Introduction
For decades, countries across the globe have used food and fuel price subsidies as a form of social protection. A subsidy is a financial contribution provided by a government or public body that confers a benefit to a producer or consumer, which may include direct budgetary payments, tax breaks, low-interest loans, or other forms of financial incentives. Thus, a subsidy has three basic elements: a financial contribution, a government or public body as the source of the contribution, and a beneficiary.
From an economic standpoint, subsidies serve to relocate resources, altering economic activity to achieve more desirable outcomes than would occur otherwise. Subsidies can be an effective policy tool when addressing market imperfections, where competitive private markets fall short in delivering socially beneficial outcomes. The economic rationale for government subsidies can be categorized into three primary areas: correcting market imperfections to enhance efficiency; achieving economies of scale in production, especially for domestic firms, to overcome initial competitive disadvantages; and addressing social policy goals, such as supporting low-income individuals, redistributing income, and promoting employment.[1]
As such, subsidies can broadly be categorized as follows:
- Consumption subsidy
The government can offset part of the expenditure for citizens/households to maintain their real consumption levels. This is through direct payments made to consumers, reduced taxes on the subsidized consumer product, or through price controls that set the price below the prevailing market levels. Food subsidies are a good example, with vouchers or direct payments to facilitate purchase at grocery stores. Consumer subsidy schemes for widely consumed goods such as bread, rice, sugar, and cooking oil fall into this category. There are also subsidies for healthcare services and medications offered to individuals who cannot afford to pay for themselves out of pocket. In other circumstances, subsidies are provided to cover the cost of education and water access, particularly in areas where these services are not readily available or are prohibitively expensive. While consumption subsidies are an important part of social safety nets for the poor, they are expensive and therefore not sustainable, particularly if they are not well-targeted.
- Production subsidy
Production subsidies encourage the production of certain commodities in a country. Usually, when a good or service costs more than people are willing to pay for it, it does not get produced since there will be few buyers in the market. Consequently, producers will not be able to sell enough of that good or service to cover their costs and make a profit. As a result, they may choose not to produce that good or service. For example, for manufacturers to increase their production, the government compensates for some of its production cost to reduce their prices while increasing their output. For example, fertilizer and seed subsidies are offered to reduce the cost of production and boost agricultural production. In addition, price support programmes are offered to help farmers maintain a minimum level of income when market prices for their crops fall below a certain threshold. This is achieved when the government purchases goods at prices higher than those in the market. For instance, in Kenya, the government, through the National Cereals and Produce Board, buys maize from farmers at a price higher than the prevailing market price. This is done to cushion farmers from making financial losses. Research and development subsidies are also considered as types of production subsidies because they are aimed at encouraging industries to invest in research and development to support the production of new and innovative products or technologies. However, production subsidies can make producers to oversupply goods to a given market than they would have otherwise supplied, which can depress prices and affect producers who are not benefiting from subsidies, particularly in the context of cross-border trade.
- Export subsidy
Exports are important drivers of economic growth and can influence macroeconomic stability. Financial support is offered to exporters in the form of direct payments, tax breaks, or other incentives to make their goods more competitive in international markets. For instance, in the 1970s and 1980s, Kenya implemented the export compensation fund, which aimed to provide cash compensation to offset import duties paid on inputs used to produce certain qualified manufactured exports. The objective was to stimulate the production of non-traditional manufactured exports. However, this programme was discontinued in the early 1990s due to its limited influence on the performance of manufactured exports. The initiative suffered from multiple shortcomings, including unclear criteria for eligible export products, insufficient incentive value, strict eligibility conditions, and burdensome paperwork and procedural requirements.
- Employment subsidy
This is an incentive the government gives to employers to enable them enhance job opportunities. This is done through wage subsidies or payroll tax credits to employers, either by offsetting some percentage of the wages paid to hire new workers or as a fixed amount per employee. However, wage subsidies can be difficult to target effectively, as employers may be reluctant to hire workers who do not have the skills or experience, they are looking for. Additionally, in a situation of widespread unemployment, employment subsidies may be very expensive for the government in the long run as they may need to provide them over a long period to significantly impact on unemployment.
