The regulation Vs subsidy debate and international trade law

Consider the three scenarios.

In the first, the government of Regulationland promulgates a law that prescribes certain domestic content requirement for equipments used in domestic solar power generators. It ensures that the local manufacturers are directly favored over imports under all conditions. It involves no direct subsidy by the government, though the entry barrier erected is an implicit subsidy protection. This is the classic pre-WTO domestic industry protection strategy.

In the second, the government of Subsidyland provides a large direct subsidy to its equipment manufacturers. This enables these manufacturers to beat off competition from their external competitors and imports. Alternatively, it also helps them outbid foreign manufacturers in their own markets. This strategy requires that the government of Subsidyland incur huge subsidy expenditures. China has been following this policy in many sectors, including renewables.

In the third, the government of Tariffland offers to purchase the output from the solar industry - generated solar power - at a (higher) concessional tariff, provided the generator meets certain local equipment sourcing requirement. This indirectly promotes local manufacturers over their external competitors. This approach is a mix of regulation and subsidy, and it reduces the huge upfront subsidy burden on governments. Canada has adopted this strategy under its FIT Program and India under its Jawaharlal Nehru National Solar Mission.

Substantively, in all the three cases, the issue involved is the same. National governments have deployed various strategies to favor their domestic solar equipment manufacturers over their foreign competitors. The objective is to promote domestic industry and prevent them from being swamped by foreign competition. Any international trade law that seeks to promote trade discrimination has to necessarily address the issues raised by all the three strategies in an equitable manner.

Why do countries adopt these different strategies? Individual nations adopt these strategies based on their respective national strengths and weaknesses - fiscal balance, strength of local industry, nature of national renewables program etc. Those unwilling or unable to spend public resources prefer the first, while those with deep pockets prefer the second. The third alternative is deployed by countries with limited fiscal space.

The international trade law provisions that regulate such measures by national governments are covered in the Article III: 4 of Trade Related Investment Measures (TRIMS). This "national treatment" rule prohibits protectionism and discriminatory treatment against imported products and in favour of domestic products. This effectively means that the regulatory restrictions of Regulationland and Tariffland are illegal.

However, and very interestingly, Article III 8 allows for payments of subsidies to domestic producers and consumers. This means that it is permissible for governments to subsidize their manufacturers by offering them direct subsidies or to subsidize consumers by providing power at concessional rates. Accordingly, the action of the government of Subsidyland and that of the Tariffland authorities in providing tariff concessions are permissible. Now there is something clearly amiss with this differential treatment.

The principle of fairness in any law demands that for any particular objective, the law should not be path dependent and should constrain or promote all sides equally. In other words, the mechanics of its implementation should not favor one country over another. In this case, given the specific objective of ensuring that foreign manufacturers of solar equipments are not discriminated against, any law should ensure that none of the three - Regulationland, Subsidyland, and Tariffland - are discriminated against or left less well-off than the others.

This effectively means that the law should equally neutralize the ability of governments to either regulate or subsidize away foreign competition. Regulation and subsidy are two sides of the same coin - a regulation is a negative subsidy (or tax) on the foreign competitor while a fiscal concession to domestic manufacturers are direct positive subsidy to them. In other words, any WTO regulation to restrict trade discrimination can itself be fair only if the degree of restraints imposed on regulation is the same as that imposed on subsidies.

India's fiscal crisis in graphics

It is clear that whatever the RBI does with monetary accommodation, the path towards creating conditions for sustainable economic growth lies in reining in the growing fiscal deficit.



A recent report by the Goldman Sachs estimated the combined fiscal deficit of states and center for 2011-12 to touch 9% of the GDP, easily the highest among all the major emerging economies. It attributes this high deficit to the twin problem of falling tax base and ballooning subsidy burden. The Rs 40000 Cr gap in the ambitious disinvestment target is another major contributor.



The biggest long-term concern is the low tax-to-GDP ratio. India's tax-to-GDP ratio is again among the lowest among the major emerging economies.



Worse still, after steadily rising since beginning of the last decade, it has been falling since the recession struck. And it shows no signs of having bottomed out and is expected to fall further this year.



Subsidies are the elephant in the room. The food, fertilizer and fuel subsidy bills have been rising alarmingly in recent years. Unfortunately, with the 2014 elections looming large, the prospects of structural reforms to roll-back subsidies appears bleak.

Subsidies - back to square one?

Subsidies as a percentage of central government budgetary expenditure is at an all-time high and as a percentage of GDP is fast approaching its 1990-91 peak. The graphic below appear to indicate that the much discussed subsidy reforms over the past two decades may have come to naught.



On the back of weakening rupee and high global oil price, fertilizer and fuel subsidies have risen alarmingly. Fertilizer subsidies, estimated currently at Rs 95000 Cr, are sure to breach Rs 1 lakh Cr. Fuel subsidies are expected to touch Rs 1.3 lakh Cr.

Every time the rupee depreciates by one unit against the US dollar, Rs 8,000 Cr is added to the fuel subsidy bill. Since the rupee has depreciated from Rs 46 to roughly Rs 52 per US dollar, Rs 50,000 Cr has been added to the fuel subsisdy bill itself.

The newly promulgated Food Security Bill, which gives legal entitlement of 7 kg of rice, wheat and coarse grains per month at the rate of Rs 3, Rs 2, and Rs 1 respectively to over 63% of national population, has increased the food subsidy burden by another Rs 27,663 Cr to about Rs 95000 Cr.

Why taxes are important to reduce poverty and inequality?

Free market conservatives oppose big government and favor reduction in taxes as the preferred route to the achievement of economic growth. They argue that governments are inherently ineffective in efficiently allocating resources and therefore should give way and facilitate private enterprise to achieve the same objective.

They claim that economic growth, thus achieved, will "trickle down" to benefit everyone by way of more jobs, higher wages, and better living standards. They therefore advocate that government's role should be confined to unshackling the restraints to private enterprise and providing everyone with the basic opportunities - health care, education, and skills - to compete in the market.

However, as Lane Kenworthy (see also this earlier) points out with empirical evidence, reality is not as simple. In fact, examining the trends in income levels among those at the lower end of the income ladder in the advanced economies since the 19760s, he finds that it was not trickle down but direct transfers that kept incomes growing. He writes,

"In almost all of these countries (Ireland and the Netherlands are exceptions) the earnings of low-end households increased little, if at all, over time. Instead, increases in net government transfers — transfers received minus taxes paid — tended to drive increases in incomes when they occurred."

The graphic below captures the average household income in the bottom decile of the posttransfer-posttax income distribution. Group 1 is Denmark, Finland, Ireland, Netherlands, Norway, Sweden, and United Kingdom, while Group 2 includes Australia, Canada, Germany, Switzerland, and United States.



