidy-Reform-Lessons-and-Implications-40410.
4 International Monetary Fund (IMF) (2014), Country Report No. 14/80.
5Fatimah, K., Masud, M. M., and Saifullah, M. K. (2017). Subsidy rationalization for general purpose flour: market and economics implication. Journal of Asian Finance, Economics and Business, 4(2), 25-36.6Malaysia, 2017 Budget, Ministry of Finance.