Subsidies
Are Some of the Worst Economic Policies
Subsidies are generally bad and can sometimes be disastrous.
Subsidies cause consumers to misuse and waste subsidised goods and services (water, electricity, public medications, and hospital services).
Subsidies promote the development of black markets in subsidised goods and services, in which looters profit from arbitrage opportunities, especially cross-border opportunities and make a business acquiring and reselling those goods and services, cashing in on the difference between the subsidised price and real market price (Diesel Fuel / subsidised foods etc..) at the expense of the public budget.
(It is no coincidence that a nation like Kuwait with so little industrial activity, is amongst the highest per capita users of fuel and electricity, higher even than the USA).
Subsidies fuel the development of bloated government organisations and bureaucracies to not only manage and distribute the subsidies, but more importantly, to police the misuse of those subsidies and prevent abuse and theft. The machinery involved in this management of subsidies is of a high cost but with little real effect and serves as a further drag on economic activity and burdens the economy with another layer of costs and bureaucracy.
Why do you think the Ministry of Commerce requires a business plan and a feasibility study for every industrial project license? To prevent the misuse of the generous subsidies offered by the government in the form of subsidised land, electricity, labour permits etc. Similarly, we have controls on the importation of labour to prevent abuse of subsidised health and public services, while attempting to protect the salaries of Kuwaitis in the private sector.
Subsidies encourage the development of a corrupt, inefficient and weak political system and political culture, as it encourages politicians who are willing to ignore the real long term interests of the people and society; politicians who have little ability to offer effective solutions because they are more challenging to formulate and implement. Such politicians would rather survive by bribing voters with subsidies and grants at the cost of the public treasury than pursue sustainable economic development that strengthens the economic and political stability of the country, and helps it build wealth as opposed to just consume it.
Subsidies destroy a nation's competitiveness by causing a steady deterioration in work and social values in a manner that hampers the competitive capabilities of a society, by reducing the incentive to individuals to be efficient and productive.
Take a look at the free university education which is granted to everyone; where corrupt politics has reduced the barrier to enter a university. As a result, the quality of average high school and university graduates has fallen further as well as the quality of University graduates.
After university, there is a guaranteed government job for any graduate irrespective of his or her grade, with equal pay. What do you think would become of the competitive capabilities of such a society or culture in comparison to countries where university places and government jobs are granted on merit?
Do we really believe the problem of productivity and competitiveness of Kuwait lies in its teachers' pay? Or the quality of its buildings? Or the standard of its educational materials? Or even government organisations and the structure or efficiency of government processes? Or the right man in the right government job? It is in fact the lack of incentive, it is the No Reward and no downside risk or punishment policy, it is a subsidy a government owned and operated economy.
Public Sector employment (another form of subsidy) can also be very damaging. For it should be understood that the public sector is a tax on economic activity as it is financed by taxing non-government economic activity (in Kuwait after oil).
Government should not own an economic activity as it is never an efficient owner at the best of times. See ZAIN before and after it was privatised, or Public Warehousing Co., and others in Kuwait. Even when it attempts to own economic activity it is usually with the justification of equality and wealth re-distribution, or national economic and strategic interests, etc., but never for reasons of competitiveness or profitability. In fact, these reasons are given most of the time to justify the existence of those businesses when there is no justification for them economically.
When the public sector expands beyond an optimal size appropriate to the needs of its economy (compare as a percentage of total GDP with other competing economies) it competes for talent, assets and infrastructure with the private sector, raising costs to the private economy and starving it of resources.
To summarise, the problem with subsidies is that they waste resources, add red tape and bureaucracy, and corrupt the work ethics of the work force and the political system. Government support of industries redirects critical resources (like talent, assets, infrastructure, political attention and national focus) away from those activities that sufficiently competitive to survive alone to sectors that will vanish when subsidies are removed one day.
To recover the lost competitive capability of the economy after we have realised the mistake, or when we reach a point where the country can no longer afford to subsidise goods and services, requires at least a generation of recovery work (15 or so years) and the redirection of substantial capital and efforts to rebuild lost competiveness and infrastructure. This is my problem with subsidies.