Clearly, incomes have increased substantially after transfers for those in Group 1. In fact, Kenworthy goes further and argues that jobs and higher wages cannot produce the same trickle down effect on those at the bottom end. He writes,

"At higher points in the income distribution, they do play more of a role. But for the bottom 10 percent there are limits to what employment can accomplish. Some people have psychological, cognitive, or physical conditions that limit their earnings capability. Others are constrained by family circumstances. At any given point in time, some will be out of work due to structural or cyclical unemployment. And in all rich countries, a large and growing number of households are headed by retirees. We surely can do better at helping able adults get into (or back into) employment, but we shouldn’t pretend that paid work is a realistic route to guaranteeing rising incomes for everyone."

He also points to the importance of keeping income transfers dynamic enough to ensure that its share of incomes do not fall appreciably with time. He draws attention to the fact that in most affluent nations, including the Scandinavian ones, while transfers have increased, it has not done so at the rate required to keep its share of the GDP from falling. He writes,

"In most of these affluent nations... increases in the share of GDP allocated to public transfers largely stopped after the 1970s. In recent decades, the distinction has been between countries that kept transfers rising in line with GDP versus those that did not. Sometimes doing so requires no explicit policy change, as benefit levels tend to rise automatically as the economy grows. This happens when, for instance, pensions, unemployment compensation, and related benefits are indexed to average wages. Increases in other transfers, such as social assistance, typically require periodic policy updates. That’s true also of tax reductions for low-income households."

In particular about the US, his suggestion is,

"What the income data tell us is that the United States has done less well by its poor than many other affluent nations, because we’ve failed to keep government supports for the least well-off rising in sync with our GDP... Modest, regularized increases in the inflation-adjusted benefit levels of existing social programs — the Earned Income Tax Credit, unemployment compensation, social assistance (TANF and SNAP), housing assistance, and disability benefits — would yield significant improvements in the incomes of America’s least well-off."

Kenworthy's findings carry important lessons for policy makers in India. It clearly establishes that economic growth alone cannot address the problems of poverty and inequality, all the more so in regulated and under-developed markets like India. Government transfers are more important in achieving poverty reduction objective, especially for those at the bottom of the income ladder. However, there are two points of qualification.

One, transfers can be meaningful only when the the fiscal balance is in order and governments have the resources to carry out such transfers. Robust economic growth is the only route to keeping public finances in good strength. Two, it is important to ensure that these resources are utilized to deliver bang for the buck. The most effective strategy to optimize public spending is to channel it towards those activities which address market failures and enables equality of opportunity to all citizens in accessing the market. This requires a very scarce commodity - far-sightedness in public policy making.

Hastening grid-parity or solar bubble?

A little late on this. The tariff quotes received in the second round of bids, concluded in first week of last December, for setting up solar projects under India's National Solar Mission (NSM) appears to indicate that solar energy prices will converge with conventional thermal power tariffs much sooner than expected. Or does it?

The lowest bid, in a reverse auction bid process, was for Rs 7.49 per unit, which is 50% lower than the benchmark tariff of Rs 15.39/unit fixed by the Central Electricity Regulatory Commission (CERC) and about 27% lower than winning bids in the first round of NSM auctions. The highest successful bid was only Rs 9.44/KWh and the average price for the winning bids for a total of 350 MW came to Rs 8.78/KWh (16.5 cents). Rajasthan was the preferred location for most bidders, with 295 MW out of the 350 MW located there. Germany, the world’s biggest solar-power user, pays about 17.94 euro cents (23 American cents) per KWh.

The projects are in the range of 5-20 MW capacity. The lower prices are attributed to the steep decline in prices of solar modules, which make up 50-65% of the total project cost. The successful bidders have to complete their projects in 13 months, failing which they face forefeit of large bank guarantees besides other steep fines.



In the first phase of the NSM, a total of 28 Solar PV developers aggregating upto 150 MW and 8 Solar Thermal Developers aggregating upto 500 MW were selected based on maximum discount offered on CERC determined tariffs. The feed-in-tariff determined by CERC was Rs 17.91 for PV and Rs 15.31 for solar thermal. The cut off discounts were 515 paise and 297 paise for Solar PV and Thermal projects respectively.

The NTPC Vidut Vyapar Nigam (NVVN) is the nodal purchaser of solar power under the Mission. It then sells to distribution utilities who have to meet their mandated renewables target. In order to incentivize indigenous production facilities, the NSM mandates the use of only indigenous crystalline silicon solar panels and solar cells. The NSM was launched in 2010 and has an ambitious 20,000 MW target by 2022.

Official estimates on grid cost parity for Solar is around 2020. However, at this rate, it may happen much faster. KPMG's excellent recent report on the prospects of solar power in India foresaw rapid declines in prices of solar PV panels and forecast grid-parity by 2017-19. However, if the recent solar bids are any indication, even its best case scenarios may be outstripped and the grid-parity could occur much earlier.



Some estimates point to a more aggressive convergence. The latest bid rates lend credence to this view.



Since industrial and commercial retail tariffs are already in the 700 paisa range for many consumer categories like commercial, solar roof-top is viable even today.

But amidst the euphoria, there may be a need for closer examination. Is there are winner's case associated with these extraordinarily low bids? It not only goes completely against conventional wisdom in the industry circles, even with the sharply declining panel prices, but there are also signs of irrational exuberance associated with bubbles. The quoted prices are far lower than anything anywhere in the world. There are stories that the bids from even the first round of auctions are commercially unviable.

Many generators have questioned the wisdom of these successful bidders and claim that the projects are commercially unviable at these rates. It cannot be a coincidence that most of the larger solar players remained away from these bids. Another concern is the fact that out of the 30 short-listed bidders, almost 20 have had nothing to do with solar photo voltaic (PV) power. These are normally prima facie indications of bubbles.

In this context, lessons from the first phase may be instructive. However, the project commissioning prospects for projects approved under the first phase of the Mission wherein 28 projects of 5 MW each were awarded late in 2010 and due for completion by January 9, 2012, appears not very encouraging. Atleast 12/28 projects are certain to miss the deadline and incur penalties.

In this context, India's solar industry and policy makers would do well to pay heed to the cautionary tale from Spain, once the unrivalled European solar market. In 2007 the government announced a solar policy that guaranteed fixed electricity rates of up to 44 euro cents per KWh to all new solar panel projects plugged into the electrical grid by September 2008. In 2008, backed by generous feed-in-tariff (FIT) subsidies, there was a flood of investments and Spain accounted for more than 40% of the world's total solar PV installations. In just 2008, the country committed itself to solar FIT payments estimated at $26.4 billion.

Against a modest target of 400 MW, some 3000 MW of solar capacity were installed in Spain within 18 months. Then the bubble burst on the face of over-capacity and fiscal strains. The entire industry was devastated. Its faulty regulations have become a watchword for how government renewable-energy programs, poorly conceived, can go awry.

