Subsidies and long-term economic costs

Last week, the decision by the Election Commission to suspend the Government’s move to increase the existing fertiliser subsidy from Rs. 15,000 to Rs. 25,000 for the benefit of paddy farmers as well as granting a fuel subsidy to the fishing community because of the impending General Election caused an uproar and subsequently the Commission gave the green light to go ahead with two measures of financial assistance.

Appeasing paddy farmers with generous financial assistance is part of the play book of political parties to garner the votes of an influential constituency. They also receive water at no cost through irrigation systems for cultivation. What is more, after having received all such benefits, farmers demand that the Government buy their harvest at guaranteed prices that are above the market-determined rates. Under what grounds can one particular community receiving such unprecedented financial assistance from taxpayers’ money be justified? 

Ideally, direct monetary support from the Treasury needs to be directed towards underprivileged and destitute communities through schemes such as social safety nets. Why should people in urban areas who live in flats/small lands and salaried professionals bear the cost incurred by landed proprietors in rural areas in the form of VAT and other types of taxes?

Economists argue that subsidies for the production of particular industries/sectors result in misallocation of resources whilst sustaining uncompetitive and inefficient sectors of the economy apart from distorting market forces. Chemical fertiliser is not produced locally and subsidising imported inputs like fertiliser result in depletion of foreign reserves.

Most of the rice that is produced locally is used for domestic consumption and very few varieties of rice are exported in small quantities. On the other hand, export-oriented crops like tea and coconut do not receive financial assistance from the Government. Last year, to meet the cost of fertiliser subsidy for paddy farmers, the Treasury incurred Rs. 11.5 billion while Rs. 7.5 billion was allocated to subsidise fertiliser during the previous Yala season.

Overreliance on paddy is one of the primary causes for the sluggish state of the nation’s agricultural sector. The continuous financial aid towards paddy also prevents farmers from shifting towards high-yielding, profitable agricultural crops. As up to about 3,000 litres go into the production of one kilogram of rice, paddy farming is a heavy consumer of water. Most of the water used for agriculture in Sri Lanka goes into rice cultivation. Around 1.8 million families are dependent on paddy farming and it is clear that the inclination to continue with the fertiliser subsidy is driven by vote bank politics and not economics. Policy makers need to critically reconsider the amount of effort and money invested in paddy cultivation in light of the economic costs associated with the initiative.

Meanwhile, a fuel subsidy too would be granted for both multi-day and one-day fishing vessels on a monthly basis from this month onwards. Worldwide, fossil fuel subsidies are viewed with consternation due to negative environmental effects. Like in the case of fertiliser subsidy, the fuel subsidy causes a drain on foreign reserves and thus causing the local currency to depreciate. Both these measures result in redistribution of wealth/income which compels individuals who are not associated with paddy farming and fishing having to foot the bills of beneficiaries via higher direct and indirect taxes. 

It is often claimed that good economics is not good politics. One would hope that the newly elected Government would refrain from undertaking ill-advised measures like the fuel subsidy for fishing communities once the parliamentary election is over. The prices of essential utilities like electricity and fuel need to reflect the actual costs as per the IMF arrangement, and it would be in the best interest of the country to ensure the continuity of politically unpopular yet economically realistic actions.