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Beyond cheap unga: Do subsidies really work?

By X.N. Iraki | May 28th 2017 at 12:11:13 GMT +0300

Subsidised housing in London, Canada. How many Kenyans live in such houses? [XN Iraki]

The headlines over the last one month have been dominated by the price of unga, Kenya’s staple. The debate, in my opinion, has more emotions than facts; not unexpected in an election year.

Food is an emotive issue and this year we shall experiment if it’s a vote-getter. Some blame the Government for unga shortage, others the drought. It is another issue why we equate food in Kenya to ugali or anything derived from some flour.

Let us distill the emotions in the debate and look at the bigger picture – subsidies. Oxford Dictionary defines a subsidy as “a sum of money granted by the state or a public body to help an industry or business keep the price of a commodity or service low”. Unga is not the first item to be subsidised. Health, education, maternity, vaccination, fertiliser and housing in slums have been subsidised; maybe for so long that we do not notice. For unga, it is literally our daily bread, we notice keenly.

The price of a packet went down to Sh90. The Government will pay the millers the difference between the market price and the subsidised price. Did this decision make economic sense? How do subsidies work elsewhere? Are there unintended consequences?

Set price floor

The immediate consequence of this subsidy is as expected - shortage of cheap flour. Everyone rushed to buy the cheaper unga. But it goes further than that; why can’t I buy the cheaper unga and sell it at higher price because there is a shortage? That is Economics 101, arbitrage. Unga sellers can be more creative, they can demand you buy something else like sugar or tea leaves before you get subsidised unga. They used to do that when prices of everything was controlled.

Another problem; how do you ensure that sellers do not go beyond Sh90 per packet? Do you hire price police?

And why is the subsidy at the end of the supply chain? The most logical thing is to put it at the start of the supply chain, in the farm. Suppose instead of a price cap for maize flour we get a price floor for maize so that it does not fall below a certain price. If it does, the Government pays you the difference. Example: If the minimum price (floor) is Sh3,500 per bag and the price in the market falls to Sh2,500, the Government pays the difference of Sh1,000 to the farmer. A good price floor should be above the equilibrium price.

What will happen? The farmers will produce more maize because they are assured of a good price. The millers will have enough maize and the prize of unga will fall. We could export surplus maize or turn it into animal feed. A win–win solution.

This would have another advantage; farmers have more votes than millers. But the Government wanted a quick solution, hence getting to the end of the supply chain. 

Kenyans who have “eaten a lot of salt” can recall we once had something like a price floor; guaranteed minimum return for wheat and other strategic crops. The Government guaranteed the farmers a certain minimum price in case of price fluctuations. I am told lots of Kenyans became ‘farmers’ to exploit this loophole. The project died.

Political appeal apart, subsidies distort the market and have unintended consequences. If the Government subsidises maize farmers, they have no incentive to become more productive and lower the cost of maize production and make profits. If subsidised, the millers have no incentive to become more efficient (they can merge and reduce costs) if they are guaranteed a profit.

Those receiving subsidies have no incentive to improve on quality or become innovative. Subsidised industries are protected from the gale of creative destruction (thanks Joseph Schumpeter) resulting from innovation. A good example is telcos. If the US government had subsidised fixed-line owners after the original AT&T was split up in 1982, we would still be using telephone booths. The small companies (Baby Bells) from the split had to compete for the market. They became innovative, unleashing the mobile phone revolution that spilt over to Kenya and the rest of the world.

Subsidies lead to low quality. In Kenya, higher education is highly subsidised, with some university students paying less than children in private kindergartens. Students in public institutions should not complain about overcrowding in classes, lack of textbooks or unmotivated teachers. Subsidised education leads to overproduction of less-marketable degrees because students do not feel the pain of paying. Check the courses Government-sponsored students are taking in private universities.

Open window for others

When we distort the market system someone pays the price, usually the taxpayer. The money going to subsidies could have better uses in other sectors of the economy. The truth is that subsidies (and tariffs) usually benefit those who can lobby hardest. In the long run, a few benefit at the expense of the majority. Gordon Tullock put it very succinctly: “In many instances subsidies redistribute wealth from a large number of unknowing contributors to a smaller number of beneficiaries.” Politically, subsidies are very expedient but not in economics.

The other problem is that once you introduce subsidies in one product or sector, you open a window for others to ask for more. Did you hear the Government ask schools to release certificates for students with fees arrears? Did you hear one governor demand that schools be reconnected to water system despite arrears? Maybe soon there will be a subsidy for the unmarried to pay dowry which has skyrocketed because of market forces. What of unintended consequences, some which cross the borders? Subsiding coal leads to pollution and climatic changes that know no borders. Subsiding fishing could lead to overfishing in international waters, often treated as the “international commons”.

Subsidies are necessary for the disadvantaged members of the society. The big problem in Kenya is determining who needs subsidies and who does not. In other countries, an individual’s data is well kept from birth to death including from residences, work places, taxes and convictions. This makes it easier to determine who needs subsidised food, housing, education, health services and even jobs.

Subsidies are a global issue at the World Trade Organisation (WTO). The meeting in Nairobi in 2015 set to end export subsidies on foods, which lead to huge surplus in exporting countries and to lower prices in importing countries, mostly developing countries. The lower prices in importing countries make it hard for local farmers to compete. Sounds familiar?

Heinz Strubenhoff of Brookings Institution notes: “In the long-term, this system undermines competitiveness of food production in both exporting and importing countries.” From steel to agricultural products, subsidies have rarely left the headlines.

- The writer Senior Lecturer, Department of Economics, at the University of Nairobi.

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Unga Government subsidy commodity prices
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