Sabsidi Tambah Permintaan Menjadikan Inflasi Lebih Teruk

(Baru aku perasan sebab kenapa inflasi di Malaysia lebih tinggi dari di Singapura. Sabsidi menambah permintaan sebab harga rendah. Kalau permintaan tinggi, harga pasti naik sebab pembuatan berkurangan. Pembuatan berkurang sebab pembuat tidak boleh saing harga sabsidi. Lagi senang dan murah beli barang sabsidi.)

Misconceptions of Subsidies

I notice that there are so many misconceptions on subsidies. When they are supported by Nobel prize winners, we should know that this is an extremely serious issue.

There are 2 basic misconceptions. One is that any grant from the government is a subsidy. Although true in some aspects but should another word "subsidy" be invented if it has exactly the same meaning as grants. Yes, subsidies are forms of grants but not all grants are subsidies, for example universal basic income. Subsidies are only partial payments but the effects of Subsidies increase with the percentage of Subsidies given.

Second, subsidies are specific to the targeted objectives, and not general, which is why universal basic income or usual unemployment benefits cannot be considered as subsidies.

The reason why we need to separate subsidies from universal basic income is that subsidies have bad effects on the economy of the nation. Universal basic income has none of those bad effects.

To give an example is the wage subsidy proposed by Phelps, a Nobel prize winner. https://en.m.wikipedia.org/wiki/Wage_subsidy

"A wage subsidy is a payment to workers by the state, made either directly or through their employers. Its purposes are to redistribute income and to obviate the welfare trap attributed to other forms of relief, thereby reducing unemployment. It is most naturally implemented as a modification to the income tax system.

The wage subsidy was proposed by A. C. Pigou in his 1933 book The Theory of Unemployment.^[1] It was subsequently advocated by American economists Edmund Phelps^[2] and Scott Sumner,^[3] by American policy advisor Oren Cass,^[4] and by British economist Tony Atkinson under the name of participation income.^[5] "

^{Any subsidy is bad and should be balanced against the objective of the subsidy. The aim of the wage subsidy is to reduce unemployment. Indeed it will reduce unemployment but it will lead to the reduction of the GDP of the nation as a whole. What is the point of reducing unemployment when the whole nation becomes poor as what had happened to all nations that spend heavily on subsidies instead of cash handouts? You cannot argue with facts.} 

^{Supporters of Subsidies, such as Phelps, argue that wage subsidies is superior to minimum wage enforcements. While minimum wage will certainly reduce employments but at least it will not enslave citizens by being paying below the poverty rate.}

^{Unemployment is caused by structural weaknesses of the nation. Subsidies do not remove these weaknesses but make the weaknesses worse by allowing inefficient employers to thrive. Let market forces determine the most efficient employers by not giving out any subsidy to them. There will be a lot of unemployments in the short term but residents must not be made to suffer or else social ills will incur costs to the nation.}

^{By supporting residents so that they are above the poverty level, using cash handouts, their economic activities will stimulate the economy while allowing them to develop themselves to face the challenges ahead. Structural weaknesses in the nation can only be resolved by productive workers. Workers can only improve their productivity if they can improve themselves by being paid above the minimum salary.}

^{Universal basic income(UBI) is more fair because every citizen is given cash assistance regardless of status. However, it reduces the amount given to the poorest so that they may not escape poverty. UBI reduces the incentive to not look for employment or business venture to the minimum if no effort were made to identify needs.}

^{An alternative is to provide minimum income to those who are unemployed provided they can provide evidences that they have tried their best to look for work as is done in Belgium. However, this method is not foolproof because it creates bureaucracy that cost money and cause delays. It should be backed up by unconditional survival assistance such as free meals and accommodation.}

Subsidies vs Grants

I notice that many dictionaries change the meaning of subsidies into just grants or allowances.

https://www.merriam-webster.com/dictionary/subsidy#:~:text=Definition%20of%20subsidy,by%20one%20state%20to%20another

subsidy

Definition of subsidy

: a grant or gift of money: such as

 : a sum of money formerly granted by the British Parliament to the crown and raised by special taxation

b : money granted by one state to another

c : a grant by a government to a private person or company to assist an enterprise deemed advantageous to the public

Wikipedia gives a more thorough definition but they are too long.

https://en.m.wikipedia.org/wiki/Subsidy

There 2 aspects of subsidies people should take note of because their economic impacts are completely different.

