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Kathmandu Thursday April 26, 2001 Baishakh 13, 2058.
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Good
and bad subsidies
Your editorial, headed "Subsidies still
needed" on Saturday April 21, 2001, which followed front page reports on the issue of
the possible reintroduction of subsidies for shallow tube wells (STWs), stated that
‘subsidy’ should not be a dirty word at the ADB or anywhere else. I quite agree.
Indeed, ‘subsidy’ is not a dirty word in the ADB. As a multilateral development
bank dedicated to alleviating poverty in Asia, how could it be otherwise? For example, the
ADB fully recognizes and supports the subsidized public provision of vital social
services, such as the provision of basic education and primary health services. Water
supply and sanitation are other critical areas where the problems of market provision and
the presence of sizable positive externalities justify subsidies. In all of these areas,
however, levying some charges may still be necessary to ensure that beneficiaries do value
and conserve resources and make efficient use of these subsidized services and facilities.
Thus, even in the case of Melamchi, for which ADB is the lead donor, the need to ensure
that access to water remains affordable means that even after water tariffs are increased,
there will be an implicit subsidy equivalent to about 50 percent of the cost of bringing
Melamchi Water to the Kathmandu Valley.
But once we turn to subsidies in the more
directly productive sectors, then life becomes much more complex. First, if like Nepal, a
country faces severe fiscal constraints, the government clearly must prioritize
expenditure if it wishes to avoid a fiscal crisis and/or a situation where the resulting
lack of funds for subsidies limits the provision and hence access to the goods and
services being subsidized. Second, subsidies on productive goods and services encourage
their inefficient and wasteful use, since their prices do not reflect their scarcity
value. This is true whether we are talking about fertilizer, irrigation water, credit,
fuel or electricity. Third, the price and market distortions caused by subsidies on the
public provision of goods and services prevents the private sector coming in to supplement
the inadequate supplies from the public sector. Fourth, there is overwhelming evidence,
from all countries, that broad and untargeted subsidies are captured not by the poor but
by the relatively well-off and socially and politically well-connected members of the
community.
Regarding subsidies on the provision of STWs for
groundwater irrigation, all four of these problems were evident under the earlier subsidy
regime. Since the early 1990s, there had been a steady fall in the number of STW
installations due to a shortage of budgetary funds to meet the subsidy requirement. Also,
the very low utilization rate of the STWs shows that farmers benefiting from the subsidy
have not been making efficient use of their STWs, while the subsidy encouraged investment
in pump sets that were larger and more costly than necessary. At the same time, the
subsidy policy and the market distortions it created discouraged private sector
participation in the provision of STWs. Finally, poor and marginal farmers were being
bypassed by both the subsidy policy and the technology. Against this background it is not
surprising that HMG decided to move gradually towards a no subsidy policy. At the same
time, to help ensure that the poor have access to STW technology despite the absence of
subsidies, HMG has, with support from ADB and CIDA, launched the Community Groundwater
Irrigation Sector Project (CGISP). In this project the focus is on social mobilization and
the organization of small and marginal farmers into groups who together can obtain and
afford the credit necessary to invest in an STW. While no cash subsidy is involved, there
is a substantial implicit subsidy involved in social mobilization but one that is, unlike
the earlier cash subsidy on pump sets and construction costs, a highly targeted subsidy.
Significantly, the demand for STWs from the farmers groups under the CGISP remains very
strong.
That said, there is certainly some evidence that
the overall demand for STWs has fallen since the remaining subsidy on STWs was removed
last year, although HMG is still gathering information on this. But one has to ask,
‘Whose demand has fallen off?’ Is it the demand of relatively well off farmers
who are in any case not using their STWs efficiently? Is the reduction in demand due to
the final removal of subsidy or to the current general low prices for agricultural
commodities which clearly reduces the incentive to invest in farm improvements? Even if
subsidy removal is the reason, for the reported decline in the number STW installations,
given all the problems with the earlier subsidy regime, will the reintroduction of subsidy
really help to ensure a rapid and steady growth in number of STWs and more importantly, in
agricultural production and productivity expected. Equally, would it enable poor and
marginal farmers to benefit from STW technology. Finally, rapid changes in policy clearly
destroy the prospect of increased private sector involvement in the provision of STWs
which has been so crucial to the success of STWs elsewhere in the region, especially in
Bangladesh. In short, the situation is not as simple as you try to make out and requires
much more through analysis.
Your editorial also discusses the need for
subsidies to be used to ensure a more level playing field, equal opportunities and equal
prices for commodities throughout Nepal. Certainly, just as subsidies targeted at poor
groups can be justified, so can special assistance for particularly poor and remote areas,
as in the case of the subsidized distribution of food to remote mountain districts. But to
follow such a policy on a large scale is a recipe for economic disaster. Apart from
producing a fiscal crisis that would lead to a collapse in the provision of most public
services, it would support huge inefficiencies in the allocation and use of resources
since it implies investment in infrastructure, such as irrigation and roads, irrespective
of the costs and benefits involved. This would ultimately lead to slower economic growth,
lower savings and lower investment. And even so there would be no guarantee that the poor
would benefit. Rather as noted above, most likely it would be the better-off or
better-connected people in these areas who would benefit most. Thus, while on the surface
such a set of policies might seem fairer, the ultimate loser would be the poor areas that
we all agree should be the primary focus of Nepal’s development efforts.
Finally, I find it very surprising that you
should try to use the subsidy policies of the EU to bolster your argument in support of
subsidies. First, we have to remember that the EU member countries do not face the same
kind of fiscal constraint as Nepal and have only a relatively small proportion of their
populations engaged in agriculture. Even so, there is very little support these days in
Europe for the agriculture subsidy policies which result in unwanted and unsellable
surpluses, produced and stored at great cost to the European consumers. These subsidies
are a major cause of the EU’s budgetary difficulties and, in addition, harm the
prospects of agriculture exporting nations including many developing countries. Sadly, but
rather predictably given what I have said above, it is mainly the vested interest and
political power of the relatively small farming lobby in the EU which benefits from these
subsidies that is preventing a more rapid reform of these policies.
In summary, there are ‘good’ subsidies
and there are ‘bad’ subsidies. ADB has no problem with policies that embody
‘good’ subsidies that contribute effectively to poverty reduction, encourage
economic growth and are consistent with prudent fiscal management.
Richard Vokes
Resident Representative, ADB |
