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Breaking the Unhelpful Subsidy Cycle
Economy, Domestic Economy

Breaking the Unhelpful Subsidy Cycle

Providing subsidies on important social services such as medical care, education, etc. together with a reliable system of ‘wealth and income distribution’ would be better alternatives to cash subsidies. The government needs to stop experimenting with unreliable models and trust informed minds to walk the country out of the crisis.
With more than 1,620 trillion rials (approximately 110 billion dollars based on average official exchange rates) spent by the government on cash subsidies since March 21, 2010, one is compelled to ask what are the benefits of cash subsidies for the country’s economy after all, and is the government willing and able to put an end to this wasteful cycle?
Surprisingly, the government’s capital budget over the same period has been 63 percent of the amount spent on cash subsidies, standing at 1,030 trillion rials (approximately 70 billion dollars based on average official exchange rate). The shocking data shows that it is using oil revenues mostly to cover its current expenses which is in fact similar to a “food-for-oil program”.

  Subsidy Reform
Since taking office on August 4, 2013, President Hassan Rouhani has been skeptical about the former government’s so-called ‘Subsidy Reform Plan’. Former President Mahmoud Ahmadinejad was so confident about the benefits of implementing this plan that he called it “the biggest surgery on the nation’s economy in half a century” and “the most important undertaking in Iran’s recent economic history”.
Ahmadinejad who promised to “bring the oil revenues to the people’s pockets” during his presidential campaigns in 2005 but failed to achieve any outstanding economic or political success during his presidential term till 2010, made a hasty decision to implement the subsidy reform plan. The outcome was disastrous: Inflation rate increased (due to the injection of high powered-money), cost of living almost tripled in urban areas, unemployment and economic recession continued and even got worse.
“The government has been spending billions of dollars since 2010 on cash subsidies but nothing has improved ever since. Some try to highlight the benefits of cash subsidies for rural families, while in fact more than 70 percent of Iranians live in cities”, a political activist commented on the issue.
Iran used to be the largest provider of fuel subsidy by 2009. Almost everybody agreed that the government’s subsidy policies had to change. But, “it is impossible for the administrations to run the economy through charity”, suggested a fellow journalist with nearly 40 years of experience. Ahmadinejad took minimum advice from economic experts. He was quite confident about his own decisions as “he was an engineer and knew everything”.
The former administration conducted a vast political campaign (in Ahmadinejad’s populist way) to convince the parliament that cash subsidies are beneficial and that the government is able to handle the policy’s side effects. But evidently, their ability to handle the situation did not even get close to expectations.

  Living Costs    
Over the past five years, the living cost in Iran has risen dramatically but wages have not. The cost of living in cities has increased than twice, based on data by Statistical Center of Iran. The average living expenses for an urban housefold was about 99 million rials per year in 2009-10 (the year before the initiation of subsidy reforms). The urban households’ average living expenses was estimated at 205 million rials in 2013-14, showing more than 107 percent increase in just four years.
On the other hand, the urban households’ average annual income did not increase enough to cover their increased expenses. The average annual income of urban households in the Iranian calendar year ending on March 20, 2014 showed 92 percent increase compared to the year ending March 20, 2010.
Yet, most experts believe the data released by the government organizations do not reflect the whole picture but only (the less unpleasant) part of it. Analysts suggest that the average cost of living for urban households in fact increased by more than 200 percent from 2010 to 2014, while the average incomes hardly increased by 92 percent – that too in the best-case scenario.

  Stagflation
The government’s monetary policy has created a gap between the consumers’ incomes and expenses by injecting high-powered money to the economy which in turn resulted in stagflation.
“Stagflation, a portmanteau of stagnation and inflation, is a term used in economics to describe a situation where the inflation rate is high, the economic growth rate slows down, and unemployment remains steadily high.” It raises a dilemma for economic policy since actions designed to lower inflation may exacerbate economic recession, and vice versa.
When inflation rises to ten percent or more, it creates a spiral which causes even higher inflation. Money loses value so fast that business and employee income can’t keep up with costs and prices. Foreign investors avoid the country and the economy becomes unstable. On the other hand, lower income in consumers’ side reduces market demand, decreases manufacturings and lowers the economic growth.
The Rouhani administration took office in August 2013, at a time when stagflation had reached its maximum level in the country and unfair sanctions against Iran was pushing the country over the edge.  

  Income Inequality
Another consequence of the former administrations’ “Subsidy Reform” policies was income inequality. In 2010, following the implementation of Subsidy Reform Plan, the Gini Index – a measure of statistical dispersion intended to represent the income distribution of a nation’s residents, with 0 indicating perfect equality and 1 indicating maximum inequality – dropped to 0.3813. The index dropped further to 0.3750 in 2011 to register a two-decade record low. However, as it was anticipated by many economists, the money injected into the economy through the cash payment mechanism led the inflation rate to increase with an unprecedented pace, reaching nearly 40% in October 2013.
What resulted from such galloping inflation was a widening rift between the social classes, making the poor vulnerable to the rising prices, to the extent that they significantly lost their purchasing power. The Gini index reportedly took an upward direction since 2011 and reached 0.3944 by the end of the fiscal year ending March 20, 2014.
The decision is up to Rouhani now; whether to do the right thing or walk the path of populism. Fortunately, the right thing (a trustworthy economic model to exit the current situation) is already known to economists. It has been experienced for years by countries, such as Norway, which are now regarded as the worlds’ developed economies.
President Rouhani needs to prove that his government of “Hope and Prudence” is determined to act in line with national interests and will stand against anything violating this principle even if it is a “chain of wrong decisions” made by the former administration.

Short URL : http://goo.gl/nptAfA

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