End-user subsidies

Policy Instruments

Description

Subsidies are typically provided to stimulate demand for products that have socially desirable outcomes. In the past, subsidies on goods have often been provided to the companies that produce them. Governments are increasingly seeking to bolster market forces and stimulate competition among firms by providing subsidies directly to the products’ users. These kinds of subsidies may also drive user-oriented innovation and efficiency gains. Subsidies can also play an important role when users need some initial experience in order to grasp a product’s benefits or where positive external effects exist. As consumers adapt to the new product, subsidies can be rolled back or discontinued.

Vouchers are one method by which to administer “smart” subsidies to end customers. Vouchers have the advantage as compared to cash transfers that their use is predefined, thus directing expenditure towards the specific products or services with the desired social benefits. Moreover, voucher schemes can represent a partial subsidy, which – unlike giving out products for free – allows firms to gauge user demand and willingness to pay. The level of the subsidy can subsequently be reduced over time as customers start to recognize the value of the products.

Points to consider

Instrument:  Subsidies can be expensive and can displace commercial purchases. To determine the most appropriate and effective subsidy instrument, it is critical to first identify the market failure that it should address and whether that market failure is real or perceived.
 

Implementation:  End-user subsidies require careful implementation. Eligible target groups must be clearly identified and any agreements with intermediaries should be defined to ensure that the subsidy is properly distributed. Subsidies should build on existing private distribution networks. As with all financial incentives, subsidies are prone to abuse and it is necessary to maintain a clear understanding between the theory and the practice of how it is being implemented.
 

Timeframe:  While user subsidies can, in principle, be used to correct market failures and stimulate markets, experience suggests that they are often difficult to terminate. Therefore, establishing a credible, time-limited exit strategy is crucial. If stakeholders expect the support to continue indefinitely, they are less likely to prepare for a point in time when consumption of the inputs will take place purely and sustainably on market terms.

Case Example

India: National Mission on Micro Irrigation

The growing population and demand for food security in India in the early 2000s led to a need for increased agricultural production. Increasing the use of irrigation in agriculture would be critical to meeting this need.

In 2006, the Government of India launched the Centrally Sponsored Scheme on Micro Irrigation, which was later expanded as the National Mission on Micro Irrigation (NMMI). The objective of the program was to save water, reduce poverty and enhance food security.  As part of the program, most states began to provide a subsidy for the cost of installing a micro irrigation system. Many states subsidized over 70 percent of the cost, however the portion covered by the subsidy varies from state to state. The subsidy is limited to 5 hectares per farmer and farmers must use their own funds or borrow to cover the remaining portion of the cost. Farmers must apply for the subsidy and the implementing agency is tasked to process applications within 60 days.

As a result of the program, the area under micro irrigation increased from 11,817 hectares in 2005 to over 3.6 million in 2012.  While total irrigated land is only 5 percent of the total potential area, an evaluation of the program in 2014 showed that farmer productivity increased 40-50% and that the cost of irrigation declined, on average, by one third. Micro irrigation also helped farmers to reduce their use of electricity and fertilizer.

Source:

Policy Case Study

Further Examples

Additional Resources