Subsidies and Overall Economic Development in the Developing Countries - Research Paper Example

Subsidies are financial assistance provided by the government of a country to some of its domestic firms or a specific industry or sector (Schaffer, Agusti & Earle 374). The governments of different countries allocate subsidies to its industries with a variety of objectives both in direct and indirect forms. However, the central purpose of levying a subsidy is to keep the price below the level normally determined by the market forces in the sector in which the subsidy is provided and accelerate the course of development in the entire nation (Moltke, McKee & Morgan 23). In particular, subsidies are provided to those industries or sectors which are lagging behind the other sectors in the economy in terms of performance or are not being able to perform up the expected level. In this paper we shall focus on the subsidies provided by the governments of the less developed countries (LDCs) and developing countries. In these countries subsidies are provided by the government on the trading of different goods and services, and can be categorized as energy or fuel subsidies, agricultural subsidies and educational subsidies. However, the World Bank and the IMF has stated that subsidies act as barriers to investment in the developing country by foreign and international companies. This in turn proves unbeneficial for the country’s long term development. It is in the country’s own interest towards its development that the government should abolish subsidies and promote perfect competition. This paper aims at examining the relationship between subsidies and economic growth in the context of developing countries. The Research question The research question addressed by this research paper can be described well with the help of some small questions. They are; do subsidies result in increasing the overall economic development and growth in the developing countries? What is the importance of the subsidies for the developing countries? How do subsidies impact the government spending and federal budget? How do subsidies influence the operations of the international companies in these developing countries? In order to answer these questions the relationship between subsidies provided by governments and economic development of the developing countries will be examined. Literature Review The subject about impact of subsidies on the developing countries is quite researched upon. Before going into the details of my research work I shall review some of the existing literature on this topic in this section. Peacock elaborates in his paper the role of subsidies is important in the overall welfare of the economy (Peocock 323-335). Although elimination of subsidies on necessary goods, such as agricultural products, medicines and other items related to health sector and the petroleum products, is a key policy prescription for the developing countries by the World Bank, no persuasive theory has been developed supporting this policy. Amegashie states in this context that the governments of the developing countries should exercise caution in following a process of removing subsidies since it might give rise to agitation on part of the citizens (Amegashie 7-15). In his paper, Amegashie has compared the logic put forward by the World Bank and the IMF justifying the validity of perfect competition with the fact that while subsidies are readily recognized as forces creating distortion in a perfectly competitive market they are not so in a non-competitive market. There are some studies that reflect upon the negative aspects of providing subsidy. The paper by Munro and Ussif (233-250) discusses the adverse impact cast by subsidies on the fisheries management in the North Atlantic. Their paper demonstrates that subsidies on fisheries can have serious negative impacts on distribution of income, management of resources in fisheries and sustainability. Besides examining the effect of subsidies on the welfare of the economy as a whole, it is also important to investigate in what way do subsidies affect the performance of the companies. García‐Quevedo (87-102) has explored in his paper the ways in which subsidies affect business organizations. Another field of study is the effect of subsidies on productivity of firms. Bergstrom (183-193) has presented a paper in which he has demonstrated that although subsidies influence growth positively, there is not much evidence to support the fact that subsidization leads to rise in productivity. Methodology This section on research methodology is included in this paper with the aim of providing an overview of the design of the procedure followed for this research. The research design allows the researcher to form a structure that has been followed in the course of conducting the study. This is the theoretical framework for analyzing the effect of subsidy on the phenomenon of growth in the developing countries. The research method adopted is quantitative in nature and has been conducted with the help of the secondary data. Quantitative data facilitates measurement of the findings with the help of numerical values (Babbie 24). The secondary data about the subsidies provided by the governments of the developing countries along with the data pertaining to their economic growth is available from different websites and databases like that of World Bank and IMF. A regression analysis is made to generate a cause and effect relationship between the subsidies and economic growth. Further has been gathered in relation to the impact of the subsidies on the government spending and international trade from the reliable websites of the different governments, the World Bank and other databases. Findings and Analysis Importance of subsidies The importance of subsidies can be judged from the implications of the policy of subsidization. The impact on output has to judged taking into consideration several climatic factors along with the procurement of subsidies. The estimated value of output of maize for the year 2008-2009 was 2.4 million tones. But the actual value of output of this crop was more than 2,5 million tones in this year (Wiggins & Brooks 11). The value of output has also increased for some other crops in this period. This can be attributed to the favorable rains that have occurred during the year. Therefore making measurements of the impact of subsidization on agricultural factors of production is a complex task. A regression analysis has been made with the amount of increase in output of maize on the quantity of subsidy provided. The experience of providing subsidy to the target population has been positive on the whole. The effects are visible in two ways; the increase in the level of output of the main food crop produced and consumed in the economy and the reduction in the cost of living of the common people of Malawi. Impact of subsidies on the Federal budget The impact of energy subsidies on the Federal Budget has been investigated in depth and analyzed in a report published by the