Firstly, subsidies are only partial payments of any requirement. They are not supposed to pay all expenses. If the subsidies cover 100% of the total costs, these assistances can be considered as just gifts, grants or allowances. It is true that subsidies are forms of gifts but if they are only partial or considered as partial, only then can it be called subsidies. Whether partial or complete is subject to judgement.

Secondly, subsidies are specific to the purposes that the payments are for. The more choices are given to the recipients of the payment, the more the payment behaves like cash payments. For example the food stamps issued in the USA. They behave more like cash handouts. Because the cash handouts have conditions attach to them, the economic impacts of subsidies apply to all the conditions.

The economic impacts of subsidies are:

1. favour the rich or those with more means.

It applies even to the food stamps. Poor people will need more things than just food so will end up selling the food stamps or the food themselves, at a huge discount.

2. more wastage.

Prices are low so demand increases even to the point of buying more than what is required.

3. discourage self-production.

The price of goods will drop below the production cost so it is not profitable to produce these subsidised item for self-use.

What are the pros and cons of subsidies?

https://www.quora.com/What-are-the-pros-and-cons-of-subsidies/answer/Othman-Ahmad?ch=15&oid=369916019&share=5ea95f1b&srid=Yr6w&target_type=answer

What are the pros and cons of subsidies?

There are no pros or advantages for subsidies. The apparent pros are illusions only. There are only cons.

The overall impact of subsidies is to make the rich richer and the poor poorer. It may be a pro for the rich but it is not good for the rich overall. Compare the rich in Malaysia versus the rich in Singapore. These are ideal countries to compare because they used to be the same country. The wealth of the rich in Malaysia is still lower than in Singapore. Also, Singapore is not a true developed nation because its income gap is still very high, so you can see the effects of subsidies for both countries.

Let us start with the cons:

1. subsidies favour the rich much more than the poor because the rich consume more. It is true for all forms of subsidies, including education and health;
2. subsidies encourage waste. Education and health may appear to be exceptions because excessive education and health are beneficial but these extra benefits are not certain and not really essentials, so can be considered as wastage;
3. subsidies stiffle production because it is cheaper to consume than produce;
4. subsidies favour non citizens more. It may appear to allow more exports but these exports are not beneficial to the citizens and therefore a wastage of the nation's resources. Subsidies therefore allow the nation to be exploited by outsiders;
5. subsidies lower salaries of workers because their living expenses are lower so workers are satisfied with lower salaries;
6. lower salaries cause brain drain because skilled and valuable workers are enticed by nations with higher salaries despite the higher cost of living for those countries with lesser subsidies;
7. lower salaries and lower prices for export goods and other products reduce gross national product making the nation poorer;
8. lower national production and lower wealth reduces the strength of the nation and therefore exposes the nation to military attacks;
9. the larger number of poor people increases social ills and diseases that will impact on the quality of life of the rich as well. For example, the rich will be targets for crimes;
10. lower salaries also encourage more corruption and thus reduces securities of the nation even more;
11. subsidies create shortages as demand increases because of the artificially lowered price. The lack of petrol in Sri Lanka in 2022 is not due to unwillingness of petrol suppliers to supply petrol, but because the government of Sri Lanka cannot supply enough subsidised petrol to all the demand. If there is no subsidy for petrol, people can get petrol but at market prices, but there is no possibility of any shortage of any item, as long as the customers have the money to pay for petrol. Customers who cannot afford the offer prices cannot be considered as true demand any more , but more of a charity;
12. subsidies allow the rich to buy the most subsidised items and export them for even more gains. After all, the rich have been exporting their items at subsidised rate anyway.
13. Subsidies only reduce half of inflation because the subsidy money goes to the producers also: http://www.sanandres.esc.edu.ar/secondary/economics%20packs/microeconomics/page_22.htm . It is therefore better to just give cash to consumers.