On the positive side, there are two features of the solar policy that is laudable and stands in contrast to the governance failures that characterize such policies. One, instead of plunging big time into solar generation, the government is right in testing the waters with such small calibrated auctions. It will help the government learn about the market and help design effective policies when the implementation is done on scale.

Second, the transparency associated with auctions is in stark contrast to the opacity that has been the source of numerous corruption scandals that have rocked the country in recent years. In fact, this has ensured that the government does not face the problems created by the overly generous FIT subsidies of Spain and other European countries. But this is also a reminder to those advocates of mindless auctions that the most effective allocation process is market-specific and is not always open-ended auctions.

Update 1 (20/2/2012)

Government of India has encashed the bank guarantee worth nearly Rs 2 Cr each on 14 project developers for failing to meet the commissioning deadline (January 9,2012) under the first batch of phase I of the JNNSM. After this, the developers are given two months' time to finish the project, and if they still don't, this would entail further loss of bank guarantee — thereafter, three months time is provided with penalties to complete the project, failing which the project would stand removed from the Mission. The total extension in this manner is up to six months beyond the scheduled date.

Under the first batch, 35 new projects were expected to generate 610 MW of solar power (140 MW of photovoltaic and 470 MW thermal) and grid connectivity was expected by January 2012.

The pricing problem with subsidies

I have an op-ed in Mint today which examines the implications of tinkering with prices and how subsidies can be delivered without distorting price signals.

The simplification of public debates

At the outset, let me clarify that this post is not a defence of any government. Nor is it an attempt to blame anybody. It is only a reflection of the environment in which public debates are taking place in modern societies.

Why is the government unable to lower inflation? Why is the government failing to provide employment to the massive numbers of people joining the workforce? Why is the government raising the prices of petrol and cooking gas periodically? Why is the government unwilling to tackle corruption? Why are governments failing to provide good quality utility services? Why are governments increasing the utility tariffs?

These are the dominant themes in our public debates today. The agenda of the debate is framed in a manner that puts governments at the center of the issue. The audience, mostly passive recipients, have come to believe that governments are either "failing", "unable", or "unwilling" to resolve these important and universal issues. Even when there is a rare attempt to search for the causes, it ends up in a circular manner reverting back to the government.

This framing of the agenda and questions suits all sides to the debate. The villain of the piece, government, is easily identifiable. This narrative fits nicely into the widely accepted stereotype of governments being the source of all evils. In this simplified world-view, citizens find easily identifiable villains. Most often, these debates end up as opportunities for collective middle-class catharsis. It is perfect staple for tweets and Facebook comments. They also make for good media events - soundbites, short op-ed columns, blog posts and half-hour television debates involving 4-6 people. The opposition and intelligentsia love it. The former's job is after all to oppose the government, while the later are known to just criticize, without offering solutions.

Ironically, governments too may not be unhappy. It helps them to avoid confronting the difficult issues that need to be addressed to meaningfully settle the issue being debated. In fact, it makes governments try out populist band-aid solutions which merely kick the can down the road. In many respects, we have a classic collective action problem.

The fundamental issues are complex, not amenable to quick-fixes, requires hard-thinking, and painstaking and long-drawn out action on multiple fronts. It involves all stakeholders facing up to bitter truths that unsettles and often discards the settled conventional wisdom. Most importantly, it requires communicating to all of us certain fundamental realities and the need to accommodate our opinions and ideologies based on them.

These issues are important for developing economy democracies like India, which are in the middle of far-reaching social and cultural transformations. These countries have a strong and deeply entrenched legacy of dominant government role in all walks of life. All the surviving generations are used to relying on governments to resolve all their problems. Accordingly, the dominant discourse invokes the language of regulations, enforcement, punishments, subsidies, and so on.

When governments are making pretences of controlling inflation by coming down on hoarders, or helping farmers by raising the minimum support price, or protecting consumers by keeping tariffs and oil prices unchanged, or controlling corruption by sending the corrupt to jail, it is this discourse that is being played out. This discourse has limited space to explain the complex dynamics of modern markets and the limitations of governments.

The theatrics associated with these debates means that we lose the opportunity for informed debates about critical issues of concern to all of us. In all these cases, since the government is the perceived villain, we stop or refrain from examining these issues in greater detail in search of "real" answers. Take the case of the debate surrounding inflation. What are its causes? What can be done to mitigate, in the short-term, and resolve, in the medium and long term, the causes of inflation? What should be the responsibility of governments, academicians, media, citizens and the society in this endeavour?

Or take the case of corruption. What are the major sources of corruption? What are the different categories of corruption and what are its dynamics? How can we systemically prevent rent-seeking for each category of corruption? What should be the role of different stakeholders in collectively addressing this problem?

This is not to be fatalistic - the resolution of all these problems require collective effort, and since such efforts are difficult to mobilize, we are left with no choice! But a more nuanced perspective of these issues and their challenges helps all participants in the debate to atleast appreciate the complex nature of the problem. I am sure all of us realize that we stand a better chance of success with addressing a complex issue when we have a well rounded understanding of the forces contributing to the problem.

If we are able to elevate public debates to this level, all of us will quickly realize that controlling inflation, job creation, keeping tariffs and user charges constant, and so on are issues that are increasingly beyond the competence of mere governments. They require long-term structural changes and societal adjustments, where all of us have an important role to play, either directly or by co-operating with and assisting in the process. The governments have to take the lead (sadly, even this is missing!).

However, as mentioned at the beginning, none of this is to underplay or overlook the central role of governments. They can, and should, play an important role (though their degree of control varies from situation to situation), in both mitigating the adverse consequences of these problems and putting in place the mechanisms to enable their effective resolution. Addressing market failures are the basic responsibility of governments. Public debates and policy making will be much the richer for this realization.

Power sector reforms - farm power and tariff revision

The Business Standard reports that the Union Power Ministry have advised State Governments to transfer the massive losses, estimated at Rs 1.06 lakh Cr at end of 2009-10, off the balance sheets of state distribution utilities. It has also advised that states take action to ensure no further cash losses.



If the bailouts or restructurings happen, it will be the second time in almost a decade that state distribution utilities have received such help. At the turn of the century, as part of the first flush of reforms in electricity sector across the country, many state electricity boards were bailed with a Rs 41,400 Cr package. State governments assumed the debts and issued long-term bonds.

Like with the earlier bailout, the present need for bailout appears to have been triggered by similar reasons - the near inevitability of widespread defaults to central generating utilities by state and private sector distribution utilities. This is a clear sign that very little appears to have changed with the sector except in processes and formalities.

In fact, for all the structural reforms that have been enacted in the sector over the past decade, central and state governments have refrained from addressing the twin-elephants in the room - limiting free power for agriculture and regular increases in power tariffs. Unbundling, private sector participation in generation, liberalization of regulatory restrictions in transmission and distribution, and operational improvements like loss reduction, can only get you to the starting line.

