Consumer Predilections and Price Subsidies

Subsidies in India on essential goods like water, electricity, food is a manifestation of political populism . It is a known fact that as the general elections drawing near , each political party irrespective of ideology or political mandate offers some good utilitarian or otherwise at a subsidized rate to lure the voters . The present government in the interim budget estimates bill of Rs 1,15,000 crore for food subsidies. Such fiscal largesse heavily impacts the national exchequer.

Similarly the promise of providing free supply of 700 litres of water every day for Delhi households with metered connections or slashing power tariffs by the Delhi government are onerous for a electricity and water suppliers who are already inundated with poor revenue streams.

It is pertinent to examine the behavior of consumer when goods are given to him in at subsidized rate. By looking at how the subsidies affect individual consumption we can assess the impact on utility of the consumer.

Subsidies create distortion in prices. They tend to reduce prices and encourage consumption. However these consumption decisions have a potential to generate negative externalities, if these subsidies are not allowed judiciously.
This is typically true in case of electricity and water which when provided indiscriminately encourages over consumption and crowds out responsible behavior.

The skewed consumption pattern, for electricity and water in particular, apart from promoting wastages tend to have deleterious environmental consequences. Some of which may be irreversible.

The subsidized electricity given to farmers free of cost for years is one such glaring example After the advent of the green revolution, in an attempt to bolster the agriculture consumption, many states like Punjab shifted to supplying electricity at subsidized rates.

Several states like Andhra Pradesh, Madhya Pradesh, Maharashtra, and Punjab, as populist measure started supplying electricity free to farmers (Dubash & Rajan, 2001). In Punjab where irrigation is dependent on tube wells , such subsidization had a negative impact on environment. Free power to pump water meant that the marginal cost of water for pumping additional unit of water was zero. Such subsidies altered consumer behavior and promoted wastages and over consumption of water. Such wastages led to falling ground water table. It is estimated every year in Punjab the ground water tables are falling by half a meter.

The falling ground water table meant that the farmers are required to pump water from deeper bore wells resulting in higher consumption of more electricity to irrigate the same fields. This has led to a divide between farmers who are relatively rich to afford irrigation pump sets and marginal farmers who cannot afford them . It also created parallel ground water markets where the large and medium farmers sold water to small farmers who could not afford irrigation pump sets.

The dwindling of water table has been a direct outcome of altered consumer behavior to overuse electricity which was supplied freely or at subsidized rate . Much like what the social scientist calls the “law of unintended consequences”
These subsidies have been disproportional and regressive and benefited the large and medium farmers. The state electricity boards too, lost a lot of revenue on account of such political populism. Power sector subsidies remain an important fiscal drain exceeding 1 percent of GDP in India. Thus any price subsidy needs to factor-in the consumer behavior; bias and the costs of negative externalities before being doled out.