The apparent pros of subsidies:

1. subsidies lower the cost of living for those who have some work. If you have no income at all, you will get zero assistance from subsidies. In reality, despite various efforts, many citizens still cannot get jobs, so face acute poverty. The least suffering is that they get some assistance from the subsidies but not enough to lift them out of poverty. Most of the subsidy money goes to the rich who can afford to consume more and thus get more money from the subsidies;
2. rich become richer simply by exporting subsidised items at lower prices. This is only apparent because lower costs translate to lower revenues so the overall gain cannot match those in nations that have taxes instead of subsidies. Because the poor becomes poorer, with many in abject and desperate poverty, crimes and corruptions are rampant and these cost money to overcome eating into export revenue;
3. the subsidies enhance the targeted items. Wage subsidies encourage more jobs to be created. Educational subsidies create more education for people. Subsidies on essential items allow more people to buy essentials. This appear to be a pro but actually a con. People are steered into wasting these good things. More of good things can be harmful;
4. subsidies reduce inflation. In the short term, yes. In the long term, subsidies create more inflation as shown by Malaysia in comparison with Singapore. 
5.  Real inflation is caused by problems in production so nothing much can be done about it except to increase production. False inflation is caused by over production of money. Subsidies cause the overproduction of money because of its inefficiencies, and even cause the lower production of items, making real inflation worse instead of solving it in the long term.
6. Subsidies increases demand for the subsidised item because prices are lower. Increasing demand causes prices to rise. That is why subsidies will increase prices unless there is price control and supply is sufficient. Making supply sufficient is difficult because subsidies make producing less profitable because they have to compete with subsidised items.
7. In some cases, deflation is bad and inflation is good because inflation stimulates the economy. Buy property and then sell later at higher prices. Industries also use buildings as collaterals in loans to expand businesses;
8. subsidies allow experts to control the economy by manipulating demand. In most cases human experts cannot match the speed and effectiveness of market forces. However, there may be cases where expert intervention is required for certain objectives such as during wars, national competition for survival or prestige, e.g. race to the moon. Race to MARS and reduction of global warming.

Deflation is good

 https://www.investopedia.com/articles/personal-finance/030915/why-deflation-bad-economy.asp

Why Is Deflation Bad for the Economy?

By

The Investopedia Team

Updated June 02, 2022

Reviewed by

Somer Anderson

Fact checked by

Amanda Bellucco-Chatham

Deflation is a fall in the overall level of prices in an economy and an increase in the purchasing power of the currency. It can be driven by an increase in productivity and the abundance of goods and services, by a decrease in total or aggregate demand, or by a decrease in the supply of money and credit. 

Key Takeaways

• Deflation is when the general price levels in a country are falling—as opposed to inflation when prices rise.
• Deflation can be caused by an increase in productivity, a decrease in overall demand, or a decrease in the volume of credit in the economy.
• Most of the time, deflation is unambiguously a positive trend for the economy, but it can also under certain conditions occur along with a contraction in the economy. 
• In an economy dominated by debt-fueled asset price bubbles, deflation can lead to a temporary financial crisis and a period of liquidation of speculative investment known as debt deflation.

Understanding Deflation

Changes in consumer prices can be observed in economic statistics compiled in most nations by comparing changes in a basket of diverse goods and products to an index. In the U.S. the Consumer Price Index (CPI) is the most commonly referenced index for evaluating inflation rates. When the index in one period is lower than in the previous period, the general level of prices has declined, indicating that the economy is experiencing deflation.

This general decrease in prices is a good thing because it gives consumers greater purchasing power. To some degree, moderate drops in certain products, such as food or energy, even have some positive effect on increasing nominal consumer spending. Beyond these basic staples, a general, persistent fall in all prices not only allows people to consume more but can promote economic growth and stability by enhancing the function of money as a store of value and encouraging real saving. 

However, under certain circumstances, rapid deflation can be associated with a short-term contraction of economic activity. In general, this can occur when an economy is heavily laden with debt and dependent on the continuous expansion of the supply of credit to inflate asset prices by financing speculative investment, and subsequently when the volume of credit contracts, asset prices fall, and speculative over-investments are liquidated.

