Posted: Monday 7th July 2014 at 8:06 am

IMANI verdict: Ghana’s economy can’t afford further subsidies unless…

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Introduction
The widely implied definition of subsidies in Ghana is the provision of goods and services at no cost or below market cost. Subsidies are direct expenses borne by the government with the central aim of lessening the burden of the cost of living on the poor, who make up 28.5% (2006) of the national population.

Subsidies have become a permanent fixture in the Ghanaian economy.

However, the toll on the national resource purse, along with mounting subsidy arrears, have reared up debates over whether subsidies are good or bad for Ghana’s developing economy. 

The report evaluates the effectiveness of subsidies in achieving its aim of targeting the poor, of driving competitiveness of certain economic sectors and on the basis of its sustainability.

The overarching theme evidently is that, the escalating debt and scarce resources demands prudent spending. Yet, the second quarter of 2014 alone has seen the government spend USD85 million in fuel price subsidies.

Meanwhile, the provisions of basic amenities remain a challenge, and a bane to the livelihoods of households and businesses. It might be time to put an end to subsidies as they do not present a lasting answer to the countries developmental challenges.

Subsidies are Poorly Targeted
In Ghana, most subsidy programmes instituted by the government have the poor as intended beneficiaries. However, poor targeting has rendered them ineffectual.

Subsidies, be it, in the Energy sector, Education sector, or Agricultural sector largely benefits the non-poor at the expense of key development projects and programs.

The current fuel crunch in the country is due in large part to the subsidies owed to Bulk Distributing Companies. Yet, over the past years, how much of these subsidies have actually benefited the poor?

For petrol and diesel (not including kerosene), the share of subsidies that in effect accrues to the poor is a paltry 2.9%. These petroleum products are used as intermediary inputs for a wide range of activities, including transportation, and as such the share of the subsidies that indirectly reach the poor is likely to be marginally higher.

Kerosene is the only petroleum product that is consumed in a substantial way by the poor, that is, 20.7% of kerosene subsidies reach the poor[4]. Though, comparatively better than other petroleum products, the yawning gap of undercoverage depicts an unwise usage of resources. Similarly, $80 million of the $110 million government subsidies on Liquefied Petroleum Gas intended for rural communities were instead used in urban areas[6]. 

Poor targeting also extends to electricity consumption which is amongst the least targeted subsidies. About 66% of the population has access to electricity[7], however only 8% of electricity reaches poor households.

This is because most poor households are not connected to the national grid. More than 60% of electricity is consumed by industries, hence becoming the largest unintended beneficiary of electricity subsidies. Considering the country’s perennial budget constraint, electricity subsidies have enormous opportunity costs, as scarce financial resources can be reallocated to developmental projects with higher payoffs.

Additional targeting outcomes of various programmes can be found in the table below.

Share of Benefits from various programmes accruing to the        Share of Outlays

Poor                                                                                                      Benefitting the poor (%)

Poorly targeted programs and subsidies
Tax cut on imported rice during food price crisis                                                 8.3%

Electricity subsidies embedded in tariff structure                                                8.0%

General funding for tertiary education                                                                    6.9%

Subsidies for petrol and diesel products (except kerosene)                             >2.3%  

Programs and subsidies with limited benefits for the poor

Fertilizer subsidy scheme                                                                                             15.8%

General funding for senior high school (SHS) education                                   15.1%

NHIS general subsidies                                                                                                  12.4%

Programs/subsidies benefitting the population fairly evenly

General funding for primary education                                                                    32.2%                         

Free maternal (ante- and post-natal) and child care                                            29.1%                    

General funding for kindergarten education                                                          27.2%

General funding for junior high school (JHS) education                                     24.0%

General funding for health care                                                                                  22.4%

Ghana School Feeding Programme                                                                          

Kerosene subsidies                                                                                                          20.7%

Source: Improving the Targeting of Social Programmes in Ghana, World Bank (2012)

Masking underlying factors which hamper productivity

In addition to poor targeting, subsidies offer a band-aid solution to underlying productivity issues which ought to be tackled in-depth for sustainable results.

Several countries have employed subsidies with the intent of increasing competiveness on the global trade market. Developing countries are no exception. Subsidies have been used in Ghana with the goal of enhancing global competitiveness in manufacturing, agriculture and other economic activities.

However, subsidies in a poor policy environment, fail to tackle the structural issues that raises the cost of production rendering the sectors inefficient and uncompetitive in the first place.

In Ghana’s energy sector for instance, two key challenges to efficient production have been identified. These include the difficulties in procuring fuel for power generation at sufficient and reasonable prices and the unavailability of public funds to finance the investment requirements of the sector. Interestingly, research suggests that subsidies reduce investment; which as noted above, is one of the identified challenges of the sector. 