Any earnest and meaningful effort to reform the sector has to place farm sector reforms and periodic tariff revision at its center. There is nothing secret nor mysterious about this. Any trading enterprise can survive only if its cost of purchase and service delivery matches its price of delivery. In simple terms, the power procurement cost plus the transmission and distribution cost have to match the aggregate tariffs.

In fact, its importance for the long term health of the sector itself cannot be over-emphasized. The problems faced by privatized distribution utilities in Delhi, who too have massive pending dues with generators, is a reflection of the magnitude of the problems. If the present trends are allowed to continue, it will adversely affect the prospects of private sector generation too. Unlike state generation utilities, private generators will not be able to manage their operations without regular payments on their power sales.

In many respects, the current sorry state of affairs is a serious indictment of the state and central power sector regulators. It is also a classic case of how easily important reforms can be subverted and given lip-service in implementation. It also drives attention to the important issue of tariff revision and the need for public conditioning to accept such revisions.

1. The Electricity Act 2003 and the various state regulatory acts clearly mandates that utilities should not bear state subsidies and state governments should transfer upfront (and not reimburse) the subsidy amounts to utilities for all subsidies being implemented by them. The regulators are supposed to safeguard the interests of the regulated utilities through the annual tariff revision filings. They are mandated to fix tariffs in a manner that reflects utilities' cost of power procurement, a reasonable level of operational efficiency improvements (read loss reduction), and required capital and operational expenditures.

But regulators across states have made a mockery of this, accommodating the interests of their paymasters, the state governments, at the expense of the utilities they were statutorily mandated to protect. Tariff filings in most states have been reduced to a charade, an academic exercise, and most often unprofessional at that, that has no relevance to realities in the field. Regulators, barring a few occasions, have failed to exercise their due powers and force states to bite the bullet on tariff and farm power related issues.

2. The policies of state governments since the reforms were initiated is a classic example of how easy it is to subvert well-intentioned and critical reforms. States have not raised tariffs on domestic consumers for many years now. Assuming inflation and the general increase in cost of procurement, the real subsidy has increased massively. Free power to farmers has remained a holy cow. Even the issue of mere metering of agriculture services raises unbelievable amount of passions.

Even with the latest crisis facing utilities, and despite being fiscally constrained, state governments are unlikely to take any meaningful steps to address this issue on a sustainable basis. It will require commitment at the highest levels to stand even a reasonable chance with pushing through such reforms.

3. Despite nearly two decades of liberalization, the one area where public debate, both in the political realm and in popular media, has remained entrapped in the mindset of the bygone era is that relating to cost-recovery and tariff revision. We cannot shy away for too long from the inevitable fact that consumers have to pay the full cost of any service consumed by them.

Public and political opinion needs to be conditioned into accepting the reality that there are no free lunches. Apparent free lunches are unsustainable and cause serious indigestion down the line. Reforms are not just cheap talk. For any meaningful reforms in sectors like utility and municipal services, important structural reforms have to complement with cost-recovery in service delivery. In simple terms, the culture of free or subsidized delivery has to end. At best, cost-recovery can be ensured in the aggregate through some form of cross-subsidization.

There can be a silver-lining to the crisis. If utilities are to be bailed out, it is a great opportunity for all stakeholders - regulators, state and central governments - come together and agree on some minimum steps with reforming farm power and tariff revision. This blog has always talked about scalable and practical steps in public policy reforms. However, the time may have come to stretch the definition of practicability given the serious magnitude of crisis facing power sector in India. I can think of three such minimal set of steps

1. All agriculture services should be metered. Leave alone bringing in efficiency and accountability in farm power consumption, this is an absolute essential requirement for many upstream reforms. For example, current estimates of distribution losses are badly flawed in the absence of any reliable estimate of agriculture consumption. It is common practice for utilities and regulators to use this as a sinkhole to doctor various operational efficiency and tariff figures that suit their respective agendas.

2. There is scope of considerable reforms with the terms of free farm power supply. To start with, free power supply should be restricted to only certain types of farmers, with the restriction being confined to easily enforceable or detectable parameters or proxy parameters. As I have blogged earlier, governments should move over to a system of fixed monthly units for agriculture consumption, to be reimbursed into the farmers accounts when they pay their monthly farm and domestic supply bills. Its benefits are manifold and the availability of Aadhaar, atleast in certain areas, makes the logistics simpler.

3. Periodic tariff revision, for all categories of consumers, must be made mandatory. In fact, even a simple, rule of thumb increase based on inflation or some other fixed parameter, will be one of the biggest boost for the sector. Just as was done to encourage unbundling of state utilities in the first generation of reforms, state governments should be directed to enter into MoUs or agreements with their utilities or mandate rules that define the terms for periodic tariff revisions. A mandatory and automatic requirement to periodically revise tariffs, agreed between all states and the centre can overcome, atleast partially, the political and collective action problems that accompany such hard reforms.

Tax and subsidy way to healthy eating?

Mark Bittman bites the bullet and advocates taxing unhealthy food like soda, French fries, doughnuts and hyperprocessed snacks, and subsidizing fruits and vegetables.

He suggests that sweetened drinks could be taxed at 2 cents per ounce, so a six-pack of Pepsi would cost $1.44 more than it does now. An equivalent tax on fries might be 50 cents per serving; a quarter extra for a doughnut. He argues that "taxes would reduce consumption of unhealthful foods and generate billions of dollars annually. That money could be used to subsidize the purchase of staple foods like seasonal greens, vegetables, whole grains, dried legumes and fruit."



Such taxes are justifiable despite arguments that it will unfairly target poor people who pay a higher percentage of their income for food. Such critics overlook the long-term health effects of these foods and the much higher medical and other costs imposed on low-income people. Such criticism can be mitigated by subsidies on high-quality, fresh and healthy foods.

Though no American city today has taxes that are explicitly aimed at reducing consumption, many have proposals to tax soda or all sugar-sweetened beverages. Research by the Rudd Center for Food Policy and Obesity at Yale have found that such soda taxes become significant at the equivalent of about a penny an ounce. Further, it is also suggested that these taxes should be in the form of excise taxes on inputs, so that the taxes will be incorporated into the shelf price of the drink, thereby nudging consumers on their purchasing decisions.

There is also an excellent graphic that points to how economic incentives, signalled through prices of cigarettes, have contributed to a dramatic drop in smoking among Americans since the eighties.



Remarkably, more than half of all Americans who once smoked have quit and smoking rates are about half of what they were in the 1960s.

End of fertilizer price decontrol?

It was with great fanfare that the Government of India launched the Nutrient Based Subsidy (NBS) regime for fertilizers in April 1, 2010. It effectively dismantled the administrative control over fertilizer prices. The subsidy was to be fixed, based on the nutrient content of each fertilizer, and then transferred as a back-end subsidy to the manufacturing companies. It gave companies full freedom to fix Maximum Retail Prices (MRPs), though there was an informal understanding to keep price hikes within 'acceptable' limits.