This process is sometimes known as debt deflation. Otherwise, deflation is normally a positive feature of a healthy, growing economy that reflects technological progress, increasing abundance, and rising standards of living.

Deflation: Causes and Effects

If, as the common saying goes, inflation is the result of too much money chasing not enough goods in the economy, then conversely deflation can be understood as a growing supply of goods and services being chased by a constant or slower-growing supply of money.

This means that deflation can be brought about either by an increase in the supply of goods and services or by a lack of increase (or decrease) in the supply of money and credit. In either case, if prices can adjust downward, then this results in a generally falling price level.  

An increase in the supply of goods and services in an economy typically results from technological progress, the discovery of new resources, or an increase in productivity.

Consumer’s purchasing power increases over time and their living standards rise as the increasing value of their wages and business incomes allow them to purchase, use, and consume more and better quality goods and services. This is an unambiguously positive process for the economy and society as a whole.

The U.S. government targets an annual inflation rate of 2%.

At times, some economists have expressed fears that falling prices would paradoxically reduce consumption by inducing consumers to hold out or delay purchases in order to pay lower prices in the future; however, there is little evidence that this actually occurs during normal periods of economic growth accompanied by falling prices due to improvements in productivity, technology, or resource availability. 

Moreover, the vast majority of consumption is made up of goods and services that are not easily deferred to the future even if consumers wanted to, such as food, clothing, housing services, transportation, and healthcare.

Beyond these basic needs, even for luxury and discretionary spending consumers would only choose to reduce current spending if they expect the rate of decrease in prices to outweigh their natural time preference for present consumption over future consumption.

The one type of consumer spending that would suffer from falling prices would be items that are routinely financed by taking on large debts since the real value of fixed debt will increase over time as prices fall.  

Debt, Speculation, and Debt Deflation

Under specific conditions, deflation can also occur in and after periods of economic crisis. 

In a highly financialized economy, where a central bank, another monetary authority, or the banking system, in general, engages in the continuous expansion of the supply of money and credit in the economy, the reliance on newly created credit to finance business operations, consumer spending, and financial speculation, results in ongoing inflation in commodity prices, rents, wages, consumer prices, and asset prices. 

More and more investment activity starts to take the form of speculation on the price appreciation of financial and other assets, rather than profit and dividend payments on fundamentally sound economic activity.

Business activities tend likewise to depend more and more on the circulation and turnover of newly created credit rather than real savings to finance ongoing operations. Consumers also come to finance more and more of their spending by borrowing heavily rather than self-financing out of ongoing savings. 

Gold is usually considered to be a good hedge against inflation but it can also be a good hedge against deflation.

To compound the problem, this inflationary process usually involves the suppression of market interest rates, which distorts decisions about the type and time horizon of business investment projects themselves, beyond simply how they are financed. Conditions become ripe for debt deflation to set in at the first sign of trouble. 

At that point, either a real economic shock or a correction in market interest rates can put pressure on heavily indebted businesses, consumers, and investment speculators. Some of them have trouble revolving, refinancing, or making their payments on various debt obligations such as business loans, mortgages, car loans, student loans, and credit cards.

The resulting delinquencies and defaults lead to debt liquidation and write-downs of bad debts by lenders, which start to eat away some of the accumulated supply of circulating credit in the economy. 

Banks' balance sheets become shakier, and depositors may seek to withdraw their funds as cash in case the bank fails. A bank run may ensue, whereby banks have over extended loans and liabilities against inadequate cash reserves and the bank can no longer meet its own obligations. Financial institutions begin to collapse, removing liquidity that indebted borrowers have become even more desperate for.

This reduction in the supply of money and credit then reduces the ability of consumers, businesses, and speculative investors to continue to borrow and bid up asset and consumer goods prices, so that prices may stop rising or even begin to fall.

Falling prices put even more pressure on indebted businesses, consumers, and investors because the nominal value of their debts remains fixed as the corresponding nominal value of their revenues, incomes, and collateral falls through price deflation. And at that point, the cycle of debt and price deflation feeds back on itself. 

In the near term this process of debt deflation involves a wave of business failures, personal bankruptcies, and increasing unemployment. The economy experiences a recession and economic output slows as debt-financed consumption and investment drop.

