WHY GOVERNMENT PROVIDES SUBSIDY AND WHAT ARE THE EFFECTS TO THE ECONOMY

Introduction

A total of RM50 billion was spent by the Malaysian government on the subsidy in 2008 and major portion of it goes to petrol and gas, while RM4 billion was allocated for subsidies on food items. Generally, most of the countries in the world are providing subsidies in managing their economic activities. The question is why the government going for that strategy, as in Malaysian case the amount of money allocated for subsidies is almost the same amount allocated for the development and infrastructure projects.
To note, subsidies account for 14% of the Government's total operating expenditure in 2005 from the average 2% to 3% in the 1990s, before coming down to 10% in 2007. However, since at end of the last year, the government had forgo the subsidy on petroleum products in tandem with the drastically decrease in crude oil price.
Globally, according to national accounts statistics, 69 countries had spent around $300 billion on subsidies in 2003. Of which, 21 were developed countries which were spent $250 billion on subsidies. The average ratio to GDP was 1.4 per cent for developed countries and 0.6 per cent for developing countries.

Definition of Subsidy
Subsidy is a measure taken under the fiscal system where a financial assistance provided to a business or economic sector with an objective to support the business or to encourage activities of business that would otherwise not take place. It may come from government as well as others such as firm or non-governmental organizations.
Business dictionary define subsidy as payment or other favorable economic stimulus given by government to certain individuals or groups of economic entity, usually to encourage their continued existence, growth, development, and profitability.
Subsidy also regarded as a form of protectionism or trade barrier by making domestic goods and service artificially competitive against imports.

Type of subsidies
There are many types of subsidies fall under direct subsidies. These type of subsidies are the most simple, and arguably, the least frequently used and involves a direct cash transfer to the recipient.

Indirect subsidy is a term sufficiently broad that it may cover most other forms of subsidy. The term would cover any form of subsidy that doest not involve a direct transfer.

The other subsidies are labor subsidies, tax subsidy, perverse subsidies, production subsidies, regulatory subsidy, infrastructure subsides, Trade protection, export subsidies, procurement subsidies and consumption subsidies.

The reasons why government provides subsidies

One of the reasons why government intervene is to ensure the supply is enough in the market. In doing this, the government will provides assistance to encourage producers to produce enough supply in the market. The assistance could be in form of discount on machinery cost, providing fertilizer, seeds and others. The intention is make the production cost low and attractive, thus will encourage people to involve in this business as well to ensure the supply is enough and the people could get it at the reasonable price.
In Malaysian, government for so long has providing subsidy to paddy planters by supplying them with the fertilizers. The government also fixed paddy price below the market price to ensure that there is no increase in price of rice. However, when government preventing the increase of paddy price, the government needs to pay a subsidy to the paddy planters to cover the different in price should the government let the price is determined by the market force.

In the fuel subsidy, government has pays the different amount between the pump price and the market price. Government is controlling the price at aiming to prevent the multiple effects resulted from price increase because the fuel is used in every process starting from producing raw materials until it reach to consumers.
The government provides subsidy to reduce the price fluctuations and to ensure the price is maintain at the lower level, government will set the ceiling price on the specific products. However, by doing this it could lead to the shortage of supply in the market because the producers eventually will reduce the supply due to lower price. To overcome the problem, government will compensate the producers the different price between ceiling price and the competitive price.

Besides the economic related reason, the move taken by the government to provide subsidies also based on the political factor. By providing subsidies, the government is look concern to the people welfare. The government needs to take a popular measure for their political survival. In United States of America, politicians both at the federal and state levels aggressively used subsidies as a means to appease constituents and to solicit campaign contributions from private firms. Subsidies made it possible for members of Congress to direct federal money to their own congressional district, which thus allowed the member to present the subsidies as evidence of their commitment to constituent service.
In the social strata, the majority of people fall in the lows level income group. These people are the most affected if the price of goods and services increased in the market because their purchasing power would shrink. A caring government will not allow it citizens to suffer and will ensure that everybody share the wealth of the nation by provides an assistant to them such as subsidy in education, water supply, electricity and other basic need.

The subsidies also provided by the government to support the creation of new knowledge through research & development. Under this program, government would provide grant to the organizations to undertaking research and development projects or the organization would get tax exemption on the money it spent on the R & D. R & D is crucial to the nation especially on developing high technology because it could spur the economic development towards the industrial country.


The Effect on Economy

Subsidies are good for politics but bad for economics. As mentioned above that political decision is among the reason why government introduce subsidy in the national economic policy. Many economists believe that providing subsidy for the long run is bad for economics and distort the economic development. The money spent on subsidy is much useful for development project. To the economist, the RM10billion channeled to development spending will contribute about one percentage point increase in gross domestic product in nominal terms.

Subsidies will created low price elasticity of demand. With the government intervene the price of products are not determined by the market force, but by the government. The government the one who will set the price either the ceiling price of the floor price. However, for the agricultural based products, the prices are unstable depending on the volume of harvest for the particular season. The low yield will resulting the less supply and theoretically under the competitive market the price of product will increased, but since it was controlled by the government the price will be remained. However, to achieve equilibrium, government needs to increase the subsidy pay to the farmers to ensure the supply is enough in the market.

However, if there is no subsidy and the price is not controlling by the government the inflation will sharply increase and people will suffer especially to those in the medium and lower income groups. Inflation will shrink their purchasing power and the people is become poorer and many products could not be sold
The subsidy is supposes means to ease the burden of people from the lower income group. However, in reality, many of subsidies provided by the government also benefited the wealthy people. Subsidy also went to big firms or companies that involves in the same industry with the small farmers. It is defeated purpose

Conclusion
Providing subsidies is common policy under the fiscal economic system. However, the way of implementation will be determining the successful of the policy. To achieve it, the government must ensure that there is no leakage in allocation, misused of fund and the most import thing is the assistance is reach at the target group. Based on the present economic condition, providing subsidies would be continued to be implemented in the many countries.