THE government allowed export of 500,000 tonnes of sugar earlier this month and approved a cash subsidy of Rs10.70 a kilogram to bridge the gap between domestic and international prices, which currently stand at $499 and $376 a tonne, respectively.

That the government has to provide subsidy to make sugar exports possible, because domestic prices are much higher than international ones, is a textbook example of the distortion caused by subsidies.

Distortion occurs if the quantities of goods produced and exchanged or their prices are higher or lower than they would be if conditions of competition prevailed. Support or subsidy by the government ensures higher prices to producers than they would get otherwise.

Subsidy has both winners and losers. Major beneficiaries of the price support are big growers while the beneficiaries of subsidised exports are sugar mill owners

The higher prices, according to the law of supply, stimulate higher production. The domestic or production subsidies lead to surplus production, that is, the level of domestic supply is higher than domestic demand.

In order to dispose of the surplus production in foreign markets, the government provides export subsidies. Export subsidies are the subsidies which are contingent upon export performance: the more an enterprise exports, the more subsidies it gets.

In case of sugar, the government first fixes the support price of the commodity, which is normally higher than the price the growers would get under competitive market conditions.

The greater the sugar output, the more benefit do the growers drive.

This means the subsidy is calculated to benefiting politically influential big growers. In this way, we have a distortion at the production stage.

During 2016-17, the sugar output was recorded at 7.1 million tonnes against the domestic demand of 5m tonnes. In December 2016, the Economic Coordination Committee of the Cabinet allowed export of 225,000 tonnes of sugar without subsidy till March 31, 2017.

The deadline was extended to May 31, 2017 on the request of the Pakistan Sugar Mills Association, which commands substantial political clout.

However, due to the big gap between the domestic and world prices, it was difficult to export sugar without the subsidy. Therefore, the government has now decided to subsidise the export of sugar.

Here a question arises: if the subsidy can be an instrument of driving up output and export of sugar, or for that matter any other product, what’s wrong with it?

The answer is that the subsidy has both winners and losers. Major beneficiaries of the price support are big growers, while the beneficiaries of subsidised exports are sugar mill owners.

The losers are the consumers, as export of sugar will raise its domestic price. The government may even have to import sugar to stabilise its domestic price, which, again, will create rents for sugar suppliers. In this way, they will derive a double benefit. It has happened in the past in case of both sugar and wheat.

Besides, since the subsidy is made from the public exchequer, it is the taxpayers or the consumers that will bear the brunt of the subsidy. This amounts to adding insult to injury for the consumers (paying higher price for sugar as well as subsidising its export).

A subsidy, according to the World Trade Organisation’s Agreement on Subsidies and Countervailing Measures, is a financial contribution from the government to one or more enterprises which confers a benefit on the recipient. Cash subsidy is one of the several forms of subsidisation.

Tax concessions or rebate given by the government to an industry is another form of subsidy. Over the years, the corporate sector has become heavily dependent on government subsidies.

Earlier this year, the government unveiled a Rs180 billion package for the exporting sector in the form of removal or reduction of import duties and internal taxes on several products. The major share went to the textile sector.

The argument in favour of subsidies is that they enable the enterprises to control their average and marginal costs of production. Since cost control is on a high premium in a competitive world, government support can be an important instrument of export increase.

Such an argument seems convincing at first, but it rests on a lopsided view of competitiveness. For an enterprise, competitiveness depends on not only external factors, such as provision of cheaper electricity and inputs as well as direct cash transfers but also on internal factors.

These include presence of professional management, high productivity of the workforce, commitment to quality, efficiency in production processes, product upgrade and development, and effective marketing. Mere government support cannot make an enterprise competitive.

At times, government support may make it difficult for an enterprise to take the painful but, eventually fruitful, internal reforms as it does not feel compelled to do so.

Recently, the visiting president of the International Apparel Federation (IAF) impressed upon the need for product and brand development for increase in exports in a competitive environment. “Whether you want to remain a source of low cost products or add value, the choice is yours,” he said.

Firms compete on the basis of not only price but also quality. As the above-referred remarks of the IAF chief bring out, Pakistan remains an exporter of low quality, low value-added manufactures.

This is because our enterprises by and large do not attach high importance to product development. Being largely family businesses, they are content with doing the things the way they have been doing for decades. Exports are difficult to bound ahead in such circumstances.

Published in Dawn, The Business and Finance Weekly, October 16th, 2017