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Saturday, June 5, 2010

The Social Impact of Subsidy

We know that expenditure on food, education, and healthcare are in fact, 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 the decisive one 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 standard of living of the poor and low income groups, the government implementing direct and indirect subsidies programs. For example, government subsidized essential food items like cooking oil, sugar and flour, healthcare, education, agriculture and fisheries, electricity, cooking gas, and highway toll.

For whom is the subsidy?
All subsidies are, in the final account, consumer subsidies. In fact, the effect, and also the purpose, of subsidies is either to make the prices of certain goods and/or services within the ability to pay off the final consumers, or to enable inefficient producers (i.e. high cost producers like paddy farmers) to continue in the market where the prevailing price is less than their costs. In both cases, it is the final consumer who benefits from the subsidy. However, consumers get the benefits directly in the first case and indirectly in the second one.

The redistribution effect of subsidies
It is widely accepted that the initial distribution of income needs to be adjusted, for income equality reasons, in almost all economies of the world. This is usually done through income redistribution and subsidies programs. Needless to say, what is meant here is redistribution in favor of the poor and disadvantaged groups who are usually eligible for subsidies. However, the redistribution effect is not the same for all types of subsidies. For example, while direct consumer subsidies (i.e., the cash or in-kind transfers to certain consumers, such 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 the beneficiaries as identified by the government. Then, the redistribution effect of indirect consumer subsidies (i.e., all forms of financial arrangements to avail certain consumer products at prices less than their unit costs, such as subsidy for paddy farmers) is usually shared between all consumers of the subsidized commodities regardless of whether they are eligible or non-eligible. Furthermore, indirect consumer subsidies might also be shared between the consumers, on the one hand, and some of the producers, on the other hand. Subsidy leakage within the production and distribution processes is usually the channel through which some producers appropriate a share in indirect consumer subsidies.

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 producer subsidies given that their purpose is to enable high cost (i.e. inefficient) producers of certain commodities to continue in the market. Although, the argument for producer subsidies might be accepted within the context of an important food sectors such as paddy sectors and fishery sectors, given that the government is decisive in limiting the subsidy to certain period only.

It is quite simple to prove that direct consumer subsidies have no impact on the functioning of the price system given that when governments decide to make these transfers, they only avail additional purchasing power to targeted eligible persons and groups to enable them to buy basic commodities at the prevailing market prices. By contrast, indirect consumer subsidies 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 (e.g. the consumers from Singapore and Thailand buying subsidized food items such as cooking oil, sugar and flour from Malaysia). What matters in this context is the efficiency of the consumer subsidy in itself, i.e. its efficiency as a tool targeting low-income and disadvantaged groups of the population.

The food subsidy continued to increase gradually in the early seventies; but 2010 witnessed the first big jump in this subsidy. It is expected that Malaysia will spend some RM21 billion on direct subsidies. This was mainly due to the increase in international prices, especially of flour and sugar, on the one hand, and the government policy of keeping the prices of basic food items unchanged, on the other hand.

How successful is the food subsidy policy?
Three criteria are used to assess how successful is the subsidy system in targeting the low-income and the poor in Malaysia. Those criteria are: how necessary are the subsidized commodities as consumer goods, (since subsidy should be directed to necessary commodities); how important are these commodities in the 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. The four subsidized food commodities belong to the basic food items in Malaysia as elsewhere. In Malaysia, the four subsidized food commodities (flour, rice, sugar, and cooking oil) are present in the consumption patterns of almost all socioeconomic groups. Several studies based on the Household Income and Expenditure Surveys for different years and applying different expenditure elasticity functions, show that these four food items are considered necessary commodities for different socioeconomic groups whether in rural or urban Malaysia. At the same time, the same surveys show that the four subsidized food items are relatively more important for the lower-expenditure brackets than for the higher ones.

Why Government want to study issues of Subsidy?
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 RM47 billion in 2009. This was due to the fact that government expenditure, including subsidies, has been escalating, whereas government revenue has not kept pace as our economy (Idris Jala, The Sun, Thursday, 03 June 2010). Consequently, the government has to borrow a lot of money to cover the shortfall. Malaysian government debt in 1997 was RM90 billion and has grown at a rate of 12% a year to reach a record of RM362 billion in 2009. In addition, as a proportion to GDP, Malaysia is one of the world’s highest subsidized countries with 4.7% of GDP compared to Indonesia 2.7%, Philippines 0.2%, and Organization for Economic Co-operation and Development (OECD) countries at 1.5% on average.


Anonymous said...


Subsidy is a tool to ensure social equality and the poorer cousins of the rich are able to sustain and live a respectale life.

A good example of a country which has this culture beside Malaysia is France in the 1980s when Mitterand was the president of the country and he introduced the social net. 30 years later, the present France government has to pay the impact as the debt of the country increase.

Likewise recently we were told that if the current rate of subsidy do not stop, we will have a the problem like Greece soon and frankly alot of us went into denial but the sad fact is that this can be true.

Subsidy cannot be stop in this country but the method of how this is implemented has to be review.

Certain subsidy can be reduced or remove, example petrol subsidy. I believe when someone able to drive a 2.0 litre car for example, which cost is >100k RM per unit, i think these group of people should afford the high petrol cost.

Food subsidy should be control has a quota per family with mechanism put into it.Example cheaper rice or sugar can only be purchased from appointed outlet which has the management tool to manage such control while other retails has to go for higher pricing.

The cost of subsidy is extremely high and some of the monies can be better use to develop the country social economic status and in the long run increase the net income of the population and in the longer run subsidy can be totally withdrawn.

Subsidy is a temporary tool to ensure social net are adequate but not a long term solution and like any businesses, our government may go bust later as the net income are less then the total expenditure and if we imagine if in the next 20 years, our income from petroleum when reduced, due to lack of oil fields, what will happen?



Ivy Ng Suat Leng
MBA Melaka

Anonymous said...

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