Nobel prize-winning economist Douglass North observed that “economic history is overwhelmingly a story of economies that failed to produce a set of economic rules of the game (with enforcement) that induce sustained economic growth.” Frequently basic economic truths are willfully disregarded in a cynically calculated process of short-term electoral gains. In the long run, however, the practice of politically motivated economically unsound policies has the unsurprising effect of impoverishing the economy.India is a case in point. Despite being endowed with substantial human and natural resources, it has failed to provide the majority of its citizens the basic necessities for a decent life. An important contemporary example of a flawed economic policy is the subsidy that the consumers of petroleum enjoy.The price of a barrel of crude is hovering around $100 and yet the price of petrol at the pump remains essentially what it was when crude was selling at half that price about a year ago. The resultant gap between the cost and the price has to be bridged through a subsidy that is estimated to be around Rs 70,000 crore this year. The case is made that by keeping the price artificially low, the so-called “common man” benefits. But that is certainly not the case. It is a perverse subsidy for a number of reasons.First, it is the “uncommon man” who actually benefits directly from the subsidy. In fact, the wealthier you are, the more vehicles you own, the more subsidy you capture. For every litre of petrol or diesel you consume, you benefit by around Rs 10; for every cylinder of LPG, someone else chips in Rs 250. The really poor person does not own cars or have a gas connection. Second, when distorted low prices do not reflect the full costs, it sends the wrong signals and consumption is more than is socially optimal. India meets about three-quarters of its petroleum needs through imports at an approximate cost of $50 billion a year. Increased consumption inflates that import bill and is economically wasteful. Third, the burden of the opportunity cost of the subsidy falls squarely on the people who cannot reap its benefits. The resources that the subsidy consumes are not available for services that help the poor like subsidies for public transport, primary health and education. Fourth, the subsidy is financed by bonds issued to oil marketing companies. These bonds represent a future liability. Essentially it is a mechanism employed by the present voting generation to secure benefits that will be paid for by the future generations who do not have the option to reject that burden. Fifth, if prices reflected true costs, alternatives such as better public transportation system stand a better chance. It would lead to more conservative use of private cars causing less congestion and pollution.The basic economic truth is that there is really no such thing as a free lunch. Today’s subsidy comes at a cost that will only grow, the longer the delay in pricing petroleum products at full cost. Raising the price at the pump is the simplest but the most politically risky solution. The UPA knows that and will definitely not risk losing power even if raising prices is for the larger benefit of the economy.But those subsidies have to be reduced, if not totally abolished overnight. A start could be made by reducing the subsidy to the rich while continuing it for the poor. A mechanism for doing so would be to impose a tax on car owners which would reflect the full cost of the petrol they use. Depending on the size of the engine and average fuel consumption, an annual fee could be assessed which has be paid to maintain registration. So if a particular make and model of car typically consumes, say, 1,000 litres of petrol a year, the tax could be Rs 10,000. This type of a mechanism would leave all two-wheelers, three-wheelers, and buses untouched. Since it is usually the common man who uses public transportation, he would continue to enjoy the subsidy. Implementing rational economic policy is not impossible for India. The writer is a development economistatanudey@gmail.com
