POLITICIANS ARE ALL WRONG ON SUBSIDIES

The subsidy debate in Zambia has had the unintended effect of exposing the level of economic understanding of different political leaders in Zambia. Some of them have exposed their limited understanding or complete ignorance through carefully prepared statements while others simply let their unguarded thinking out in unplanned social forums.

First, I will begin by stating the correct position on subsidies. The PF government is actually right in principle concerning these subsidies, even if they are doing it in the absolutely wrong way, which exposes their own failure to understand what they are doing. In what sense are they right? The subsidies are simply unsustainable, and they are ultimately bad for everyone. It’s like the so-called coupons in Kaunda’s time, in which the UNIP government subsidized the mealie-meal so that people could afford to buy this food. It’s nice to be kind to “the people,” but you cannot break economic laws, just like you cannot break scientific laws.

In short, it is like giving people free food. If your money can buy only half of the bag of mealie meal, giving you a subsidy means that you are getting the other half for “free.” But as the Economist Milton Friedman famously said, there is no such thing as a free lunch  — even if it is prepared with good old mealie-meal. Someone is paying for that other half. The question is “who?” Who is paying, since the government doesn’t produce any money of its own? It is the tax payers who are paying for everyone. Although everyone pays taxes through VAT, most of the money the government has comes from a few formally employed people and companies, which means these are the ones footing the bill.

That’s simply an unsustainable situation, because it is very expensive to subsidize food, fuel, and fertilizer. You can’t have a few people paying for the food, fuel, and fertilizer of everyone else. Morally, it is wrong and unfair; economically, it discourages enterprise and hard work when you know most of your money will be taken by the government. It punishes productivity, in short, and simply promotes dependency by distorting reality for many people. Soon enough, you break the back of the few people carrying the burden of the rest and you have a bigger crisis.

So far the PF is right to recognize that these subsidies are practically unsustainable. But what they will apparently do with these subsidies shows that they do not understand WHY it is wrong. They just know that it is wrong without bothering to understand why, and this is what will make it a dangerous policy for everyone – including themselves.

If they knew why, they would immediately give that money back to the people they were taking it from in the first place: the tax payers. The people and the companies that have been giving them this subsidy would get some relief. Companies will be encouraged to expand their businesses and thus to employ more people if they could pay less taxes. Their workers will also be paying less taxes now, which means they can spend more of this money buying more things, which would mean more business opportunities and more  companies, which means more tax payers, etc etc. Relaxing regulations and other pro-business policies helps this process of increased economic activity. The government will find itself collecting even more money from taxes as the tax base broadens.

The late Margaret Thatcher and Ronald Reagan both understood this simple principle. Although they have been brutally criticized by many people who viscerally hated them for being “heartless capitalists,” no one can refute their results without just focusing on some irrelevant details. The fact is that they both inherited economies in crisis and they left a booming, dynamic and optimistic entrepreneurial economy by the time they left office.

Unlike the PF’s plan of redirecting their subsidies to other “pro-poor” expenditures, they followed their reduction on social spending and subsidies immediately with lowered taxation and reduced corporate regulations (and pursued privatization aggressively in the case of Thatcher), etc so that the capital could easily be put to use by the productive sector, without any other hindrances, instead of remaining in the hands of government bureaucrats to mismanage even more. Removing subsidies is only the first correct step; it has to have the goal of freeing up money for producers and productive workers. Without that goal you are just creating a political crisis for yourself with no benefit to anyone.

The PF has understood step 1 – stop the subsidies — but they ended there. Instead of giving back the money to the tax payers, they have decided that they will just transfer this subsidy to other areas; other “priorities” of spending. Whether they transfer it to some new subsidies or they use it for new “developmental projects,” it is still a mistake. They should have given it back to the tax payers, and when they finally get their increased revenues from the lower taxes, they could use that extra money for whatever they want. Even John F. Kennedy, a Democrat, understood this classical principle and also reduced taxes and gained more revenues.

Before Mister Michael Sata was elected, he actually seemed to understand this economic principle. It is how he justified his endless promise of reducing all taxes drastically and killing the VAT completely (neither of which he has done). Whenever he would be pressured by journalists to explain where he would get his money for his big development promises after reducing taxes so drastically, he would basically explain correctly that reduced taxes can lead to more government revenues. Besides the process described above, reduced taxes also reduce the incentive for companies to evade – or even to avoid – taxes; why take that risk when what you are gaining by tax evasion is so small?

Unfortunately, most of the opposition leaders have disappointingly shown that they have an outdated version of economics.

Dr. Nevers Mumba of the MMD condemned the PF for now practicing “capitalist” economics when they allegedly campaigned on “socialist” promises. He is demanding that the PF should go back to socialist principles! Who would have known that the day would come that the party that was formed to oppose Kaunda’s failed socialist policies would today oppose a ruling party for supposedly changing to capitalist policies?

Mr. Hakainde Hichilema had a Twitter debate with a Zambian citizen who understood that subsidies are wrong and unsustainable. Mr. Hichilema disagreed. Without investigating his facts, Mr. Hichilema suggested that the subsidy on fuel is probably smaller than the subsidy the government gives to its ministers (for fuel in their cars, etc), a comparison that is ridiculous even just intuitively. It is nice-sounding rhetoric, of course,  but you can only say that if you know it for a fact. His opponent promptly corrected this simple factual error, leading Mr. Hichilema to digress into even more shocking economic opinions.