What Is Deflation in an Economy?

Deflation is when the prices of goods and services decrease across the entire economy, increasing the purchasing power of consumers. It is the opposite of inflation and can be considered bad for a nation as it can signal a downturn in an economy, leading to a recession or depression. Deflation can also be brought about by positive factors, such as improvements in technology.

Is Deflation Worse Than Inflation?

It depends. Deflation can be worse than inflation if it is brought about through negative factors, such as a lack of demand or a decrease in efficiency throughout the markets. Deflation can be better than inflation if it is brought about by positive factors, such as improvements in technology that make the costs of goods and services cheaper.

How Do You Make Money During Deflation?

To hedge against deflation, investors can purchase investment-grade bonds, consumer-staple stocks, dividend stocks, and keep their money in cash. A diversified portfolio can protect against a variety of economic scenarios.

The Bottom Line

A little bit of deflation is a product of, and good for, economic growth. But, in the case of an economy-wide, central bank fueled debt bubble followed by debt deflation when the bubble bursts, rapidly falling prices can go hand-in-hand with a financial crisis and recession.

Thankfully, the period of debt deflation and recession that follows is temporary and can be avoided entirely if the perennial temptation to inflate the supply of money and credit in the first place can be resisted. 

All in all, it is not deflation, but the inflationary period that then leads to debt deflation that is dangerous for a country's economy. Perhaps, unfortunately, consistent and repeated inflation of this kind of debt bubble by central banks has become the norm over the past century or so.

At the end of the day this means that while these policies persist, deflation will continue to be associated with the damage they cause to the economy.

 Below is an article in Washington Post. The author believes that some subsidies such as educational and health are beneficial, but  the quran disallow any subsidy so we should stay away from any subsidy. Instead, the government just give cash handouts which is demanded by the quran.

https://www.washingtonpost.com/news/monkey-cage/wp/2015/07/16/state-subsidies-take-from-the-poor-to-give-to-the-rich/

State subsidies take from the poor to give to the rich

Analysis by M. Steven Fish

and 

Neil A. Abrams

 

July 16, 2015 at 8:09 a.m. EDT

­­

(AP)

What’s the worst thing a government can spend its people’s money on? Progressives might say the military; conservatives might point to entitlement programs. But outlays in both of these areas do at least pump money into the economy and create jobs, and most people would agree that some spending on each is justifiable.

In one area, however, government spending almost always redistributes income from the poor to the rich, encourages inefficiency and fuels corruption: state subsides.

By state subsidies, we mean government assistance to boost producers’ incomes above or reduce consumers’ expenditures below what they would be in a competitive marketplace. State subsidies might seem an unlikely candidate for this charge. After all, they are often viewed as tools of mercy. According to their advocates, governments use them to make goods and services more affordable to the poor, assist aspiring entrepreneurs or to save jobs in enterprises that can’t endure the pressures of the market without assistance.

But scratch the surface of most state subsidies and you will find much more flowing into the bank accounts of the well-heeled than into the pockets of the poor. 

New research shows that state subsidies are the opposite of Robin Hood 

A wave of recent political science publications, including our research on post-communist Europe (see also here and here), underscores this point. Far from aiding the downtrodden, state subsidies have enriched and empowered corrupt capitalists who have undermined the establishment of honest state administrations and judicial systems.

In Ukraine, oligarchs who built their fortunes on state budgetary transfers, crony-engineered loans, and selective tax breaks continue to dominate the business world today. State subsidies like these ended up bankrupting the country and help explain its ineffective response to a light-handed military intervention by Russia.

The most egregious state subsidies of all take place in the gas market. Fixed gas prices do benefit Ukrainian households — but in the most inefficient way imaginable. The real beneficiaries are shadowy intermediaries that have made billions of dollars buying gas at cheap state prices and reselling it at huge markups to industrial consumers and the state gas company.

In 2012 alone, the state’s energy subsidies amounted to 7 percent of Ukraine’s entire gross domestic product — the same amount that Ukraine spent on defense and health care combined. An estimated 40 percent of the energy subsidies were stolen by individuals linked to then-President Viktor Yanukovych. Eliminating the state subsidy for the oligarchs would generate more than enough savings to assist gas purchases by the poor.

