The fallacy of competitive energy prices

Islamabad:

The interim government, in its latest policy move, chose to raise gas prices while rejecting the idea of ​​removing subsidies for exporters.

Export subsidies have been a contentious and persistent issue in Pakistan’s economic landscape for a long time. The government’s tendency to extend these subsidies to the export sector, often dressed up in tax breaks and reduced energy prices, has been a matter of debate.

Advocates, including notable figures such as the current interim Commerce Secretary, advocate this strategy as a guaranteed method to boost exports and boost economic growth. However, it is imperative to recognize the significant disadvantages involved in pursuing such export subsidies.

One of the main arguments in favor of these subsidies focuses on providing the export sector with competitive energy prices. The rationale is that by offering low-cost electricity and natural gas in the export sector, Pakistan can become more competitive in international markets.

This perception has been deeply rooted in the national discourse throughout time. However, the reality is very different.

The implementation of a fixed interest rate approach through subsidies, especially in the export sector, has had negative effects on the economy. The practice of subsidizing energy prices simply hides the underlying reality of higher production and end-to-end transmission costs within the economy.

One aspect of this equation that is often overlooked is that the export sector does not exist in isolation. It operates within the same economy and shares the same infrastructure to obtain electricity, natural gas or any other input. The increased cost of energy is an immutable fact and cannot magically disappear.

Regardless of the subsidies given at various stages of the supply chain and inputs, the total cost of producing the same goods for the entire economy remains constant. If anything, these subsidies actually increase overall economic costs.

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The key distinction is that these subsidies shift the burden of energy costs from business owners to the general public, allowing businesses to make profits they otherwise would not have earned.

A consistent pattern of poor returns is the most telling indicator of financial inefficiency. Such patterns undoubtedly signal a pressing need for reallocation of resources.

Export subsidies contribute to resource misallocation and inefficiency by directing resources to inefficient industries. This inadvertently neglects the most efficient sectors, distorting the economic landscape and causing overproduction in subsidized industries.

Such subsidies distort trade and constantly require government assistance, a practice that is persistent and ultimately unsustainable.

In practice, government subsidization of inefficiency reinforces rent-seeking behavior, which is a significant barrier to the flow of capital into efficient sectors such as the information technology (IT) industry.

Government export subsidies have had a significant fiscal impact. From FY20 to FY23, the government provided electricity and liquefied natural gas (LNG) subsidies under the guise of an industrial support package and zero industrial subsidies, totaling Rs 339 billion.

A significant portion of these funds were directed to export-oriented and zero-rated industries. Since the government acts as a net borrower, the cost of these subsidies, at the average interest rate, amounts to a whopping Rs 460 billion.

read more Rs 1.54 trillion in electricity subsidies are sought

In addition, the sector received Rs 436 billion in funding through the Temporary Economic Refinancing Facility (TERF). While the full details of the beneficiaries remain unknown, a significant portion likely found its way into businesses aiming to boost exports or promote import substitution.

The opportunity cost of this package continues to rise due to rising interest rates, currently at Rs 668 billion and still rising. This includes the impact of financial subsidies that have been allocated only in the last 4.5 years.

It is important to consider the aforementioned benefits as well. To put these figures in perspective, the cumulative cost of the industrial subsidy package and TERF, amounting to Rs 1.1 trillion, would be enough to finance the Bhasha Dam power generation project.

Alternatively, these resources could have been used to establish more than 40 hospitals similar to the Shaukat Khanum Cancer Hospital, build hundreds of top IT universities or fund 11,000 start-ups with funding of Rs 100 million each.

These resources could have been directed towards improving transmission efficiency, which would have substantially reduced the cost of electricity.

These are just a few examples to illustrate opportunity cost. By focusing on export subsidies, the government is effectively prioritizing an inefficient subset of a single sector over other critical aspects of the economy, hindering overall growth and progress.

Although often presented as a solution to economic growth, export subsidies continue to have a significant negative impact on Pakistan’s economy.

The idea of ​​providing competitive energy rates and tax relief may be politically enticing, but the long-term consequences are far from desirable.

While export subsidies may provide temporary relief in some sectors, they have high fiscal and opportunity costs, distorting the economic landscape. It is important for Pakistan to review its approach to subsidies and focus on sustainable economic growth based on productivity and efficiency to ensure a more stable and prosperous future.

The author is a member of PRIME, an independent economic think tank based in Islamabad

Published in The Express Tribune, November 20^u2023.

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