Economic productivity is about what a nation can produce of total GDP compared to what it starts with in comparison to other nations. By this I mean how much GDP should we in Kuwait produce with the same level of oil revenue when compared to a similar nation with similar levels of oil revenue. Take the UAE for example, Kuwait and UAE produce roughly the same amount of oil annually, yet the UAE produces roughly double the total GDP of Kuwait annually! What does this tell us about the national productivity and competitiveness of Kuwait?
The economic productivity of a nation is indirectly related to:
The size of the public sector as a percentage of the total economy (% of total GDP).
- The quantum and extent of its subsidies, both direct and hidden as a percentage of total GDP. (Hidden subsidies are things like public sector overpay or public sector overemployment.)
While economic productivity of a nation is directly related to:
The level of competition within the different private sector activities and how eagerly the government fights private sector monopolies (e.g.: allowing a minimum of 3 competitors in a sector, or the sector has global competitors if it is primarily an export-oriented sector.)
- How fairly the private sector is treated in comparison to the public sector (allowing equal or more favourable treatment than government sectors).
All subsidises are bad, but some are worse than others!
Bad subsidies are those that reduce the price of goods and services, thereby encouraging theft, the development of black markets, and promoting waste and misuse by consumers of the subsidised goods and services.
Cash subsidies however are less damaging, as they are given to consumers to help them pay those goods and services, while the price of goods and services are left to market forces. This is much more effective way to give subsidises because it allows for:
Efficiency and Savings: Consumers will be incentivised to save on use of unsubsidised goods or services such as power and water because the benefits of saving will go to their pocket (see World Bank report on India).
And where goods and services are priced based on market forces, there is a little incentive to steal or trade in the black market, thus saving on the added bureaucracy and red tape required to fight theft and misuse. Subsidised diesel in Kuwait is an example of the converse of this principle where cross-border smuggling to take advantage in the price differential is a significant activity.
Unsubsidised services and goods encourage the development of competitive and efficient markets for goods and services, e.g. efficient and competitive petroleum retailing services (no diesel theft occurs from unsubsidised fuel and hence focus is on operating profit.)
Little incentive to steal fuel, medicine or food because the price differential between separated markets is minimal.
Private health insurance as opposed to subsidised government insurance policies builds a competitive private insurance industry and a competitive private health industry. (Government insurance is a de-facto for government subsidised health services.)
Removing subsidies in land prices promotes competitive industrial land developments as opposed to government-led distribution of land based on influence and political connections.
Efficiently run and competitive private power generators. In the Soviet Union tor example, cheap subsidised energy led to over-heated homes in winter, very in-efficient power plants and wastage of resources and excessive pollution from mismanagement, by not having to worry about competition.
- A competitive education system (see new private university developments).
Removing subsidies encourages consumers to invest in higher efficiency products and services (solar and other alternatives) which helps to foster better consumer behaviour and habits and focus, leading to:
The development of energy efficient goods and services.
Reduces the wastage of capital resources needed to be invested in power and water generation by encouraging optimisation of technology and output.
Increases the amount of oil and oil products available for export.
- Helps the environment by reducing wastage and inefficiency.
All these factors contribute to promoting sustainable economic development strategies.
The worst of all subsidies are those where consumers and businesses have to pay for "Subsidies delivered through protection from competition, either local or imported."
This destroys economic resource allocation by artificially inflating the profitability of a sector, thereby allowing capital and finite resources to flow to it when it is not economically feasible without such protection.
What makes these subsidies worse is the fact that their cost is paid for by the rest of the economy (part of which is not protected and has to compete regionally and globally.) This is a tax that they have to pay, while their competitors located in other regions of the world do not have that cost.
So it not only hurts the economy and society with all the previously explained negatives, but amplifies the country's non-competitiveness by weakening its non-subsidised activities by burdening them with higher costs.
IT IS CRITICAL TO REALISE THE FOLLOWING:
No economy in the world can sustain subsidies forever. All nations will see a day when they have to remove subsidies.