The post-communist region is replete with governments that have chosen to prop up insolvent state companies with subsidies rather than shut them down, thereby allowing their managers to get rich by systematically ripping off the companies’ assets.

 There is perhaps a single exception to this pattern in the region, and that is Estonia. Shortly after independence in 1991, the Estonian government virtually eliminated subsidies. It rapidly and consistently imposed hard budget constraints on firms. It reined in state assistance to unprofitable companies, shuttered insolvent state banks, and introduced effective bankruptcy and currency regimes. The beneficiaries of the state subsidies cried foul, but the government stayed the course. The result was a level economic playing field in which real entrepreneurs rather than corrupt political capitalists could thrive. The policies marginalized predatory business interests opposed to the rule of law and enabled Estonian leaders to build a state administration that stands out in the post-communist region for its probity and efficiency.

The perverse effects of state subsidies are hardly limited to post-communist countries. In Nigeria, a fuel subsidy program touted as a way of helping the poor primarily benefits corrupt state officials and their cronies. The state mandates a fixed retail price for petrol of pennies on the dollar and then compensates wholesalers for the difference between the low retail price and the market price they pay to import the fuel. In reality, the government-connected wholesalers overstate their imports by billions of dollars, thereby stealing off with the equivalent amount in subsidies.

In India, grain producers are required to sell to government middlemen at above-market prices. The policy’s original intent was to aid poor farmers, but its main beneficiaries are the middlemen themselves and well-to-do agricultural interests from rich provinces such as Punjab and Haryana. The policy inflates grain prices, thereby abusing the poor majority that spends most of its income on food. Funds for the state subsidies could be spent instead on roads that would help farmers get their goods to market. But investment in infrastructure lags. As a result, one-third of all fruits and vegetables in India rot before they reach consumers.

U.S. cotton subsidies have much in common with India’s grain subsidies, except that they generate disastrous global effects on top of their domestic consequences. U.S. taxpayers shell out $3 billion to $4 billion per year to finance the government’s program to keep a few thousand big cotton farmers rich. The policies depress world cotton prices and reduce the incomes of millions of small cotton farmers in some of the world’s poorest countries, including Niger, Burkina Faso, Mali, Uzbekistan and Turkmenistan. 

So why are state subsidies popular? 

State subsidies tend to be popular for three reasons. First, they usually include a bone for the poor. In Ukraine, the fuel subsidies reduce prices for consumers. In India, the grain-buying program raises the selling price that smaller farmers fetch. So while state subsidies are terribly inefficient and unfair, the little guy tends to feel he’s getting something, even if it’s a pittance.

Second, the government officials and well-endowed private interests who are the biggest beneficiaries have political clout. They use their influence over the government and media to trumpet the supposed benefits of state subsides for the masses.

Third, opinion leaders in academia and the media provide intellectual cover for state subsidies. Well-meaning but poorly informed, some social scientists and public commentators in both the West and developing countries assume that anything that the IMF endorses, including reducing state subsidies, amounts to an attack on the underprivileged (see here, here, here, and here).

Add to this the problem that those who benefit from state subsidies are normally more motivated to keep them than their victims are to scrap them and you have the makings of a grand injustice that is very hard to eradicate. State subsidies’ main beneficiaries are concentrated, well-organized, and well-informed, while the losers are diffuse, numerous, and often unaware of their losses. How often do we see big public demonstrations against state subsidies?

Some subsidies do good.  

Well-designed, need-based subsidies for poverty-alleviation can indeed be beneficial. Likewise, states justifiably subsidize education, health care and infrastructure since these are public goods that market forces alone cannot generate in sufficient amounts. But market forces are adequate to ensure the production and distribution of fuel and wheat. If some consumers are too poor to afford the goods, the state could provide targeted transfers to help them pay.

But state subsidies that go beyond providing poverty relief and public goods have a reverse Robin Hood effect. Fuel subsidies, in particular, also tend to generate shortages, kindle corruption and encourage patterns of consumption that degrade the environment. 

