The Contentious Issue of Subsidies

Late last year, the Ministry of Finance announced the removal of subsidies on petroleum products, a decision that has engendered diverse reactions. On the one hand, the movement to cost reflective energy has increased inflationary pressure, whilst on the other it has freed up resources for an already constrained treasury. Advocates of the subsidizing of fuel and electricity have argued the recent price hikes have taken necessities out of the reach of ordinary Zambians, with some going as far as claiming the UPND is not pro-poor. However, economists, often point out that removal of subsidies has improved Zambia’s chances of securing IMF board approval for the extended credit facility, which the country so badly needs.

Let us begin by defining what a subsidy is. The World Trade Organization defines a subsidy as a grant given by the state to a particular industry with a view to keep prices artificially low (WTO, 2006). We cannot talk of subsidies without alluding to the Free Market System. This is an economic system in which factors of production are allocated by the market forces of demand and supply, with no intervention from the government. However, it is widely known that markets do fail. This is where the allocation of resources is not optimal. It is in such situations that state intervention is recommended. This intervention can take many forms, including subsidies.

Take for instance, a rural farmer who due to inadequate natural and human resource is unable to produce a high yield of produce. Without the intervention of the state, such a farmer will not be able to raise his/her production; the free market simply will not allocate the needed resources. This can make poverty more entrenched. By subsidizing inputs, providing irrigation or extension services, this deplorable situation is attenuated. The effects of this being increased productivity at individual and eventually communal and national level, with the attendant higher incomes, at the cost, however, of greater government expenditure. What is crucial here is the subsidy raises incomes of the poor.

Prior to the removal of fuel subsidies, the Zambian government was spending roughly $67 million on subsidizing fuel (Xinhua News, 2021). This translates to $804 million per annum, a colossal sum. With the country’s debt to GDP ratio sitting at a whopping 141.3% (World Bank, 2020), amidst a sovereign debt default, it was not prudent to continue spending close to a billion dollars annually to keep fuel prices artificially low. Moreover, international bodies such as the IMF and the World Bank have been categorical in communicating the distortionary effects of fuel subsidies. An IMF working paper, established that fuel subsidies disproportionately benefit wealthier households compared to their low income counterparts (Coady, Flamini & Sears, 2015). One of the reasons advanced for this are that the budgets of the former are more energy intensive than those of the latter. Secondly, high public expenditure on fuel subsidies can crowd out other public investments such as education and health. The World Bank, in its Global Economic Prospects report, advised Emerging Market & Developing Economies (EMDEs) against resorting to subsidies in response to escalating oil prices, citing once more their distortionary nature, financial strain on treasuries and difficulties in removing them once shocks abate (Global Economic Prospects, 2022). The argument here, therefore, is that fuel subsidies are an ineffective way of cushioning high costs on the poor. More targeted social safety nets are more effective in this regard.

Subsidies are not all bad. Indeed, they can enhance welfare if implemented correctly and in a targeted manner. However, they can also be exacerbate inequalities. Thus, in deciding to discontinue a subsidy, a careful analysis of said subsidy must be undertaken so as to determine whether it is benefiting the intended beneficiaries or not. However, in the Zambian economy, given its current state, the continuation of the fuel subsidy seemed unfeasible, bearing in mind the arrears in the fuel sector which stood at half a billion dollars as the UPND came into office (Ministry of Finance, 2021), left by the PF. Furthermore, it is clear a tradeoff had to be made between investing in education, health and other social sectors versus continuing the subsidies. Adding to this the aversion of the IMF towards subsidies and I can only imagine, a compelling argument was made to scrape them off.