What’s the worst thing a government can spend its people’s money on? Progressives might say the military; conservatives might point to entitlement programs. But outlays in both of these areas do at least pump money into the economy and create jobs, and most people would agree that some spending on each is justifiable.
In one area, however, government spending almost always redistributes income from the poor to the rich, encourages inefficiency and fuels corruption: state subsides.
By state subsidies, we mean government assistance to boost producers’ incomes above or reduce consumers’ expenditures below what they would be in a competitive marketplace. State subsidies might seem an unlikely candidate for this charge. After all, they are often viewed as tools of mercy. According to their advocates, governments use them to make goods and services more affordable to the poor, assist aspiring entrepreneurs or to save jobs in enterprises that can’t endure the pressures of the market without assistance.
But scratch the surface of most state subsidies and you will find much more flowing into the bank accounts of the well-heeled than into the pockets of the poor.
New research shows that state subsidies are the opposite of Robin Hood
A wave of recent political science publications, including our research on post-communist Europe (see also here and here), underscores this point. Far from aiding the downtrodden, state subsidies have enriched and empowered corrupt capitalists who have undermined the establishment of honest state administrations and judicial systems.
In Ukraine, oligarchs who built their fortunes on state budgetary transfers, crony-engineered loans, and selective tax breaks continue to dominate the business world today. State subsidies like these ended up bankrupting the country and help explain its ineffective response to a light-handed military intervention by Russia.
The most egregious state subsidies of all take place in the gas market. Fixed gas prices do benefit Ukrainian households — but in the most inefficient way imaginable. The real beneficiaries are shadowy intermediaries that have made billions of dollars buying gas at cheap state prices and reselling it at huge markups to industrial consumers and the state gas company.
In 2012 alone, the state’s energy subsidies amounted to 7 percent of Ukraine’s entire gross domestic product — the same amount that Ukraine spent on defense and health care combined. An estimated 40 percent of the energy subsidies were stolen by individuals linked to then-President Viktor Yanukovych. Eliminating the state subsidy for the oligarchs would generate more than enough savings to assist gas purchases by the poor.
The post-communist region is replete with governments that have chosen to prop up insolvent state companies with subsidies rather than shut them down, thereby allowing their managers to get rich by systematically ripping off the companies’ assets.
There is perhaps a single exception to this pattern in the region, and that is Estonia. Shortly after independence in 1991, the Estonian government virtually eliminated subsidies. It rapidly and consistently imposed hard budget constraints on firms. It reined in state assistance to unprofitable companies, shuttered insolvent state banks, and introduced effective bankruptcy and currency regimes. The beneficiaries of the state subsidies cried foul, but the government stayed the course. The result was a level economic playing field in which real entrepreneurs rather than corrupt political capitalists could thrive. The policies marginalized predatory business interests opposed to the rule of law and enabled Estonian leaders to build a state administration that stands out in the post-communist region for its probity and efficiency.
The perverse effects of state subsidies are hardly limited to post-communist countries. In Nigeria, a fuel subsidy program touted as a way of helping the poor primarily benefits corrupt state officials and their cronies. The state mandates a fixed retail price for petrol of pennies on the dollar and then compensates wholesalers for the difference between the low retail price and the market price they pay to import the fuel. In reality, the government-connected wholesalers overstate their imports by billions of dollars, thereby stealing off with the equivalent amount in subsidies.
In India, grain producers are required to sell to government middlemen at above-market prices. The policy’s original intent was to aid poor farmers, but its main beneficiaries are the middlemen themselves and well-to-do agricultural interests from rich provinces such as Punjab and Haryana. The policy inflates grain prices, thereby abusing the poor majority that spends most of its income on food. Funds for the state subsidies could be spent instead on roads that would help farmers get their goods to market. But investment in infrastructure lags. As a result, one-third of all fruits and vegetables in India rot before they reach consumers.
U.S. cotton subsidies have much in common with India’s grain subsidies, except that they generate disastrous global effects on top of their domestic consequences. U.S. taxpayers shell out $3 billion to $4 billion per year to finance the government’s program to keep a few thousand big cotton farmers rich. The policies depress world cotton prices and reduce the incomes of millions of small cotton farmers in some of the world’s poorest countries, including Niger, Burkina Faso, Mali, Uzbekistan and Turkmenistan.
So why are state subsidies popular?
State subsidies tend to be popular for three reasons. First, they usually include a bone for the poor. In Ukraine, the fuel subsidies reduce prices for consumers. In India, the grain-buying program raises the selling price that smaller farmers fetch. So while state subsidies are terribly inefficient and unfair, the little guy tends to feel he’s getting something, even if it’s a pittance.
Second, the government officials and well-endowed private interests who are the biggest beneficiaries have political clout. They use their influence over the government and media to trumpet the supposed benefits of state subsides for the masses.
Third, opinion leaders in academia and the media provide intellectual cover for state subsidies. Well-meaning but poorly informed, some social scientists and public commentators in both the West and developing countries assume that anything that the IMF endorses, including reducing state subsidies, amounts to an attack on the underprivileged (see here, here, here, and here).
Add to this the problem that those who benefit from state subsidies are normally more motivated to keep them than their victims are to scrap them and you have the makings of a grand injustice that is very hard to eradicate. State subsidies’ main beneficiaries are concentrated, well-organized, and well-informed, while the losers are diffuse, numerous, and often unaware of their losses. How often do we see big public demonstrations against state subsidies?
Some subsidies do good.
Well-designed, need-based subsidies for poverty-alleviation can indeed be beneficial. Likewise, states justifiably subsidize education, health care and infrastructure since these are public goods that market forces alone cannot generate in sufficient amounts. But market forces are adequate to ensure the production and distribution of fuel and wheat. If some consumers are too poor to afford the goods, the state could provide targeted transfers to help them pay.
But state subsidies that go beyond providing poverty relief and public goods have a reverse Robin Hood effect. Fuel subsidies, in particular, also tend to generate shortages, kindle corruption and encourage patterns of consumption that degrade the environment.
Steven Fish is a professor of political science at the University of California at Berkeley. Neil A. Abrams received his doctorate in political science from the University of California at Berkeley. He is completing a book on corruption in Ukraine.