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Selling commodities below cost is a common practice in companies with many products. The offer of goods and services by the government to specific citizen groups, free of or below cost, is present in many countries. Indian governments either directly subsidize such offers, or more often, expect the service (or goods) provider to do so and recover the subsidy costs from other customers.
Companies with a portfolio of products might subsidize one or more by selling below cost, meeting the loss from the others till the subsidized item has established itself. One good example is that of the ITC. The ITC’s diversification into other products than tobacco-based ones began when the public learnt about the adverse effects of cigarette smoking on health and mortality. The ITC took many years before hotels yielding some profits were built. But the cigarette business was immensely profitable. Even with high taxes and consequently spiralling prices, sales revenues and profits rose each year. There was plenty to spend on new ventures.
Some diversifications like fishing and bulk exports of agricultural commodities like rice were unsuccessful. More recent diversifications into biscuits and personal care products have fast emerged as major competitors to long-established brands. The ITC had ample resources to spend on product development, advertising and distribution as compared to many established competitors. The cigarette business subsidized the new diversifications.
Thus, subsidies in corporate enterprises have justification provided they have a time limit, then can be eliminated or the venture abandoned, and the accounting allows a fix on costs. The subsidized item has to pay for all its expenses from its sales revenues within a given period. A company will not subsidize for interminable periods.
In many companies, overhead expenses are distributed between products. A new product might get a holiday for a specified period from this debit of overhead expenses to give it a chance of establishing itself. But after that it must pay a share of the overheads. If it cannot, it has failed.
The corporate experiences on subsidies are relevant for government subsidies. In India government subsidies have tended to be on commodities and services important for weak and vulnerable sections of the population. In reality they have not remained confined to the poor. They have also been given to the better-off (for example, liquefied petroleum gas) or have been appropriated by them. Governments have, so far, had limited ways to identify all the target beneficiaries, or to eliminate those not in the target group. Perhaps the unique identification (Aadhar) might improve this ability.
Further, the management of the delivery of subsidies by governments in India has been shoddy, and sometimes deliberately so, enabling the siphoning off of vast portions of the subsidy amounts. The amounts shown as spent do not reach many target households. Most subsidies also take on a life of their own and do not get eliminated over time or modified for better efficiency.
Governments, like companies, also cross-subsidize in paying for subsidies. One group of consumers pays more for the benefit of others. There are many examples. In the 1950s and 1960s cheap and rough ‘controlled’ cloth was sold at low prices to benefit the poor. (Much was illegally diverted to markets.) Textile mills were expected to recoup the cost by charging higher prices for the other textiles they manufactured. Of course, this recouping depended on the markets accepting the higher prices. Mills lost money on subsidies when there was an economic downturn and a slump in demand for the expensive textiles. Spinning mills similarly had to accept a ‘hank yarn obligation’ by supplying yarn for the handloom industry in hank form at special prices. Cross-subsidies had an adverse impact on the vibrant Indian textiles industry.
For many years, the government has asked petroleum companies to supply kerosene to the targeted and identified poor at especially low prices. (Over 40 per cent was illegally diverted to lorry owners who used it to adulterate diesel and so bring down their fuel costs.) The cost (as with all government cross-subsidies — textile mills in the earlier example), was not borne by the government but by the oil marketing companies. Other oil products cross-subsidized kerosene subsidies. However, as crude prices flared and also became very volatile, populist Central governments kept the prices of petrol and diesel at the earlier lower levels. The gap between cost and price was to be reimbursed to the petroleum companies but for many years it was never fully returned, adversely affecting the financial standings of the oil companies. They now had to bear the cross-subsidy cost on kerosene and the un-reimbursed subsidy on petrol and diesel. The accounting was mixed up. Kerosene costs had to be identified, similarly the costs of subsidized and unsubsidized kerosene. Accounting was complicated and messy.
Electricity prices are kept low for the poor. The better-off consumers paid for them. When many state governments declared below-cost or free power to farmers, subsidy accounting became fictitious. There was no control on the efficiency of the farm pumps and motors run on electricity, no metering to measure the quantity of power used, no determination of how many pump sets were in a household, or how much of the power used was for other non-farm purposes. The actual subsidy was almost impossible to measure. It was to be reimbursed to the electricity enterprises by the state government. This was rarely done in full or in time. The distribution companies accumulated losses, adversely affecting maintenance of equipment, their renovation and modernization, and new generation, transmission and distribution capacities. A good part of the thefts of electricity was also included in agricultural consumption, concealing collusion in theft by employees of distribution enterprises.
The government wanted to enable the gradual elimination of cross-subsidies in the 2003 Electricity Act. But the communists disagreed and cross-subsidies have remained. This has had adverse consequences. For example, when the Maharashtra electricity regulator allowed consumers to shift suppliers, some of the big and best paying customers switched from Reliance to Tata. Reliance was left with a few lakh customers paying below cost who had been cross-subsidized by the big ones who switched to Tata. The regulator had to modify his order so that the deserters continued to bear the cross-subsidy.
Cross-subsidies result in messy accounting. They are not easily quantified, especially when demand varies over time and a big user today might cut his usage tomorrow, reducing the cross-subsidy amount available. It distorts the pricing, demand and market. The worst thing about cross-subsidies is that the enterprise has to implement populist government policies, instead of the cost for them being part of the government budgets.
Whether with subsidies on food grains, electricity, or any other, identifying target beneficiaries has been impossible and all subsidies end up benefiting over 50 per cent or more of those who were not intended beneficiaries. Many subsidized items go into the market. Bureaucrats at all levels make substantial earnings from them.
Obviously, governments are entitled to have policies to help specific groups of citizens. But they should not make the enterprise that makes or distributes the product or service bear the cost. The cost should be paid directly by the government. Further, the subsidy should not be in kind, involving massive mobilization/procurement, and transfers of goods and services. They should be in entitlement vouchers or cash to identified beneficiaries. Here the inherent inefficiency and corruption in Indian governments will ensure that there will be misuse and theft. But it is better that we accept this. We do not need to add damage to the enterprises (like oil companies, electricity distribution enterprises) as well.
The author is former director general, National Council of Applied Economic Research |
