SUBSIDIES AND DUAL PRICING

SUBSIDY

An energy subsidy is as defined a deliberate policy action by the government that specifically
targets electricity, fuels, or district heating and that results in one or more of the following
effects:

 It reduces the net cost of energy purchased.

 It reduces the cost of energy production or delivery.
 It increases the revenues retained by those engaged in energy production and delivery
(energy suppliers).

Although the term “subsidy” is widely used in economics and in national and international law,
defining what is and what is not a subsidy is not a trivial issue. The concept of “subsidy” has
evolved significantly over the years. Its simplest and narrowest definition is that of a direct
budgetary payment by a government to a producer or consumer. However, subsidies exist in a
variety of other, more complex forms – from direct budgetary transfers, through various tax
concessions (known as tax expenditures), to price control mechanisms (including border
measures such as tariffs and quotas). The definition of a subsidy has been further expanded to
include environmental externalities (such as pollution or habitat damage), as well as under-
collected government revenue (or foregone revenue) resulting, for example, from royalty relief
associated with exploitation of publicly owned or managed resources. While subsidies are often
perceived as direct cash payments to companies, they are often actually used to control and share
the risks and rewards of economic activities.

An operational definition of subsidies also needs to reflect the following feature: subsidies are
government-provided goods or services, including risk-bearing, that would otherwise have to be
purchased in the market. For these and other reasons, the OECD favours using the concept of
support rather than subsidies as such. Several international players in the field of subsidy reform,
including the OECD, the World Trade Organization (WTO), the European Union (EU), the IEA,
the World Bank, the International Monetary Fund (IMF) and the Global Subsidies Initiative
(GSI), have contributed to defining subsidy boundaries.
Despite some differences, their definitions largely reflect the essential elements of a subsidy as
understood by economists today and constitute useful guidance for national governments. Of all
these definitions, the WTO definition is most often adopted as the starting point in subsidy
analysis due to its legally-binding character for its more than 150 member countries.
Determining the environmental harmfulness of subsidies is another major challenge. Currently,
there is no common definition of an EHS, and analysts generally use the definition elaborated by
the OECD. The OECD and other institutions have also developed various tools to help
operationalise the identification and assessment of EHS schemes. National legislation sometimes
provides a subsidy definition that may or may not be aligned with internationally established
definitions. In discussing specific subsidy schemes, these definitions are key, as they embed the
discussion in the national context. At the same time, revealing differences in national and
international definitions, and assessing the magnitude of subsidies based on internationally
defined boundaries, may point to important gaps in the national-level evidence base for
management and reform of subsidy schemes.

CLASSIFICATION OF SUBSIDIES

The mechanisms and design of government measures to provide support vary greatly, reflecting
diverse domestic political and economic settings and, increasingly, obligations in the
international economic arena. The various subsidy groupings are generally organised around one
or more of the following characteristics and dimensions:

target: e.g. consumers or producers, outputs, inputs, value-adding factors (land, labour, capital),
type of energy commodity;

instrument: e.g. budgetary expenditure, tax expenditure, market transfers, underpricing of

publicly owned or managed assets;

pathway of benefit: e.g. direct, indirect, explicit, implicit; and

purpose: e.g. regional development, energy conservation.

When governments provide subsidies for a particular purpose, they always impose some
conditions; this conditionality can also serve as the basis for subsidy classification. Subsidies can
be made conditional on a number of things, such as the recipient’s income level and production
(output) level, the use of particular inputs or the introduction of a particular technology. When
the point of impact (or effect) of a subsidy is mainly its output, this measure increases sectoral
revenue; when the point of impact is variable costs or intermediate product inputs, such as raw
materials, it lowers the recipient’s production costs. When the impact lands on profit and income,
this type of support actually has no direct impact on the input or output market. These main
points of impact are generally called incidence, and more rarely subsidy conditionalities.

OTHER DIMENSIONS OF SUBSIDY CLASSIFICATION

Subsidies can be further distinguished according to their pathway of benefit: direct vs. indirect or
cash (explicit) vs. implicit. They can also be classified as general or sector-specific and on-
budget or off-budget.