It went off relatively well in its first year, raising hopes of further reforms in the subsidy regime. However, following the steep increases in global petroleum prices in recent months, the wheels seem to be coming off the NBS regime. The manufacturers have been left with no option but to increase the MRP to cover for the increased import prices. As I have blogged earlier, in response the government has been forced into revising the subsidy for 2011-12 three times already.

Faced with continuing rise in fuel prices, the Government has issued directions to the fertilizer companies to restrict the MRP increases to a band. The Businessline points to a recent circular issued by the Department of Fertilisers asking firms to limit the increase in the MRP of di-ammonium phosphate (DAP) to Rs 600 a tonne for the kharif season ahead. It writes,

"Since the MRP, prior to April 1, averaged Rs 10,750 a tonne, a Rs 600 rise works out to Rs 11,350 a tonne. To this, if the 1.03 per cent excise-cum-education cess imposed in the 2011-12 Union Budget is added — this is recoverable from farmers — the new admissible MRP would be roughly Rs 11,470. Against this, companies like Coromandel International, Indian Farmers Fertiliser Cooperative and Zuari Industries have already declared MRPs of Rs 11,700 to Rs 12,000 a tonne, exclusive of State-level and local levies. It remains to be seen if they will now have to roll back their MRPs to the May 5 circular-prescribed levels."

The NBS regime for fertilizers is a test case for cash transfers with PDS. It highlights the challenges in subsidy administration posed by price volatility. However, unlike the fragmented food grains markets, fertilizer market is more integrated. Therefore it is possible to develop an index, also linked to global crude prices, that is a reasonable reflection of fertilizer prices. The subsidy payable to manufacturers or distributors could be calibrated with respect to this index, so as to avoid the repeated ad-hoc revisions. This does create a slight fiscal uncertainty, though the variation is not likely to be so much as to imbalance government finances.

Fertilizer subsidy rates go up (again)!

It has come faster than expected. I had blogged just yesterday about the inevitability of the revision in fertilizer subsidies for 2011-12 in view of the rising import prices. The Businessline reports,

"An inter-Ministerial panel under the Secretary, Department of Fertilisers, is learnt to have approved higher import parity prices of $612 a tonne for DAP and $420 a tonne for MOP, as against the existing levels of $580 and $390. These upward revisions would translate into increased NBS rates for phosphorus (P) and potash (K). Currently, the NBS rate on P, linked to a $580-a-tonne reference price for imported DAP, is Rs 29.407 a kg. On the proposed $612-benchmark price, it will go up to around Rs 31 a kg. Likewise, the NBS rate on K will rise from Rs 24.628 to Rs 26.5 a kg with the assumed landed price being raised to $420 a tonne."

Interestingly, even if the NBS rate on P is increased to Rs 31, the resulting higher subsidy of Rs 19,220 or so on DAP would take the gross realisation to Rs 29,970 a tonne, leaving the farmer to still pay the gap of Rs 600-700 a tonne. The report also says that the MOP prices are currently quoting at $520 a tonne, far higher than the proposed revised import parity price of $420 a tonne, leaving the farmer to again absorb the losses. Further, there will be no buffer available to cushion against future price increases, which is inevitable given the global petroleum price trends.

Two important market expectations are getting anchored here. The domestic wholesalers and retailers realize that there is nothing sacrosanct about the once a year subsidy fixation announcement. They have the incentive to raise the MRP to cover the full subsidy instead of raising the MRP based on the import prices. As I had blogged earlier, given its size, India's procurement decisions and import parity price signals will quickly get embedded into the global market prices. So what is the way out?

The price volatility problem with cash transfers

I have blogged earlier that price volatility, especially with food grains, is the most difficult challenge with cash transfers. One of the strategies to overcome this is to provide a large enough subsidy, inclusive of a volatility buffer, so that even if price increases, the buffer will cover for the increase. The nutrient-based subsidy (NBS) for non-urea fertilizers under implementation since April 2010 uses this strategy to cover for price volatility.

It is therefore instructive to examine the experience with NBS in fertilizers. Under this model, fertilizers are sold to farmers at its decontrolled MRP (minus the subsidy) and the subsidy amount paid separately to the fertilizer companies. The nutrient-wise fertilizer subsidy is fixed once a year, based on its market and import prices, and with a reasonable buffer to cushion the producers against price fluctuations over the year.

What has been the progress report with this subsidy regime in operation for more than a year now? A recent report in Businessline highlights the sharp volatility in the prices of fertilizers, as reflected in the manner in which the subsidy fixed for 2011-12 (operational from April 1, 2011) was sharply revised between November 2010 (when it was originally fixed) and March 2011 (when the subsidy amount was frozen). It now appears that even this may have to be revised.

Recent imports of DAP have been for $612 per tonne (or Rs 27,540 per tonne), which with duties, freight and other charges will retail at about Rs 30,735 per tonne. Against this, the MRP of DAP is currently at Rs 10,750 a tonne and the NBS payable from April 1, 2011 is Rs 18,474 (fixed assuming a landed import price of $580 a tonne), thereby grossing the company Rs 29,224 for every tonne of DAP. This deficit of more than Rs 1500 a tonne or Rs 75 a bag will either have to be covered through an increase in subsidy or passed on to the farmer.

Given important state elections coming up, it is almost inevitable that despite the original decision to fix the subsidy once a year, the subsidy rates will be revised again. Similarly, even on MoP, where global suppliers are apparently pushing for a landed price of $420 a tonne (which is more than the current reference rate of $390 a tonne), a subsidy revision looks certain.

Further, there is also the problem of market expectations that get formed by the subsidy price announcements. Since India is one of the largest fertilizer importers, its procurement decisions and prices signals get embedded into the global market prices. Though the subsidy rates announced includes a volatility buffer, the market prices naturally get anchored at the upper end. As the Businessline report says,

"For 2010-11, the Centre had fixed the NBS rates on nitrogen (N), phosphorus (P), potash (K) and sulphur (S) with reference to corresponding import prices of $310 a tonne on urea, $ 500 on DAP, $370 on muriate of potash (MoP) and 190 a tonne on sulphur. For 2011-12, the Centre – in a bid to talk down world prices – initially, on November 19, pegged these reference prices lower at $280, $450, $350 and $125 a tonne. But with global prices showing no signs of easing, the Centre, on March 9, announced new NBS rates for 2011-12 based on higher landed prices of $350 for urea, $580 for DAP, $390 for MoP and $180 for sulphur."

The Businessline report also quotes industry sources who claim that the government's decision to tinker with the DAP reference price has contributed to the steep increase in its import price in recent months. Also, the NBS regime has had no effect on lowering the subsidy burden. In fact, subsidy burden is also projected to go up by Rs 30,000 Cr to Rs 82, 245 Cr, up from the budgeted provision of Rs 52,837 Cr for 2010-11.

