## Subsidies: Some Work, Others Don’t

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### What subsidies are
- Subsidies are fiscal tools governments use to encourage economic development, help disadvantaged groups, or advance other national objectives.
- Forms of subsidies described:
  - Keeping prices artificially high to boost incomes of farmers.
  - Offering services, such as a university education or a subway ride, at below cost.
  - Paying some of the interest on loans used to finance construction of a road or a power plant.
  - Granting relief from taxes on certain products or technologies.
- Examples given:
  - Norway exempts owners of electric vehicles from paying highway tolls.
  - Australia pays part of wages when businesses hire young people, indigenous Australians, or older workers.
  - Singapore offers tax breaks to companies that establish global or regional headquarters in the country.

### When subsidies make sense
- Appropriate use:
  - To correct market imperfections when competitive, private markets fail to deliver socially desirable outcomes.
  - To encourage businesses to invest in research and development that benefits the industry or society beyond the firm.
  - To help start-ups survive an initial period of losses until they grow large enough to be profitable (provided governments have enough information to determine whether firms will succeed when they grow larger).

### Impact on inequality
- Key findings:
  - Energy subsidies intended to help low-income households can be a drain on government resources if they are available to everyone, including the relatively well-off; a targeted cash transfer aimed at poor households costs far less.
  - Subsidies can exacerbate inequality if they disproportionately benefit those producing or consuming the most.
  - Across Africa, Asia, Latin America, and the Middle East, the top 20 percent of households capture on average seven times as many of the benefits of energy subsidies as do the bottom 20 percent (Coady, Flamini, and Sears 2015).

### Environmental and fiscal costs
- Distortions and misallocation:
  - Subsidies that do not address market imperfections can distort prices, causing a misallocation of scarce labor and capital that undermines growth.
  - Examples: propping up petroleum prices may keep firms afloat in energy-intensive sectors and damp investment in alternative energy; producer subsidies in agriculture can reduce incentives for improving efficiency.
- Quantified global impacts:
  - Using an expansive measure that includes environmental costs, global subsidies in 2015 are estimated at $5.3 trillion, or 6.5 percent of global GDP (Coady and others 2017).
  - These subsidies are larger than what governments spend on health care throughout the world.
  - Subsidies were largest in China, at $2.3 trillion, followed by the United States, at $700 billion, and Russia and India, at about $300 billion each.
- Specific sectoral statistic:
  - In the European Union, producer subsidies in agriculture averaged 20 percent of gross farm receipts in 2014–16 (Organisation for Economic Co-operation and Development, 2017).

### Reform strategies and policy recommendations
- Challenges:
  - Subsidy reform often involves raising prices of goods such as gasoline or food, which immediately affects consumers’ pocketbooks and can prompt reversals under public and interest-group pressure.
- Recommended elements of a reform strategy:
  - A comprehensive and detailed reform strategy that specifies clear long-term objectives for future price paths and the use of revenues (Clements and others, 2013).
  - A far-reaching communications strategy to show how subsidies crowd out more efficient and equitable public spending.
  - A gradual approach to reform, allowing consumers and firms time to adjust.
  - Compensatory measures such as cash transfers to protect vulnerable households and retraining for displaced workers.
- Progress and remaining priorities:
  - Many mostly energy-producing countries have raised domestic prices in recent years, including Angola, Egypt, India, Mexico, and Saudi Arabia.
  - Reforms need to go further, particularly in reflecting environmental costs in fuel prices, which should be a key component of countries’ strategies to implement the pledges made in 2015 under the Paris Climate Change agreement to reduce carbon emissions.

*International Monetary Fund (Finance & Development, September 2018).*

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_Source: https://www.imf.org/-/media/files/publications/fandd/article/2018/september/what-are-subsidies-basics.pdf_