Steven Fish is a professor of political science at the University of California at Berkeley. Neil A. Abrams received his doctorate in political science from the University of California at Berkeley. He is completing a book on corruption in Ukraine.

 

Subsidies Encourage Waste

April 17, 2014

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• This page in:
• English
• Polski

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Xavier Devictor Rzeczpospolita

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The recent discussions about reforms in Ukraine have highlighted the detrimental impact energy subsidies can have from a social, fiscal, environmental, and governance perspective.

Poland has had its own experience with artificially set prices, which do not reflect any economic reality, and with widespread subsidies which end up fueling corruption.  Poles know firsthand about the deleterious effect of such policies.  Yet, in a number of countries, from Eastern Europe to the Middle East, from Latin America to East Asia, they remain in force.

In many instances, energy subsidies are probably well intentioned – it is about making it possible for the poorest to afford the gas or the fuel they need for their daily lives.  On the face of it, removing such subsidies may appear as unfair and heartless, a move that would further aggravate the situation of those who are already struggling.

Yet, this is one of those situations where well-intentioned policies can have a very negative impact.

Indeed, in many instances, energy subsidies do not mainly benefit the poor, not even the lower middle class.  Time and again, detailed analysis of “who gets what” reveals that the well-off are those who gain the most: since they tend to have larger homes to heat and more powerful cars, they use more energy...  What was designed as a scheme to protect the poor ends up being a transfer of public resources to the wealthier part of society.

Furthermore, subsidies encourage waste.  Subsidized energy is relatively cheap, and hence wasting it is cheap.  Countries with large energy subsidies tend to have a poor track record on conservation and energy efficiency.  And the numbers are huge.  For example, the energy wasted in the countries of the former socialist block (that is, the amounts that could be saved if energy systems were as efficient as in OECD) is equal to… the entire consumption of Latin America.  Less subsidies, and hence higher prices, would no doubt encourage a more efficient use.

Energy subsidies also often drain public resources.  Instead of investing in the future – of building schools, improving infrastructure, or modernizing hospitals – countries spend to fuel their immediate consumption.  Subsidies also reduce the resources available for other social expenditures (including those which would have really benefited the poorest).  Considering that in many countries energy subsidies still amount to 5 to 10 percent of GDP, they often account for a large share of the fiscal deficit, and are a primary cause of public indebtedness.    

And finally, subsidies foster corruption.  If energy prices differ across the economy (for example, if households consumption is subsidized while industries are not), profiteers will take advantage of the opportunity to buy in one market and resell on the other (or to smuggle across the border)… and they will pocket the subsidy.  Considering the amounts at stake, this can become an avenue for rapid enrichment by a few profiteers at the expense of society: typically several percent of GDP end up in such pockets, year after year !

The solution – as the Poles know well for having done it in the early 1990s – is to get the prices right.  That is, to remove the subsidies and sell energy at market prices.

So, why do so many countries not do it ?  Simply put, because they are afraid of the short-term political costs, as citizens will see their energy bills increase dramatically.  Experience across the world, from Central Europe to Latin America and the Middle East, provides important lessons for countries like Ukraine which are considering an in-depth reform.  In particular, it suggests that this political risk can be reduced through a combination of communication and compensation.

Communicate –explain to the people the reasons for change, the fact that what was designed as a genuine way to help the poorest actually helps the well-off, or even worse the corrupters, and show how the resources saved from the removal of subsidies will be redeployed. 

Compensate – and ensure that the poorest do not end up being worst off without the subsidies.  Where a social protection system is in place, this is relatively easy to do: the Government can increase social assistance payments by the amount corresponding to the forfeited subsidies.  Even if the poorest are integrally compensated, the savings for the Government will be very large, since the subsidies benefit mainly the well-off and are in part diverted into corrupt schemes.

There are of course voices calling for caution, and for taking time to implement such difficult reforms.  And indeed, haste can be counterproductive.  But caution can also easily become an excuse for procrastination, especially for those who would lose the most from a well-handled removal of subsidies: not the poorest, but the rapidly-enriched profiteers.  In fact, when a country is on the verge of economic collapse, there may not be any option but to act.

https://www.worldbank.org/en/news/opinion/2014/04/17/subsidies-encourage-waste