The experience of fertilizer highlights the difficulty of managing price volatility and also ensuring access to fertilizers (or food grains) at affordable prices. The much greater price volatility and political sensitivity associated with food grains means that any buffer will have to be much larger. Far from lowering it, the food subsidy outgo will therefore increase.

Admittedly, with fertilizers, given the reasonably integrated national market, it may be possible to calibrate subsidy to a price index. However, this approach cannot work with food grains whose prices vary so widely across the country at any point in time, that it is impossible to capture it in one index with any reasonable degree of reliability. So what is the way forward? More food for thought!

Free distribution or positive subsidized price?

Over the last few years, there have been a proliferation of field experiments across developing countries which have tried to examine the impact of pricing on the uptake of various health protecting products by poor people. What is the price (in terms of both incentivizing purchase and ensuring usage of the product) or subsidy that delivers the greatest bang for the buck?

The standard belief has been that people will not value products and services that are provided free. It is therefore most effective if these products and services are delivered at some small nominal cost, so as to foster a sense of ownership among the beneficiaries. People are more likely to use soap for cleaning their hands or chlorine for sanitizing drinking water or ITNs to keep-off mosquitos if these products are provided at nominal rates.

However, Randomized Control Trials (RCTs) in Kenya, Zambia and India have shown that uptake for products like insecticide treated bednets (ITNs), soaps, chlorine pellets, and de-worming tablets was highest when they were distributed free and uptake reduced exponentially when prices were raised even slightly. These findings are now being invoked to call for free distribution of health protecting, education improving and other welfare enhancing products and services to poor people across the world.



In fact, the RCT experiments have gone further and explored various other dimensions of usage. Pascaline Dupas and Jessica Cohen found several interesting results from their ITNs RCTs in Kenya - those who purchase ITNs are no more likely to be sick at the time of purchase (screening effect); those who are distributed free are no less likely to use it than those who paid (subsidized prices) and purchased nets (sunk-cost effect).

However, they found that subsidized positive prices dampens demand - ITNs uptake drops by sixty percentage points when its price increases from zero to $0.60 (or from 100% to 90% subsidy). Another study that provided un-subsidized ITNs with micro-consumer loans in India found that the uptake (usage the previous night) was just 16%, compared to 2% in control areas and 47% with free distribution.

There are several imponderables and mixed results that prevent drawing any generic inferences about pricing from these experiments. It is not possible to argue that free provision unambiguosly increases usage. Further, if a price is charged, it is even more difficult to arrive at a reasonably accurate price point where both purchases and usage is optimized for each product. Uncertainty on pricing can tip the scales either way. A few observations from these studies

1. It is premature to start generalizations from these results. I am inclined to believe that there may exist a trade-off between awareness and price that determines uptake of such products. Accordingly, the uptake is likely to be more even with positive subsidized prices if people are aware of its benefits (this does not equate to those who require such products more). Conversely, with lower awareness, free provision is likely to be more effective. It is however, difficult to draw a generic conclusion to this effect for all products and services.

2. Further, unlike non-acute care products like ITNs, critical care products are likely to exhibit lower price elasticity of demand (uptake). In other words, they are likely to be less sensitive to prices. This begs the question, what are non-acute care and which are critical care products?

3. The inferences from these studies are critically dependent on the contexts and varies across products. For example, while there is little evidence that those most in need of ITNs are more likely to buy and use it, the purchase (though not usage) of chlorine disinfectant liquid has been found dependent on need.

Another example of contradictory outcomes is with the provision of free school uniforms for children. Diana Hidalgo, Mercedes Onofa, and others found negative impact from a randomized experiment that provides free uniforms to primary school children in Ecuador. They found that "parents who pay for their children’s uniforms (the control group) feel more committed to the school than parents who got the uniforms for free (the treated) and therefore encourage their children to attend school". In contrast, a study in Kenya "found that providing a free school uniform increased attendance of young children by 6.4 percentage points".

4. In the final analysis, the purchase and use patterns of each of these products depend on a series of perceptions about its relative efficacy and utility for the consumer. In some cases, people are likely to show a reduced uptake when a product which was hitherto offered free was now offered for a small positive subsidized price, whereas in some others there would be no such effect. In some other cases, people are likely to see free products as signalling inferior quality and therefore show limited interest, whereas a high (but affordable) enough price would signal superior quality. In some cases, when people play a high enough price (how much is this "high enough" price?), the sunk-cost effects would take prominence and force people into using the product, while is cases like chlorine usage in Zambia showed no such effect.

5. Finally, to the extent that all such interventions are ultimately successful if they deliver on outcomes, there is no guarantee that such free supply will generate the intended results. A recent RCT of ITN usage in Orissa involving free distribution and purchase at unsubsidized prices with consumer micro-loans found little evidence of any "improvements in malaria and anemia prevalence, measured using blood tests". The authors attribute the failure to "insufficient ITN coverage" among the treatment villagers.

This debate again highlights the fundamental weakness with RCTs - the problem of generalizability. How and why do these interventions succeed? What processes and which environments are a pre-requisite for the success of a program? What is the role of cultural and other environmental issues on each intervention? Then there is also the limitation with how much can we generalize such results.

Update 1 (26/5/2011)

See this JPAL Bulletin explaining the benefits of free supply.

Who are the eligible beneficiaries?

In my previous post, I had drawn attention to the debate about whether the Aadhaar identity would help more effective targeting of welfare beneficiaries. I had argued that Aadhar-based identification would not help screen out those beneficiaries who do not meet the eligibility requirements.

In this context, one of the comments pointed to the psychological deterrent effect of any Aadhaar-based identity in screening out the ineligible. This works on the presumption that since Aadhaar localizes the identity and makes it easy to trace individuals, the possibility of being noticed when drawing benefits would deter the ineligible from accessing those benefits.

I am not sure about the effectiveness of such deterrent for two reasons. First, the margins between the eligible and ineligible are never cut-and-dry. For example, it is impossible to accurately avoid inclusion errors (ineligible getting included) when identifying people below or above the poverty line based on the standard income parameter. What should be the cut-off income? How do we quantify that income? Second, given the widespread poverty in the country, the numbers of people who straddle the blurred boundaries of eligibility are considerable.

In other words, a large number of people face the ambiguity about whether they are eligible or not to receive certain welfare benefits. In the circumstances, the deterrent effect gets considerably diluted. Where is the need to fear when many of your neighbours belong to the same category? In any case, given the difficulty with income quantification, how can anybody establish that you are not income poor (especially when the major share of incomes of those under scrutiny generally comes from the informal sector)?

This challenge will remain with or without Aadhaar and raises the question of what is the most appropriate method to identify welfare beneficiaries. In this context, I am reminded of George Akerlof's famous paper that advocates the use of "tagging" - which tags (identifies) people and then makes specific transfers (or concessions) to them - in taxation. Tagging eliminates the ambiguity arising from eligibility parameters (like income) and enables easier differentiation of the eligible from the ineligible.

