Aug 27, 2014

Cash Subsidies & Financial Inclusion

Over the years there have been thousands of hours invested in debating how to deal with the Egyptian budgetary drain, the  subsidies. The context of that debate hasn't been whether we need to have subsidies or not (we do need them) but rather is the current subsidy system economic (has little waste) and effective (reaches target audience). These debates have resulted in two different propositions, each presented by members on opposing economic ideologies.

The first is that the government should invest in improving the subsidy supply chains as well as the quality of the subsidies themselves. While this is a noble and expensive approach it fails to take into consideration a few things. For one that the government is really broke and doesn't have the financial or human resources to do such investments. More importantly that the government will have to deal with established enterprises benefiting from these supply chains. Seeing the government's track record it's difficult to see this really working.

The alternative approach, recommended by the liberals and capitalists, is to float the prices of goods and services, phase out the subsidies and price control mechanisms, and introduce a cash subsidy. This way the subsidy recipient can prioritize his expenditures based on his own realities and needs. Furthermore this should increase consumer expenditure and empower markets. Finally and most importantly, the government would have an easier job targeting subsidies to people that needed and therefore reducing waste. That would be done through linking subsidy levels with tax filings or wage level. Although there are many obvious challenges to implementing this (recipients gaming the system, subsidies increasing to match inflation levels, growth of oligopolies and monopolies) the main challenge is different. It is how do we connect millions of Egyptians (businesses and individuals) to the grid. The failure to do so would result in an uproar of all these people who will suddenly wake up to realize all the prices have gone up and they have no methodology of benefiting from the system.

In order to deal with such a challenge, the government must put a well plan medium term transition plan from in-kind to cash subsidies, where it would prioritize subsidy regimes that involve a high percentage of connected individuals (petrol subsidies) and leave to the end ones that have a high number of off-the-grid recipients (bread). Through-out this transition the government would be slowly changing the ratio of in-kind to cash subsidies all while creating awareness on the importance of connecting to the grid. But before anything, the government needs to figure how it will technically architect the system, the last thing it would need is to have parallel, dis-connected subsidy in cash regimes. This would only increase the chances of the system being gamed.

Recently India has been attempting to do a similar transition in its subsidy mechanism, it has been facing major challenges with the level of financial exclusion. Read more about India's experience here.