Given that the purpose behind subsidies is to reduce levels of inequality by providing more for the poor, it has to be galling to hear that the spending may actually be causing an increase in inequality. Yet, that’s what IMF’s First Deputy Managing Director David Lipton argues when he says redistributive policies can generate a tradeoff between equality and efficiency, and if misconceived, the tradeoff can be very costly. The IMF’s argument emanates from the huge leakages in most government programmes. In many developing economies, Lipton says, the poorest 40% of people receive less than 40% of the total benefits under various social sector programmes. In India, things could be a lot worse—the Kirit Parikh report pointed out that just 0.07% of the LPG subsidy in rural areas went to the poorest fifth of households; in the case of urban areas, around 8.2% of the subsidies went to the poorest fifth.
For the government, the choice is between spending, say R100, on food subsidies or building a road to connect villages to towns.
Research by Ashok Gulati, Shenggen Fan and Sukhadeo Thorat found that while spending money in fertiliser subsidies generated a 0.53% return in the 1990s (in terms of rupees of extra farm GDP per rupee of subsidy), the same money generated 3.17% if spent on building rural roads and 6.93% on agricultural R&D. The impact on reduction in rural poverty is even starker. While every million rupees spent on fertiliser subsidies reduced the number of poor by 24, the reduction was 335 for investments in building roads and 323 for agricultural R&D—given that fertiliser subsidies, like most others, go primarily to the better off farmers while a road benefits everyone, the results are intuitively obvious. And if the rich benefit more than the poor, this accentuates inequality. Which is why, as Lipton puts it, the benefits of additional spending on redistribution should be compared with the benefits of raising spending in other priority areas such as infrastructure.
Greater access to education and health for the poor, like roads, will greatly benefit the poor, the IMF points out. But if the education spending is done through permanent and highly paid government teachers who don’t teach, it will have a lower impact as compared to delivering this through lower-paid but more motivated para-teachers as several states have discovered—giving parents education coupons which can be used in private schools may be even more