With the current worldwide inflation levels, governments around the region are giving more attention and time to the issue of subsidies, a form of financial assistance destined to either individuals or the economic sector.
There are two different approaches to subsidies, which can be defined from either a supply or a demand perspective. Ultimately, subventions work by either contributing directly to people’s income or by financing industry sectors.
“Subsidies generally result in a transfer of wealth from one group to another, and mainly targeting low income households,” said Marwan Mkhael, head of research at Lebanese BLOM Bank.
Direct subsidies are based on the transfer of a cash amount to individuals who are either unemployed or belonging to a lower income population category. According to Mkhael, “This type of subsidy is one of the most efficient and the least practiced in Lebanon, as it requires specific data in order to identify people in need.”
Other types of subsidies include tax subsidies (i.e. “tax breaks”) and production subsidies; the latter involve a direct financial contribution to certain production areas in order to promote their development. Trade protection measures are also considered indirect or hidden forms of subsidies, as they ultimately support the local industry which benefits from protective measures. They may also refer to government actions limiting competition or raise the prices at which producers are allowed to sell their products, by means of tariff protection.
Procurement subsidies are usually used when governments decide to buy products from a certain industry at a higher price than the regular market price.
Some types of subsidies can often go unnoticed, as many consumption subsidies — which usually provide goods or services at lower prices than the market — are frequently taken for granted by the public. Such subsidies are applied to sectors such as education and health care, as well as the development and maintenance of infrastructure.
Not always on target
Each regional country has a different approach to subsidies. Mkhael believes that in Lebanon the implementation of indirect subsidies is not efficient as it does not reach its target, which is the poorest portion of the population. “If we take the example of wheat that is used in the production of local bread, we observe that the industry is often plagued by corruption. Although we don’t have actual figures to know how much wheat is needed to produce the bread to cover national consumption needs, we know for sure that part of that subsidized wheat is either sold on the black market or used for other products, such as cakes and sweets,” he said. By the use of such indirect subsidies the government in Lebanon is thus financing wheat across the board, with the rich benefiting as much as the poor, in the absence of accurate market data to guide the government’s efforts.
In addition to local bread, the Lebanese government also subsidizes the tobacco industry by buying tobacco at higher than market prices, an initiative that is currently costing Lebanon some $50 million per year. Gas is another household expense that is indirectly subsidized. “In this particular case, the government has progressively decreased taxation until it was simply eroded,” Mkhael pointed out. A budget is also allocated for financing fuel oil used specifically in winter for heating homes, a decision taken by the government every year in the fall. In 2007, this particular subsidy cost the government around $30 million. The Lebanese economist underlined that the issue of subsidies to the Electricité du Liban (EDL, Lebanon’s national power company) remains the thorniest issue on Lebanon’s agenda. According to Mkhael, EDL’s electricity is still priced at the rate of $25 per barrel of oil while prices have gone up to over $140, which in conjunction with the lack of sector reform will cost the budget as much as $1.5 billion this year.
Covering the essentials
Indirect subsidies are also used by Gulf countries. Qatar and Saudi Arabia heavily subsidize their petrochemical industries. Other forms of subsidies include electricity, gas, and basic food items such as rice and sugar. However, according to Dr. Mahdi Mattar, head economist and strategist at SHUAA, “The financial burden of subsidies on government is offset by international soaring oil prices that benefit oil producing countries.”
Mattar explained that this type of subvention when applied to the industry certainly offers the sector an unfair edge as it provides it with higher profit margins. For example, in Saudi Arabia gas is sold to the petrochemical industry for $0.75 per million BTU (British Thermal Units) and $1.25 per million BTU in Qatar while global prices are currently estimated at $10 per million BTU. “However this form of subvention can’t be described as unfair competition as long as industries are not dumping goods on international markets,” he added.
According to economist Dr. Heba Nasser, vice president of Cairo University, subsidies applied in Egypt target mainly basic products such as bread, rice, oil and kerosene, with over 50% of gas and about 40% of wheat prices currently subsidized.
“The main problem we are currently facing in Egypt is how to reach and improve living conditions of lower income households. In order to improve efficiency of subsidies, a household budget survey has been recently conducted, which has provided us with an actual poverty map,” Nasser said.
Disparities in subsidies exist from one country to another. Throughout the region, countries that had adopted a socialist system naturally tended to subsidize more goods and industry sectors — whether by relying on direct or indirect subsidies — than liberal economies. “As an example, the Syrian government subsidizes bread and many other products used by the masses,” said Mkhael.
In some cases, subsidies may effectively reduce the competitiveness or delay the development of products’ possible substitutes. In Lebanon, subsidies to the agricultural sector have led to market inefficiencies. Export Plus, a program which was sponsored for five years by the Lebanese government and recently renewed for another five, allows for subsidies for transporting local agricultural products. “This program in conjunction to certain protective measures has led to increase of prices of certain products on the local market,” explained Mkhael. Another of its disadvantages is that it mostly benefits traders and not farmers. Other market distortions arise when a subsidy for the consumption of a basic product may appear to benefit consumers, but supply of this particular product is constrained, resulting in higher demand and, subsequently, higher prices. In these cases, the producer will benefit and the consumer does not derive a net gain, as the higher prices for the product offset the actual subsidy. However, Mkhael averred that “Export Plus has certainly improved quality controls on Lebanese farm produce,” which in and of itself is a gain for consumers.
Further distortions that might be created by subsidies are, in some cases, the deterrence of new entrants into a market because selective sectors or companies are supported. In addition, in the case of debt ridden countries such as Lebanon, subsidies may also lead to an increased public deficit, and thus are not a good policy if the country aims to control its debt.
Economists interviewed by Executive argue that direct subsidies are preferable to other forms of subventions — such as hidden subsidies or trade barriers — because they specifically benefit the poor. In addition to being more efficient, direct subsidies also offer the advantage of transparency.
Many economists believe that subsidies should be used only in the short term. Ultimately, however, the choice to put a subsidy in place is one of a political nature, which also allows maintaining social stability. In conclusion, Mattar said that, “subsidies are certainly an inefficient tool in the longer term, but they remain a powerful instrument as long as governments can afford them. Subsidies undoubtedly alleviate poor living conditions of lower income population, and thus promote fair economic development, however, only on the short run.”