Direct subsidies are generally provided through targeted (cash-based) payments, such as loans
or tax preferences. These subsidies may be implemented per unit of output or per unit of input
used into the activity, or per unit of output or input value. A fixed subsidy per unit is called a
“specific subsidy”, and a fixed subsidy per value is called “ad valorem”.

Indirect subsidies are received indirectly by the recipient as a higher market price for output
and/or a lower market price for input goods and services, purchased from an upstream industry
that is able to discount its prices thanks to the subsidies it also receives (e.g. a reduced cost of
diesel fuel sold to fishing vessels as a result of subsidies to oil refiners).

Cash (explicit) subsidies are paid out as a transfer to a recipient in the form of budgetary
expenditure (most analysts also include tax expenditures in this category). Implicit subsidies are
a specific category of input subsidy generally provided in kind by a government at a price that is
below market value or insufficient to cover the costs of provision. These subsidies are often
difficult to identify and measure as their amounts are not routinely reported in government
documents. One important variant of in-kind subsidy is privileged access to a government-owned
or controlled natural resource. Primary industries benefit greatly from such access (e.g. to public
lands for mining or grazing livestock, state forests for logging, rivers for irrigation, and foreign
seas through so-called fishing “access agreements”) for free or at below market prices.
International disputes over the subsidy element of privileged access to natural resources have
been among the most contentious and long-running (Steenblik, 2007).
On-budget subsidies are more easily identifiable, while off-budget subsidies are often hidden
and elusive. Both on- and off-budget subsidies can be directed at both consumers and producers.
Consumer subsidies are rather on-budget and take the form of quasi-fiscal instruments, such as
electricity tariffs provided at a price lower than the full supply cost. Producer subsidies are often
off-budget and less visible. The problem with the existence of so many terms to analyse
subsidies is that they are used very loosely and can have different (and even contradictory)
meanings in different countries. Hence, interpreting them can be very confusing. Differences in
classification systems partly explain why comparing subsidy schemes across countries can be so
difficulty compounded by differences in countries’ methods of quantifying subsidies. To date, no
systematic comparison has been made of these classification systems, methods and practices.

DUAL PRICING

Dual pricing is a situation in which the same product or service is sold at different prices in
different markets. There are a number of reasons why a company might decide to set different
price points for its products in different markets. An aggressive competitor may use dual pricing
to drastically lower its price in a new market. The intent is to drive out other competitors and
then raise its prices once the other parties are no longer selling in the market. This practice can
be illegal. There may be financial and tax reasons for pricing differently. For example, adverse
currency exchange rates or currency retention requirements may make it more difficult to sell
into a market, so the seller must raise prices to offset these costs of doing business. Distribution
costs may be different in each market. For example, distributors must be used in one market,
while sales can be direct to consumers in another market. Each distribution variation results in
different margins, unless prices are altered to generate a uniform margin in all markets. Prices
may be demand-based. Thus, an airline can offer one price to an early-booking customer and a
higher price to someone attempting to buy a seat at the last minute.

Dual pricing is a legitimate pricing option in some industries. However, it can be illegal if it is
done with the intent of dumping goods in a foreign market. The practice of product dumping is
most often seen in international trade. In such cases, a manufacturer enters a foreign market with
unrealistically low, even below-cost, product prices. This may be permitted or even subsidized
by the nation in which the manufacturer operates. The purpose is to drive other competitors out
of the business in order to dominate a product niche or even an entire industry. Dumping is
banned under most trade agreements. However, the practice is difficult to differentiate from dual
pricing. Enforcement has been difficult and expensive.

PROS OF DUAL PRICING

1. It can be used to lower prices in a new market.

When dual pricing is implemented, a company is able to offset a low price in a new market with
an established higher price in a mature market. That allows the company to subsidize the losses
in the new market while expanding its footprint. When implemented successfully, this strategy
can be used to drive their competition out of the new market. Once that occurs, the company
would be free to raise prices to then subsidize another new market.

