Subsidies: A double-edged sword that must be dealt with carefully

SUBSIDIES have been an important policy instrument in many countries from economic, social and political perspectives.

According to the World Trade Organisation, a subsidy is defined as a financial contribution by a government that provides a benefit to its recipients.

Subsidies, whether provided to producers or consumers, are a form of transfer payment. Unlike expenditures, subsidies do not generate direct value-added

In general, subsidies are one of the mechanisms to foster economic development and help disadvantaged groups in the effort to further boost business investment and improve quality of life.

Subsidies, if implemented appropriately, are able to counteract market failures and externalities to attain economic efficiency.

In times of economic recession or higher global commodity prices, subsidies can assist in stabilising the prices of essential goods to protect households against sudden price shocks and subsequent inflationary pressures.

Nevertheless, subsidies can also be harmful to the economy as they may cause price distortion and further contribute to market imperfection, causing wastage and misallocation of resources.

In addition, inefficient and untargeted subsidy implementation may exacerbate inequality due to disproportionate benefits accorded to certain households and industries.

Subsidies can impose a significant burden on the government as they require a large amount of allocation.

Certain subsidies, such as those provided for fossil fuel, undermines the environmental agenda as it promotes carbon emissions and worsens air pollution.

Subsidies act as a double-edged sword, while they may benefit certain individuals or industries, they can also have negative and unintended consequences.

As global commodity prices increase, subsidies can cushion the impact of higher prices of goods and services yet potentially increasing the government financial burden and reducing fiscal space.

A broad definition of subsidies is required to capture different forms of government intervention, both explicit and implicit.

The International Monetary Fund generally classifies subsidies based on the following seven categories: cash subsidies (direct government payment to producers or consumers); credit subsidies (interest subsidies or soft loans); tax subsidies (reduction of specific tax obligations); equity subsidies (government equity participation); in-kind subsidies (government provision of goods and services at below-market prices).

The categories also include procurement subsidies (government purchases of goods and services at above-market prices); and regulatory subsidies (implicit payments through government regulatory that alter market prices or access).

According to the World Bank, Malaysia needs to phase out broad-based subsidies and move towards subsidies through a cash transfer mechanism to better support vulnerable groups.

The mechanism is proposed to be applied gradually and reviewed periodically to avoid an abrupt subsidy removal that could lead to a sharp increase in inflation.

The subsidy rationalisation aims to enhance efficiency in the economy and rebuild fiscal space while minimising the risk of economic shocks.

In 2022, total subsidies recorded an all-time high of RM70.3bil, as compared to an average of RM15.2bil for the past 10 years and almost equal to the development expenditure of RM71.6bil.

This was triggered by, among other things, the Covid-19 pandemic, geopolitical tension and climate change, affecting global commodity prices.

In addition, the government also provided RM24,3bil for a one-off wage subsidy programme during the pandemic period as an effort to sustain jobs and reduce retrenchment.

Overall, this programme has benefitted close to 360,000 employers to retain about 1.95 million local employees.