Subsidies reduce investment by way of the forced sale of low cost energy, which inevitably affects the short term and long term supply chain demands. In a constrained fiscal environment, such as Ghana’s, amidst mounting debt, and arrears in subsidies owed to various sectors, the constraints to the supply chain are further aggravated.

The low profitability ultimately leads to underinvestment and poor maintenance, thus perpetuating the cycle. The only way to break the cycle is the removal of subsidies, which will then attract investments to the sector and have the positive externality of freed up financial resources.

Inefficient use of Financial Resources
About 50% of Ghana’s annual budget is supported by Donor partners. Furthermore, over 60% of revenue is spent on public sector wages. Subsidies compete with developmental projects on how these remaining funds are allocated. For a growing economy, investments should be paramount and any spending short of that defies logic and economic principles.

Government subsidies consume significant portions of an insufficient revenue pie, inherently limiting the volume of developmental projects that can be undertaken within each budget year. And as already discussed, subsidies have not successfully delivered the desired outcomes and as such, no case can be made for maintaining these harmful schemes.

Subsidies breed dependency and are unsustainable

Subsidies have been employed in the agricultural sector for decades, with the goal of reducing the cost of input below market prices (such as seeds, and equipment and fertilizers) to farmers. For a subsidy to the agricultural sector to be considered sustainable, its long term sustenance must not create pressure on national resources.

Secondly, the outcomes should facilitate widespread adoption[13]. Agricultural input subsidy programs pursed in the 70s and 80s are believed to have failed, to a large extent in sub-Saharan Africa. In Ghana, the cessation of subsidy programs in the 80s and 90s, led to a reduction in fertilizer usage from 22kg/ha in 1978 to 8kg/ha in 2006.

Fertilizer subsidies were restored shortly afterwards to mitigate acute crisis. Evidently, the subsidies in this case did not prove sustainable and employing the same strategies in terms of fertilizer subsidy today, only masks a root problem. ‘

Inherently, subsidies schemes of this nature necessitates that it ought to remain a fundamental component of agriculture in the country to sustain the sector. In this regard, subsidies create dependency and do not reflect prudent use of resources.

Implicationsof t nutshell, subsidies sk general and specific ghana ed then, that, in an economy with no robust data suggesting the size of t

Summarizing key points made above, subsidies in themselves to not drive economic development. Rather they divert scarce resources away from the factors that drive the growth of the economy.

To maintain subsidies, government’s options are limited to borrowing, increasing taxes, or diverting even more resources from key growth areas. In each of these cases, it’s the ordinary citizen and businesses that bear the brunt of these choices. Presently, a 17.5% VAT on banking services looms on the horizon, amidst power cuts, lack of water, and a shortage of petroleum products in the country.

Government arrears to BDCs and its concomitant effect on fuel supply also play out across other areas – Agriculture, School Feeding Programme, Power sector, etc. In essence, the government’s financially suicidal policy of deploying subsidies within these sectors has dire consequences for the financial fortunes of private sector actors.

In the Power sector, subsidies have led to under recoveries by Independent Power Producers (IPPs). Also slow repayments and continuous government interference in the setting of market prices, has led to the inability of suppliers in the Power sector value chain to upgrade their equipment to ensure efficiency in their service provision.

Since 2012, government has defaulted in payments to suppliers of subsidized fertilizers within the fertilizer subsidy programme.

Arrears owed to caterers and their respective suppliers under the School Feeding Programme have negative externalities, with school children being fed low nutritional meals.

Way Forward
Holistically, majority of the mainstream subsidy programs have failed in their goal to protect the vulnerable in society. Rather, it has bred a culture of dependency amongst these groups.

With regards to driving development needs through investments, the underpinning problems are evident, and need to be tackled head on. Rather than ‘dumsor dumsor’ limiting productivity and driving down industrial growth, consumers will be willing to pay the ‘real’ price for commodities when guaranteed efficiency, minimal wastage and a no tolerance for corruption approach.

Ghana cannot deploy subsidy programmes in the footprints of developed economies when it obviously lacks the commensurate financial wherewithal to be sustainable. Government must formulate coherent policies that collectively address the development issues of the country.

As an alternative to these mainstream subsidy initiatives, well targeted social programs which empower the poorest groups, to be productive, to create livelihoods for themselves and create incentives for them to educate their children should be pursued. In the next set of reports, IMANI and other leading think tanks will be exploring scenarios under which removal of subsidies will not completely derail efforts at holding inflation down.

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