v) Energy subsidies
Energy subsidies, as defined by the International Energy Agency (IEA), are government policy actions aimed at lowering energy production costs, increasing revenue for energy producers, or reducing costs for energy consumers. In essence, energy subsidies exist when the prices paid by consumers, including both firms (for intermediate consumption) and households (for final consumption), are lower than the total supply costs, which include transportation and distribution expenses. These subsidies can be implemented through various methods, such as government budget transfers, policies that impact energy costs for specific customer groups or regions, government-induced transfers between producers and consumers, tax exemptions, and under-pricing of energy-related inputs. Energy subsidies influence prices directly, such as grants and tax exemptions, or indirectly, such as regulations favouring particular fuels or technologies. Government decisions regarding energy subsidies depend on factors such as the total programme cost, administrative expenses, and the impact on different social groups (UNEP, 2008).
Experience with Subsidies
Subsidies are mostly intended to enhance human welfare and achieve social policy objectives, for instance to protect the poor and increase employment.
Production – fertiliser subsidies
Fertilizer subsidies have been implemented since 2009 to ensure availability and access to affordable farm inputs and promote agricultural productivity. In 2009, the government subsidized fertilizer to sell Di-Ammonium Phosphate (DAP) and Calcium Ammonium Nitrate (CAN) fertilizer at a reduced price of Ksh 2,500 and Ksh 1,650 per 50kg bag, respectively, from a high of Ksh 3,500. This was achieved by the government procuring 40 per cent of the national fertilizer requirement.
In September 2022, the government similarly introduced fertilizer subsidies to increase productivity and ensure food security. The subsidy led to decrease in fertilizer prices. For instance, 50 kg bag of DAP fertilizer decreased by 49 per cent from Ksh 6,900 to Ksh 3,500 while a 50 kg bag of Urea fertilizer decreased by 44 per cent from Ksh 6,300 to Ksh 3,500. Notably, the government further reduced the price in August 2023 to Ksh 2,500 per 50 kg bag to ensure affordability by farmers during the short rains planting period. It is expected that the subsidized fertilizer will reduce the cost of production and increase output, thereby reducing the cost of food and improving food security issues in the country.
Consumption – food subsidies
In 2009, the government introduced urban food subsidy programme in response to a prolonged drought and effects of post-election violence that led to increase in prices of basic commodities such as maize. The programme was introduced by an inter-ministerial task force in collaboration with Concern Worldwide, World Food Programme (WFP) and Oxfam. It targeted the most vulnerable in informal settlements of Mukuru kwa Njenga and Korogocho in Nairobi and Nyalenda in Kisumu. The targeted households (5000) received humanitarian cash assistance of Ksh 2,000 per month for 8 months. Due to its success story on cushioning poor households, the government in 2015 expanded the programme to cover 68,000 households in Mombasa, Nairobi, and Kisumu. The international non-governmental organizations continued to support the government through provision of technical and capacity building support.
Further, following a prolonged drought which saw increased food prices, the government similarly offered subsidies on maize and maize flour in 2022. Specifically, the government through a Gazette Notice published on 20th May 2022 provided a waiver of import duties and levies on non-genetically modified organisms (GMO) white maize of not more than 540,000 metric tonnes. Further, the government granted a subsidy of Ksh 105 per 2 kg on retail prices of sifted maize flour that lowered the cost of 2 kg maize flour to Ksh 100 from Ksh 205 in August 2022. However, the subsidy was suspended in September 2022 due to inadequate exchequer releases from the National Treasury. The waiver of import duties and levies on white maize and the subsidy on retail prices of sifted maize flour was expected to moderate domestic prices but was deemed unsustainable. It also resulted to shortage of the subsidized maize flour in the retail shops.
