Advancing subsidy reforms: towards a viable policy package.

Executive Summary: World subsidies may total some $800 billion, of which perhaps two-thirds occur in the developed economies of the OECD. Reforming subsidy regimes that damage the prospects for sustainable development is immensely complex. Simply calling for subsidy removal is unlikely to succeed. The complexity arises from the fact that subsidies are manifestations of rent-seeking, which, in turn is part of a wider category of unproductive activity in economic systems. Rentseeking involves redirecting economic resources to special interest groups rather than using resources productively. Interest groups then use those resources to reinforce their privleged positions. Subsidy reform will inevitably conflict with those special interests. The idea that subsidy reform is a ‘win-win’ policy is therefore misleading – there will always be losers, even if they are undeserving losers. In many cases, the most harmful subsidies will be those that are least easy to remove. Subsidy reform is therefore about dissipating rents, has to be part of a wider programme of macroeconomic and political reform. Subsidies are often linked to corruption, thus emphasising the difficulty of securing the political changes that are needed. Moreover, instituting democratic reform is not sufficient either: democratic societies have even larger subsidy regimes than less democratic societies. Political change has to be combined with economic reform. Some have advocated ‘sudden shocks’ whereby dramatic events are seized as an opportunity to institute reform. There is some evidence to suggest that if a crisis does occur, it may be best to implement subsidy reform along with other transitional measures in one large package. An alternative is to let the almost inevitable growth of subsidies produce economic bankruptcy, and then institute reform. But many societies have proved surprisingly resilient whilst sustaining extensive subsidy regimes, and the costs of waiting may not be acceptable anyway. In the absence of crisis, a gradual approach is best. Policies need to be pre-announced and gradual subsidy reduction needs to be combined with careful public awareness campaigns and efforts at political transparency and accountability. Bilateral and multilateral lenders have a strong role to play, even though reforming subsidies as part of a conditionality package is still controversial. Reform almost inevitably involves privatisation since exposure to market forces is essential for rent dissipation. Nonetheless, reform is complex and its success if difficult to guarantee: for example, privatisation may simply shift rents from the public to the private sector. Subsidy regimes seem peculiarly resilient to change.