Most of the time this moment of truth is reached when the economic situation is very difficult and hence there is not enough money to help adopt a gentle adjustment period.
It is important to note too that no nation is competitive in every sector. The best of nations are competitive in one, two or three sectors.
Japan is globally competitive in electronics and automobiles.
USA is globally competitive in technology, defence, and education
Dubai is a regional business and leisure hub.
Italy is globally competitive in fashion and specialised industries
UK is globally competitive in financial services.
- Add a different level of tourism to each.
All nations need to attract their best and most effective resources (starting with people, government focus and priority of capital resource allocation) to those sectors. The more efficient the rest of the economy is, the more competitive those sectors become because there are more resources available to them, as well as providing them with a lower cost base to operate from. Even then it's a tough job keeping that competitive edge; look at Korea competing with Japanese electronics and auto industries, or US mobile technologies.
The solution to the economic deterioration of Kuwait's competitive capabilities and its competitive rating regionally and globally is in adopting the following policies:
Separate and disengage the welfare state from the real economy.
Install the correct form of subsidies ("cash") and not price subsidies.
Pass all economic activity to a competitive (not monopolistic) private sector including:
As much of in medical services as possible
Production and distribution of electricity and water
Educational services
Ports, airports and customs management, etc.
Create a very effective competition board to fight monopolies, anti-competitive behaviour, collusion and market control, and to ensure we have at least three competitors in every sector of the private economy.
Release land designated for specific uses to the public to buy via government auctions.
Remove government as a competitor from all sectors where possible and create independent competition or regulatory boards to regulate competitive activity in different parts of the economy much like what the Capital Markets Authority does for financial markets.
Telecom authority for the telecom market
Health care authority (for health services)
Education
- Etc.
The government should never become a competitor because it has access to subsidised funding to cover losses, thereby killing the free market because government owned operators are subsidised and can sustain losses while the private non-government operators cannot continue operating at a loss. For example, Kuwait Airways and Wataniya Airways. This is similar to dumping which is normally challenged by governments via Anti-Dumping laws (the killing of competition through loss-making pricing).
Neither should the government be a player and a regulator. That is why the above authorities are critical in Telecoms, Health and Education. As the government is still a player (competitor) and in this case, the regulators must be empowered to take action and prevent government-owned operators from practicing dumping policies.
- Passing laws that guarantee equal treatment and a level playing field for the government and the private sector in all aspects.
If a government contract permits labour licenses, a private contract should also be permitted the same privilege.
If a government player gels free land, the private sector player should also get the same.
- Any benefits to public sector employees should also be offered
to private sector employees. A simple example is being accepted as a guarantor for a housing loan 10 a relative, whether you are a Kuwaiti government and private sector employee!
It is as simple as the above and as complex...
Here is a very nice story that puts much of the above in a real example.
SOME IDEAS ARE SO STUPID ONLY INTELLECTUALS BELIEVE THEM. -- George Orwell
When the reward is great, the effort to succeed is great, but when government takes all the reward away, no one will try or want to succeed.
An economics professor at a local college made a statement that he had never failed a single student before, but had recently failed an entire class. That class had insisted that Obama's socialism worked and that no one would be poor and no one would be rich, a great equaliser.
The professor then said, "OK, we will have an experiment in this class on Obama's plan". All grades will be averaged and everyone will receive the same grade so no one will fail and no one will receive an A.... (Substituting grades tor dollars - something closer to home and more readily understood by all).
After the first test, the grades were averaged and everyone got a B. The students who studied hard were upset and the students who studied little were happy. As the second test rolled around, the students who studied little had studied even less and the ones who studied hard decided they wanted a free ride too so they studied little.
The second test average was a D!! No one was happy.
When the 3rd test rolled around, the average was an F.
As the tests proceeded, the scores never increased as bickering, blame and name-calling all resulted in hard feelings and no one would study for the benefit of anyone else.
To their great surprise, ALL FAILED and the professor told them that socialism would also ultimately fail because when the reward is great, the effort to succeed is great, but when government takes all the reward away, no one will try or want to succeed.
It could not be any simpler than that.