What are the most effective tags to identify poor people eligible to receive welfare benefits? The commonest tags are height, weight, looks, gender, age, educational qualifications etc. These are all, for obvious reasons, unsuited for identification of the income poor.

Among the more effective likely tags could be the nature and/or size of ones house. For example, a person living in a temporary or semi-permamnent house could be treated as income poor. Alternatively, the carpet area of the house, discounting for locations, could be used as tags for income levels. Either way, it becomes possible to verify and mark out a person who claims benefits despite failing the eligibility norm. Though administration of house-type based tags too raises concerns, it does look a more promising approach to screen beneficiaries than the current practice of identification based on incomes.

It is possible there are more effective tags, especially for certain subsidized products. In any case, irrespective of whether Aadhaar is used or not, the problem of beneficiary identification, with a reasonable degree of accuracy, has to be satisfactorily resolved.

Pitfalls in cash transfer implementation

The decision by the Union Government to replace the current subsidy regime in fertilizers, cooking gas and kerosene with a system of cash transfers in a phased manner has triggered off an intense debate about cash transfers. This post will summarize the most relevant and common objections to cash transfers and critically examine each of them.

1. It does not resolve the targeting problem

The biggest criticism of Aadhaar is that it leaves the critical issue of beneficiary identification, or targeting, unresolved. The Aadhaar identification merely validates whether the particular individual has come to receive his welfare benefit. It does not say anything about whether the individual is, in the first place, eligible to receive the benefit itself. The means testing of the beneficiary for his or her eligibility is essentially an administrative process.

There are four possible sources of leakages in any welfare program – beneficiary impersonation, ghost, duplicate, and ineligible beneficiaries. Aadhaar-based identification can easily eliminate the first three possibilities. It ensures that benefits are transferred only to the registered beneficiaries. However, ineligible beneficiaries cannot be immediately addressed with Aadhaar. The concern about failure to ensure targeting is therefore only partially correct.

Aadhaar-linked processes are a definite and significant improvement on the prevailing system of beneficiary identification and benefit disbursement. Its effectiveness will improve incrementally as Aadhaar is adopted by a critical mass of user departments so that databases can be shared to screen out the ineligible. In any case, Aadhaar cannot be a substitute for the administrative failure in keeping the beneficiary selection process honest.

It also provides governments an excellent second-best tool to effectively target benefits on petroleum products like cooking gas and fertilizers that are currently universally subsidized. Any such change in regime will be a qualitative and substantial improvement on the current universal subsidy regime.

2. Cash transfers cannot factor in price volatility

The most serious concern about cash transfers, one that deserves the strongest consideration, is on the issue of price volatility. Critics point to the possibility of sharp and sudden price fluctuations, especially for food grains, and argue that this would adversely affect the consumer’s purchasing power. They argue that unless subsidy amounts are calibrated real-time to in response to local market price, a virtually impossible task given the diverse and fragmented nature of rural markets, the cash transfers will fail to achieve its objective.

It is undeniable that prices of commodities, especially food-grains, fluctuate sharply across regions (even within districts, between the head quarters and rural interiors) and over even small time-periods. I have blogged about this here and here. To the extent that the ultimate objective is food or fuel security, or making available these commodities at affordable prices, price volatility poses serious problems.

The new nutrient-based fertilizer subsidy regime overcomes the problem of price volatility by providing a large enough subsidy to act as a buffer against reasonably large manufacturing cost increases. The subsidy transferred to the manufacturers, which is fixed once a year, is deliberately kept high so as to discourage manufacturers from indulging in any market manipulation. It is also hoped that with this subsidy, even if costs increase, the subsidy will cover the increased costs and keep fertilizer prices affordable. However, it has to be admitted that this approach may not be practical for products like food grains and other products.

In the circumstances, at least in the initial phases, it may be more appropriate if cash transfers for products like food grains are restricted to areas where the volatility is least. Urban markets experience less price volatility and they are also more closely integrated into each other. Therefore, an arrangement where the subsidy amount is indexed to the relevant inflation measure is likely to address most of the concerns on price volatility. It has to be admitted that this strategy does not address local price shocks and sudden spikes which cannot be accurately captured on a pan-Indian inflation index.

3. The cash transferred will be frittered away on wasteful expenditures

One of the long-held opposition to cash transfers revolves around the premise that recipients are likely to fritter away their cash on wasteful expenditures. This is all the more so in rural areas, where men are more likely to manage household finances. The widespread self-control problems that bedevil human beings, as highlighted by research in behavioral psychology, adds credence to this claim.

Consider the case of a beneficiary who receives cash transfers on fertilizers and cooking gas into his account, besides NREGA wages and other welfare transfers. There is the possibility that these multiple and often lumpy inflows into a single account would be diverted for other purposes, especially on wasteful expenditures, thereby defeating the purpose of such transfers.

Such concerns can be effectively addressed through vouchers, smart cards, and structured savings bank accounts. The retailers can be reimbursed their subsidy on production of the vouchers for the subsidized product received from the beneficiaries. Debit cards with purchases restricted to only the prescribed commodities can also be used to administer cash transfers. Transfers to the account of the woman family member can also help address such concerns to some extent.

Finally, there are multi-tier savings bank accounts. Insights from recent research in behavioral economics show that use-directed sub-accounts within the main account, designed to take into consideration people’s "mental accounting choices", may be more effective at optimal management of multiple inflows. Accordingly, savings accounts, with say, food or fertilizer sub-accounts, can combat people’s behavioral urges to spend their cash transfer incomes on other expenditures.

In any case, there are doubts on the assumption itself. A study of unconditional cash transfer schemes in 15 Eastern and Southern African countries by S Devereux, J Marshall, J MacAskill and L Pelham indicates that the fungibility of cash transfers does not necessarily undermine the intended outcomes. They also found that recipients used the freedom of choice provided by unconditional cash transfers in a wide range of ways that directly or indirectly benefited children, from purchase of food, groceries, health and education services to investments in farming or small enterprise.

4. It does not address the issue of consumer choice

Another serious objection comes from those pointing to the limited consumer choice in most Indian markets. Since cash transfers are meaningful only when citizens have choice, what use is this cash when people have little or no choice with schools or hospitals? It is a reality that many parts of the country and millions of people have no access to hospital facilities. Further, such presentation of choices, far from creating competition among service provides, only adds to the rent-seeking opportunities. It amplifies the power of the entrenched sub-optimal interests.

Similarly, in most parts of rural India there are typically just one or two retailers for any product. The resultant lack of competition renders any claims of choice disingenuous. If the exclusive government outlets, say ration shops, are closed down, the possibility of price gouging (atleast on certain occasions) by the local kirana shop owner cannot be ruled out.

This concern loses its relevance outside the rural context. Even the smaller cities offer enough choice with retailers, schools and hospitals. Urban residents, who enjoy such choices, can therefore benefit from cash transfers. In any case, given the widespread prevalence of predatory practices like hoarding among retailers even in the smaller towns, such policies will have to be complemented with strong administrative actions to curb these practices.

