J. Atsu Amegashie* The Economics of Subsidies

The removal of subsidies on agriculture, health, education, petroleum products, etc is one of the key policy prescriptions by the World Bank to developing countries. Presumably, this policy is supposed to enhance economic performance in these countries. However, the removal of subsidies can have adverse effects on the poor in these countries and lead to political agitation as evidenced in the 2005 demonstrations after the ruling NPP government in Ghana removed the subsidy on petrol. But is there a compelling economic argument or basis for the removal of subsidies? Will this policy necessarily improve economic performance? In this article, I shall provide answers to these questions. Modern neoclassical economics is based on perfectly competitive markets. More than fifty years ago, the Nobel Laureates Kenneth Arrow and the late Gerard Debreu proved the existence of competitive prices under very restrictive conditions. Under certain conditions, a competitive equilibrium not only exists but is also efficient (i.e., maximizes the size of the national pie or maximizes social welfare). In this world, there can be no role for governmen