Business Times

Targeting subsidies

IMF Colombo Representative Koshy Mathai at a recent briefing to the media raised an interesting point: Why isn’t Sri Lanka targeting fuel subsidies to the poor and making the rich pay higher prices?
Explaining the need for focused subsidies in the context of rising oil prices which some experts say could even reach $200 per barrel in coming months from $115 now, Dr Mathai said the rich owning Prados, BMWs and other expensive cars should be able to afford a higher price for fuel.

Diesel and kerosene subsidies, he indicated, should be targeted to low income groups. The point he was making is that in Sri Lanka even the rich receive subsidised fuel, and free education and health, which if targeted to specific groups could reduce a huge burden in state spending.

Sri Lanka has many schemes of targeted subsidies and general welfare. Diesel and kerosene are subsidised at the expense of petrol and comes under the basket of targeted subsidies as these two items are considered to be used mostly by low income groups (diesel being used in public transportation-buses). However many people –including politicians -- have taken advantage of cheap diesel and own diesel cars and luxury vehicles, making a mockery of the scheme.

Focused subsidies include fertilizer and other inputs to rice farmers and plantations, to the fisheries sector and also cash. General welfare subsidies include fuel, milk powder, LPG, wheat flour, bread and cement among other items. Health and education are provided free to the public.

Targeting subsidies to the poor is easier said than done particularly going on the experience of the Samurdhi poverty alleviation scheme introduced in 1995. Subsidies and incentives are provided, under this scheme, to far more than those living below the poverty line due to corruption, mismanagement and abuse. Studies have shown that it doesn’t reach some low-income groups while those who have migrated to a higher level by virtue of getting a job or increasing income levels, continue to receive these benefits.

Recently President Mahinda Rajapaksa was quoted as saying that the government has succeeded in reducing poverty to 7.6 % of the population in 2009-10 from 15% in 2006-07, which is a 50 % drop.
Thus according to this calculatation, just 400,000 families should be receiving the Samurdhi benefits whereas – as of now – 1.6 million families continue to draw Samurdhi, four times the targeted number of recipients!

The realisation that Samurdhi is a failed scheme and not reaching the poorest of the poor while being a project to provide employment for young people with political connections was mentioned in a World Bank study in 2005. In that study titled “An Empirical Evaluation of the Samurdhi Programme”, the report said the credit and banking components of Samurdhi doesn’t advance the goals of Samurdhi any more than its transfer component. It has limited abilities to reach the poor.

“Credit is distributed more favourably toward non-poor recipients. Moreover, the programme's goal of teaching people savings behaviour is based on the wrong premise that the poor do not know that saving is ‘good for them’. Empirical evidence from around the world shows that people do not save not because they do not know that it is good for them but mostly because they are too poor to save,” it said.

The report said Samurdhi officers are accountable to two authorities, one of whom is a local politician. Thus the people who carry out the programme are not free of political influence, and no external checks and balances are present to prevent them from acting on the demands of politicians. The absence of strict rules for programme eligibility does not help the cause either. Politicization influences both the selection of Samurdhi administrators and the selection of beneficiaries.

The report said qualitative results suggest that other characteristics of households such as party affiliation or voting preferences also influence allocation of Samurdhi consumption grants. These patterns indicate that targeting errors are not random, but rather reflect flaws in the design of the programme that allow for the deliberate omission of certain groups of vulnerable individuals.

“Based on the empirical analysis of the distributional outcomes, Samurdhi does not emerge as an efficient transfer programme. It is modestly successful in reaching the intended beneficiaries, but it transfers a large portion of its resources to the non-poor. Moreover, the non-randomness of its targeting errors indicates that the programme would need extensive redesign in order to improve its efficiency.”
Little has changed in the Samurdhi scheme despite these concerns raised over the years and a good example of its failure is the fact that more than four million, non-deserving recipients continue to draw its benefits. What a cost to the state and the people!

Top economist Prof Sirimal Abeyratne says that the only way to make targeted subsidy schemes efficient is by developing a data base to record the wealth and income of all Sri Lankan adults, which he says is done in developed societies.

Through this process, the state knows exactly the wealth and income of every individual adult, which would be also easy to enforce taxes. “I am sure the World Bank and the IMF would help set up such a data base,” he said. However in Sri Lankan society most people, including the politicians, are reluctant to disclose their wealth for many reasons – one being the fear of the state taking more than it should from individuals.

Also will there be political will to carry out such a bold initiative like this? Given these issues, inefficient subsidy schemes will continue ‘to flourish’ until Sri Lanka migrates to a higher level from a mid-income country, and when per capita incomes rise. The need then for subsidies will gradually taper.

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