5. It is a smokescreen to roll-back Government

The strongest critics from the left view a "roll-back the government" agenda behind the cash transfer movement. They see cash transfers as the first step in a systematic campaign to divert attention from more fundamental issues. They express the fear that the focus on cash transfers would slowly displace critical basic welfare issues like investments in primary education and health care, food and fuel security, and so on.

They portray cash transfers as a convenient excuse for governments to abdicate on their responsibilities, "We have done our side of the bargain. We provided you cash, now you go and buy whatever you want". Governments, they argue, will transfer cash to students, patients, and farmers, and leave investments in schools, hospitals, and irrigation to the vagaries of market forces. Similarly, cash transfer in place of food grains, run the risk of seriously imperiling food security. Such ideological arguments are never easy to refute. It may be more effective to tackle them on similar ideological grounds, though its success is not assured.

In conclusion, the concerns of price volatility and choice are not easily refuted. They also remain formidable obstacles to widespread adoption of cash transfers. However, urban markets, which are less susceptible to random and local price shocks and may offer adequate choice, are best placed to receive cash transfers.

Accordingly, it is preferable that the first phase of cash transfers be implemented in towns and cities and for products with less price volatility and choice problems. Food grains distributed through PDS are vulnerable to sharp price fluctuations. The concerns of food security raised by skeptics are not easily refutable. Besides, any failures arising from cash transfers in food grains could become a rallying point for opponents calling for aborting the cash transfer scheme. Cooking gas and fertilizers, and less so kerosene, with their centralized distribution network, are less vulnerable to these concerns.

It is undeniable that urban areas are more suited for cash transfers in all these products. However, this dual subsidy regime, wherein city residents get cash transfers whereas villagers continue to receive subsidies through the conventional channels, may generate its set of problems.

This will be all the more so for food grains and kerosene, and especially during periods of price volatility. In this context, it is important that subsidy benefits are disbursed to consumers in all areas through an Aadhaar-linked system, irrespective of whether they receive cash or not.

The Hypocrisy Clause

Guest post by Timothy A. Wise of TripleCrisis

Trade officials in the Obama Administration have made it abundantly clear that they will move forward in the WTO's Doha Round of negotiations only if the larger developing countries agree to open their economies more to U.S. exports. As Kevin Gallagher pointed out on the Triple Crisis Blog ("Obama's New Trade Agenda"), the administration's trade policies, and its announced goal of doubling U.S. exports, backtrack from those of the Bush Administration, renege on the basic principles of the Doha Development Round, and undermine precisely the kind of multilateralism President Obama claims to stand for.

Such intransigence does not bode well for the WTO, nor does it give much hope that the Obama Administration will use the current TransPacific Partnership negotiations to forge what it promises will be a "21st century trade agreement."

Clearly, a creative new approach is needed to break the trade deadlocks. I offer a modest proposal here: Instead of negotiating reductions in tariffs and farm subsidies, it's time to negotiate reductions in hypocrisy. I call it the Hypocrisy Clause, which mandates phased reductions in "trade-distorting hypocrisy," with the greatest reductions coming from the most developed hypocrites.

Why focus on hypocrisy? Ask the unemployed workers who voted for Obama based on his campaign commitment to reform NAFTA and future trade agreements.

Ask any developing country negotiator. Ask the Brazilians, who have been waiting six years for the U.S. government to respect the WTO ruling that U.S. cotton subsidies violate WTO rules. The U.S. has flaunted the WTO finding, appealing twice (and losing), and now Obama's trade officials have the gall say they'll step up enforcement of existing trade rules. They even cut a side deal with Brazil to stave off Brazil's approved retaliatory trade measures, further delaying compliance with WTO rules. Meanwhile, Mexico waits for its NAFTA partner to comply with the NAFTA ruling on Mexican trucks entering the U.S.

But if you want to know why we should negotiate hypocrisy reductions, ask the so-called "Cotton 4" countries in Africa. Their cotton farmers have suffered more than Brazil's from the U.S failure to respect the WTO ruling. Now they listen as U.S. negotiators insist that no movement on cotton can occur until the larger Doha agreement is signed, in direct contradiction of the 2005 Hong Kong commitments to treat cotton "ambitiously, expeditiously and specifically" ahead of the broader Doha agreement.

Who cares what the rules are or what the negotiators agree to if the rich countries then just do what they want?

Under my Hypocrisy Clause, that stops. The United States, as a developed country that has benefited greatly over many years from its past hypocrisy, would have to eliminate such actions immediately. So would the European Union, whose own hypocrisy may not compare with current U.S. levels (much to the EU's delight) but still offers large trade-distorting benefits. The EU could start by scaling back its export subsidies for dairy products, which it raised last year to dump surplus milk despite its loudly proclaimed commitment to end all export subsidies under Doha.

Under the proposed Hypocrisy Clause, rich countries will have to reduce or eliminate "trade-distorting hypocrisy." Hypocritical acts and negotiating positions deemed non-trade-distorting will still be permitted. (Otherwise there would be no politicians to negotiate.)

But what about middle-income hypocrisy? Isn't Brazil one of the world's largest agro-export powers with a well-cultivated reputation for defending the interests of other countries' small-scale farmers? Isn't Brazil also guilty of hypocrisy? Absolutely. In fact, as part of its side agreement on cotton with the United States, Brazil got a multi-million dollar fund for investment in its cotton sector. Talk about hypocrisy: Africa's Cotton 4 will now have to compete in global markets not only with subsidized U.S. cotton but with Brazilian cotton subsidized by the United States!

Middle-income countries such as Brazil, which have only recently begun to benefit economically from their hypocrisy in international negotiations, will have to reduce such trade-distorting actions, but they will be given more time. This reflects the Doha principle of "special and differentiated treatment" for developing countries, with reduction schedules that demand "less than full reciprocity" from developing country hypocrites.

And the Least Developed Countries? Their governments will be allowed to be as hypocritical as they want, since their countries have yet to benefit economically from such positions.

Does my Hypocrisy Clause proposal stand any chance of success, given the rampant hypocrisy in global trade negotiations? It has at least as good a chance as the current efforts to negotiate fair tariff and subsidy reductions when the world's largest trading partner won't respect the Doha mandate, doesn't comply with existing WTO rulings, and demands further liberalization in developing countries' financial sectors after its own deregulated financial sector nearly provoked a global depression.

If rich countries are going to keep using trade negotiations to "kick away the ladder" of development, outlawing the very trade measures they themselves relied on to grow, then we're better off abandoning the pretense of negotiating about industrial tariffs, agricultural subsidies, and service-sector liberalization.

Instead, let's cut the hypocrisy.

[PHOTO CREDIT: Harvesting cotton in Brazil, by Farming Matters (CC).]