Energy – fuel subsidies
In 2021, fuel prices stabilized following the COVID-19 pandemic shock, but international fuel prices increased sharply in the first quarter of 2022. This led to a rise in domestic fuel prices, necessitating the use of subsidy to cushion citizens against the adverse effects of the high prices. The Energy and Petroleum Regulatory Authority (EPRA) in July 2022, for example, noted that petrol, diesel, and kerosene prices would have increased to Ksh 209.78, Ksh 193.70 and Ksh 181.16 per litre, respectively, without the subsidy. However, with the subsidy, petrol, diesel and kerosene retailed at Ksh 159.12, Ksh 140.00 and 127.94 per litre, respectively, during the same month. The government spent an average of Ksh 7.65 billion monthly to subsidize diesel, petrol, and kerosene. The subsidy was not only costly to the government but also led to artificial shortages of fuel in the country. This necessitated a review of the subsidy in September 2022, where EPRA removed the subsidy on petrol but retained it on kerosene and diesel following a presidential directive. From September 2022, fuel prices remained elevated with petrol, diesel and kerosene selling at Ksh 179.20, 165.00 and Ksh 147.94 per litre, but eased slightly in the months of October and November 2022. However, depreciation of the Kenya shilling against the dollar, rise in international prices and increase in VAT tax of 8 per cent on petroleum prices has increased fuel prices to retail at Ksh 217.36, Ksh 205.47 and 205.06 per litre of petrol, diesel and kerosene, respectively, in Nairobi as of 15th October 2023.
The other notable fuel subsidies in Kenya are electricity, cooking gas and urban food subsidy programme. In January 2022, the Ministry of Energy gazetted the approval of new electricity tariffs that reduced electricity by 15 per cent as a measure by the government to lower electricity tariffs. As a result, the cost of domestic consumption reduced by Ksh 4.06 per kWh from Ksh 25.93 in December 2021 to Ksh 21.87 in January 2022 whereas commercial industrial (1-415 Volts) reduced by Ksh 4.19 per kWh from Ksh 23.85 to Ksh 19.66 during the same period. The revised tariffs were part of the proposed 30 per cent reduction directed by the President during the Jamuhuri day celebration in December 2021 that was to be implemented in two tranches of 15 per cent each in 2022. As a result, the National Treasury offered Kenya Power and Lighting Company (KPLC) a Ksh 7.05 billion subsidy in June 2022 to allow the utility cut consumer electricity bills by a further 15 per cent without affecting its cash flow. However, the electricity subsidy was not extended by the government beyond its expiry date of 31st December 2022 due to it being unsustainable.
The cooking gas subsidy was introduced by the Ministry of Energy in 2016/17 to cut reliance on kerosene and charcoal. However, its implementation was hindered by suppliers who provided faulty cylinders. In 2022, the stalled subsidy scheme was revived with a new allocation of Ksh 471 million for 2022/23 with a proposal to increase the amount to Ksh 820 million in 2023/24.
Opportunities for Subsidies as a Policy Tool
Economic subsidies, while well-intentioned, can be both beneficial and costly to the government. Scrutinizing and retaining only useful and welfare-maximizing subsidies is essential.
Different categories of subsidies are geared towards different objectives. There are those that directly enhance efficiency by promoting activities with positive externalities. For example, the ongoing fertilizer subsidy continues to boost agricultural productivity, ensuring food and nutrition security while reducing food inflation. The second type encourages societal gains, like the first category but with the aim of promoting cleaner alternatives, such as the cooking gas subsidy. This subsidy reduces taxes on cooking gas, driving the adoption of cleaner energy, and mitigating deforestation and health issues associated with wood fuel. The third type involves production-reducing subsidies, discouraging activities with harmful externalities. While not currently implemented in Kenya, the National Agricultural Soil Management Policy suggests potential benefits in promoting soil restoration. Well-planned subsidies contribute to growth, development, and economic justice by providing resources to the poor, correcting market inefficiencies, and supporting critical industries.
However, subsidies come with risks. Misuse and wastage may occur, for instance where targeted beneficiary purchase the subsidized products and resell them to non-targeted population at higher prices. Additionally, subsidies can also stimulate demand, causing supply shortages and potential market inefficiencies. The financial burden on governments, especially in developing countries, may result in higher taxes and deadweight losses, undermining economic efficiency. Furthermore, blanket subsidies may exacerbate income inequalities.
As a way forward, where government intends to promote the greater good, subsidies should be well targeted and utilized only as temporary measures or better implement targeted social protection initiatives targeting vulnerable individuals and entities.
[1] Clements et al. (1995), Government subsidies: Concepts. International Trends, and Reform Options. IMF Working Paper No. WP/95/91.
Authors: Dr James Ochieng’, Principal Policy Analyst, Macroeconomics Department
Hellen Chemyongoi, Policy Analyst, Macroeconomics Department
Daniel Omanyo, Policy Analyst, Macroeconomics Department