Senator, Lamar Alexander. the report describes four principal forms adopted by the Federal energy subsidies provided by the government and its interventions. These forms are direct expenditures, tax expenditures, research and development and “Electricity programs serving targeted categories of electricity consumers in several regions of the country” (Federal Financial Interventions and Subsidies in Energy Markets xi). The report shows that the energy specific funding and support given by the Federal government to every form of energy is estimated for the fiscal year of 2007 at $16.6 billion. Since the year 1999, the subsidies in this sector have doubled in terms of real 2007 dollars (Federal Financial Interventions and Subsidies in Energy Markets xi). Yet the production of energy has remained unchanged between the years of 1999 and 2007. Although huge amount of subsidy has been provided coupled with significant rise in energy price and modest growth of energy consumption, an array of other factors are held responsible for impeding the growth of energy production. Impact of subsidies on international business firms The interests that the host government safeguards in making its “monetary and fiscal policies” (Ajami & Goddard 225) might not be in compliance with the interests of the multinational firms that are operating in these countries or are on the way of making investments in these countries. For instance, let us consider a situation in which the host country is faced with inflationary pressures. In this situation the government would raise the rates of interests at which the banks can give out loans. A higher rate of interest would reduce demand for loans. As the demand for loans falls, investment falls. This on one hand proves beneficial from the point of view of the government of the host nation, since a high rate of interest leads to lowering of inflation rate; but, on the other hand, the cost of investment to the foreign firm operating in this country would rise. Consequently, their cost of production would increase. This might hamper foreign investments in the developing countries. The other effect is perceived in terms of money supply. While the government would possibly direct the banks to maintain big sums of ceilings on loans in order to cut the level of liquid supply of money in the economy, the foreign corporations would want to retain its sources of financing its requirements so as to be able to employ them as and when necessary. This discrepancy of desires might give rise to displeasure and punitive actions on part of the government. Fertilizer subsidies in Malawi The practice of providing agricultural subsidies in Malawi can be traced back to the mid 1970s. There was a short halt in the early 1990s in the provision of subsidies during the ear of widespread liberalization. But it has again began in the later years of the 1990s with packs of seeds and fertilizers, that is sufficient to cultivate ten percent of one hectare of land, being provided to the small farmers. The purpose of this provision was to increase production of food crops and in turn improve the income of the farmers. The subsidization policy has been successful to the extent that production of the staple crops, such as, maize increased compared to the previous years. However, owing to bad harvests in the years between 2001 and 2005, excepting the year of 2003, the output did not match the level of expectation. In the financial year of 2006-2007, the government provided the target households with vouchers summing up to two million units of seeds and three million units of fertilizers. The recipients could buy two bags of fifty kilograms each at a subsidized price of twenty eight percent of the full price (Wiggins & Brooks 10-12). Conclusion The fact cannot be denied that subsidies play a major in the developing countries. Subsidies are crucial in transforming the “centrally-planned economies to market economies” (Anti-dumping, subsidies, safeguards: contingencies, etc ). The import substitution subsidies are aimed at protecting the indigenous industries from the sharp international competition. But after they become capable of competing in the international market, they should not be offered the protection of subsidies. The less developed countries should also abolish export subsidy within the stipulated time period framed by the World Trade Organization and be stopped given any preferential treatment. The pattern of intervention by the government is explained by two prominent theories; “the public interest theory of regulation” (Posner 336) and the capture theory of regulation. However both these theories require development in the modern context in order to remain acceptable. Emphasizing on the question central to this discussion, it has to be accepted that subsidies remain an important part of the economic activities of the developing countries. Although ideal policy prescriptions provided by the international institutions like the World bank and the IMF advocate abolition of subsidies from the developing countries, a complete abolition would hamper the normal economic activities of these economies. Further empirical investigation is necessary before the theory of regulation can be confronted boldly and the demolition of subsidies might be considered an appropriate policy by the governments of the developing economies. The importance of subsidies to the developing countries is explored in this paper alongside the impact it has on the interests and performance of the big foreign corporations operating in more than one nation. Form the discussion the fact emerges that subsidies are required not only to bring growth in terms of higher output but also to support the poorer section of the population to help them maintain a basic standard of living. References Amegashie, Atsu. "The economics of subsidies." Crossroads 6.2 (2006): 7-15. Print. “Anti-dumping, subsidies, safeguards: contingencies, etc”. Understanding the WTO: the agreements, 2013. Online Ajami,Riad A. & Goddard, Jason G. International Business: Theory and Practice. 2006. M.E. Sharpe. Babbie, Earl. The Practice of Social Research.2010. Cengage Learning. “Federal Financial Interventions and Subsidies in Energy Markets”. Energy Information Administration, 2007. Online. Moltke, Anja Von, McKee, Colin & Morgan, Trevor. Energy Subsidies: Lessons Learned in Assessing Their Impact and Designing Policy Reforms. Greenleaf Publishing, 2004. Print. Peacock, Alan T. "Welfare economics and public subsidies to the arts." The Manchester School of Economic & Social Studies 37.4 (2001): 323-35. Print. Posner, Richard A. “Theories of economic regulation”. The Bell Journal of Economics and Management Science 5.2 (1974): 335-358. Online. Schaffer, Richard, Agusti Filiberto & Earle, Beverley. International Business Law and Its Environment. Cengage Learning, 2008. Print. Wiggins, Steve & Brooks, Jonathan. “The Use of Input Subsidies in Developing Countries”. Policies for Agricultural Development, Poverty Reduction and Food Security (2010):1-22. Online. Read More