Mr. Hichilema suggested that subsidies are actually good for economic development, a claim he can only back by confusing correlation with causation: because Western countries like the USA etc have had subsidies, this must be what caused them to develop. Correlation is not causation, Mr. Hichilema. Those countries were also wrong to have subsidies, but because they are very rich, they could afford to have them without immediately seeing the negative effects. It’s like a rich man spending millions on alcohol consumption every day: you can’t just imitate his lifestyle if you are a poor neighbour, and you would be wrong to think that his alcohol consumption is what has made him rich. Correlation is not causation. Ultimately, the unsustainable folly of subsidies catches up even with the very rich, as the debt crisis in Greece and other countries has shown.

As his Twitter debater, Mwimbu, pointed out to Mr. Hichilema, if it was true that subsidies spur economic development, this same fuel subsidy could have spurred some development in Zambia by now, especially since fuel is important in production. It hasn’t. It can’t.

Elias Chipimo Jr, it turns out, is the only one among opposition leaders who at least understands that the subsidies had to go. I disagree with his solution, but unlike Mr. Hichilema and Dr. Mumba, he at least has his economics right on the effect of such expensive subsidies. Mr. Chipimo, like his other youthful colleague (Hichilema), also used social media (both Twitter and Facebook) to express his position on the matter. He correctly recognized that subsidies are wrong and unsustainable, even while disagreeing with the method taken by the PF, including their timing, their communication, etc. In short, he believes they are simply mismanaging a good idea and this will backfire on them. This is a reasonable position.

But Mr. Chipimo’s call for “cushioning” the social effects of removing the subsidy is fraught with contradictions. How exactly are they supposed to cushion the effects of such a policy on the farmers, the taxi drivers, the small businessmen, the workers, etc (basically everyone) without undermining the same policy? The only way to “cushion” is by giving them money or spending money on them somehow; it wouldn’t be by giving them comforting speeches like Chiluba supposedly did. But if you cushion the effects of the subsidy by giving them money – in whatever form – how have you solved anything? You give them subsidies to reduce the pain of removing subsidies?

Mr. Chipimo gives other points that he believes would solve the problem of managing this policy. He says that if the PF had communicated with the public well, like Chiluba did concerning his controversial Structural Adjustment Programme (SAP), they would have “avoided unnecessary confrontations” with the protesting students, etc. This is simply not true. Chiluba, as great a speaker and communicator as he was, did not avoid confrontation with the UNZA students over his SAP policies. They did also protest his policies, and even more violently than the current students have done. Students will always protest (Thatcher had much more than student protests); the issue is whether your policies can turn out to be right or wrong, in a bearably short time. Unfortunately, Chiluba’s and Finance Minister Ronald Penza’s SAP policies were not combined with low taxation and simplified regulations, unlike Reagan and Thatcher, which completely limited their success. It is the same problem that the so-called “austerity” measures in Europe will ultimately face.

Mr. Chipimo’s biggest mistake is that he too doesn’t seem to understand that the only way this subsidy removal would be good for the economy is if the PF government would simultaneously reduce the taxes that were sustaining it. Like everyone else supporting the subsidy (including the World Bank), he too is repeating empty bromides like “we need to use that money for national development projects” instead of subsidies. What exactly would this “national development” expenditure be which is any better than using it for fuel or fertilizer price reduction? These don’t contribute to “national development” by your definition? How would anyone even know that these other “pro-poor” expenditures you have in mind would be better than subsidies on maize, fertilizer, fuel, etc?

We cannot afford to experiment with people. The only effective use of the subsidy “saving” would be non-use: the Zambian government should give the subsidy back to the tax payers through tax reduction. In fact, this would even be the best “cushioning” they can provide. The tax reduction can be shared across corporate taxes, income taxes, value added taxes, etc, as the PF had promised in their campaigns, and this would relieve some burden on the people as they can now buy some other things more cheaply, thus saving some money to spend on the items that have been unsubsidized. This would be even better than Margaret Thatcher, who didn’t reduce the VAT in her first year but raised it. Of course the PF would have to find more areas for spending reduction in order for this to be more practical. In the end, they will still gain more in tax revenues, if they keep supporting the productive environment.

The biggest question is whether or not they have the mental discipline and intellectual independence of an Iron Lady to follow through with such a process.

 

Author is founder of Zambia Online. He has currently returned to the Hoover Institution, Stanford University, as a Visiting Fellow (2013). Email: cchisala at Stanford dot edu.

 

REFERENCES:

  1. Nevers Mumba’s press statement
  2. Hichilema’s tweets on Twitter
  3. Chipimo’s status on Facebook
  4. Milton Friedman, arguably the greatest economist of the 20th century,  wrote an article or two on Thatcher as she begun to implement her powerful anti-subsidy policies.
  5. Milton Friedman’s intellectual heir, the Economist Thomas Sowell (who holds the Milton Friedman chair at the Hoover Institution) showed from history that lower taxes led to higher revenues, ceteris paribus.