In July 2010, Prime Minister Datuk Seri Najib Abdul Razak announced that the government would conduct subsidy reforms through a gradual elimination of subsidies in fuel and sugar.

Fast forward to the end of this fiscal year, government spending on subsidies (mainly on cooking gas, toll charges and transport) will in fact be substantially reduced from RM26 billion to RM17 billion. But has the government really reduced its subsidies?

The rationale behind subsidies is straight forward. The government partially pays for goods or services which citizens can then purchase at a reduced price. The policy goal is to support consumers’ purchasing power by protecting them from volatility in prices. However, blanket subsidies are not only ineffective, they also do not reach targeted beneficiaries.

Firstly, the difference between the market price and subsidised price has to be paid for eventually. The money may come from income taxes (which reduces income), or by contracting more debts (which increases the nation’s liabilities in the future).

Secondly, subsidies do not differentiate the income levels of beneficiaries. A high-income individual enjoys the same subsidies as a person with a low income. In fact, high-income individuals will benefit more from subsidies simply because he or she will consume more.

Thirdly, subsidies are bad as they interfere with the price signals of an open economy. A higher cost, say, an expensive car or a house, under normal circumstances, would reduce buyer demand. Thus demand is rationalised. However, when the subsidy is factored in, consumers will purchase the item, not realising its actual cost.

Consumers then buy more, when in fact they should buy less. This increases the pressure on suppliers to produce more goods, and the government is then locked into providing more money to subsidise the increased production.

A clear example of this is fuel subsidies. Malaysians, thinking that fuel prices were affordable, consumed more and the government was pressured into maintaining low prices until it could no longer support it. Subsidies misguide both customers and producers, and in the end, the economy loses.

Cash transfer programmes, although more targeted than blanket subsidies, also creates the wrong type of incentives. 1Malaysia People’s Aid programme (BR1M), for example, was supposed to be temporary but it has now grown into a yearly affair.

Demand has only been increasing and the government has committed itself to a budgetary item that will only increase year after year. Although subsidies have been reduced overall, BR1M allocation has been steadily increasing over the years from RM2.5 billion, when it was first introduced in 2013, to RM6.8 billion this year, an increase of 172% in four years.

Given the opacity of fiscal data, it is difficult to estimate the real burden of subsidies on Malaysia, particularly since the government has also been giving out subsidies in the form of spending on government-linked companies, incentives and discounts. The point here, nevertheless, is that subsidies do not really solve the problem, they merely hide it.

Should the government then scrap its BRIM programme? The short answer is no. There are scores of examples in the world where conditional cash transfers have helped.

However, measures such as BRIM should have a clear sunset clause or certain caveats should be in place, such as giving cash handouts only in the case of emergencies. Some subsidies can also be conditional. Linking receiving of subsidies with receiving high skills education can, for example, be socially advantageous.

Overall, Malaysia needs to undertake a comprehensive review of our current subsidy system, not just to determine the exact amount of subsidies that are being provided, but to also develop a clear strategy on how to move forward.

Ali Salman is director of research at the Institute for Democracy and Economic Affairs

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