2. It can be used to counter exchange rate issues.

When there are currency retention requirements or detrimental currency exchange rates in a
targeted market, then dual pricing can be used to offset the issues. That allows a business to stay
competitive in each market while being able to meet their taxation and financial obligations.

3. It can be used to counter distribution cost variances.

Let’s say there is a company that is based in Maine. They have two markets: a local market in
their state and one in British Columbia, Canada. To get their products to the other coast, they
have higher shipping fees, border fees, and distribution fees that must be paid. By offering their
products at a higher price in Canada, they can implement a dual pricing strategy which helps the
company be able to maintain their required margins.

4. It can be used to meet higher demand levels.

Dual pricing is also used when there is scarcity within different markets for a specific product.
An example of this method is used by the airline industry on a frequent basis. If you book a flight
well in advance, there is a good chance that you’ll be rewarded with a low price. For someone
attempting to book a flight last-minute, the price of their ticket will likely be higher than the
ticket purchase by the customer who booked early.
5. It can be used to protect domestic businesses.

Governments can implement dual pricing models too. They do this to protect domestic
businesses who may be negatively impacted by a foreign competitor. Through tariffs, subsidies,
and similar methods, a government is able to control the pricing of foreign goods or services to
make them appear less competitive than domestic items of similar quality. This would potentially
offer more local spending, which would then create the potential for more local jobs.

6. It can be used by consumers to save money.

In markets where competition is encouraged, dual pricing gives consumers an option when
shopping for something specific. By comparing goods and services, consumers can choose the
cheapest option if they wish, which allows them to meet their needs at a lower cost. That gives
consumers more money to use for other purposes.

CONS OF DUAL PRICING

1. It is a practice that may be illegal.

There are some legitimate reasons to consider dual pricing from an organizational viewpoint.
There are also some illegal reasons why dual pricing may be considered. If a business is using a
dual pricing model as a way to gain an advantage in a targeted importing market, then it may not
be permitted. Entering a new market to undercut domestic businesses may cause harm to the
local economy and trigger the implementation of tariffs.

2. It can increase export costs.

To create a dual pricing model, there must be a loss somewhere within the economic chain taken
by the company. They must have a way to offset that loss through their other markets if this
strategy is to be successful. For many organizations, the cost of subsidizing a new market with a
predatory pricing strategy tends to harm overall profitability. That means it is not usually a
sustainable practice.

3. It can limit the number of goods available to consumers.

One of the easiest ways to deal with a dual pricing issue is to restrict the number of goods or
services permitted at discount pricing through quotas. Once the quota has been met, the product
or service is no longer permitted in that market. That means consumers affected by quotas may
not have the same level of access to the goods or services they want or need.

4. It can limit wage growth in developing markets.

One of the top reasons for offshoring, from a U.S.-based perspective, is that labor costs in other
nations are much lower. Because labor is one of the biggest expenses a business faces, reducing
its cost can create much higher profits. Now imagine an overseas company in a low-cost labor
market is able to produce a similar product. Then they export it to the high-value market. They’d
be able to make better profits from a local perspective, undercutting the existing business
offshoring labor. By allowing dual pricing, there is no incentive to encourage wage growth at a
local level.

5. It can be used for discriminatory purposes.

Dual pricing models can be implemented at the retail level as well. Individual business owners
can offer one group of consumers a lower price than another group. In a country like Thailand,
this method of pricing is widely practiced in the markets. Tourists, ex-pats, and other foreigners
are often charged 3 times more for the same product that someone from Thailand pays. The
justification for this practice varies, though it can often be used to discriminate against a specific
consumer base. It becomes easier to stop serving a specific group of people if you price your
items much higher for only them.

SUBSIDIES AND THE PRICING PROBLEM

The preferred strategy to achieve fairness in allocation is subsidization of prices of goods or

services. The subsidy can be universal, as is the case with public transport and fertilizers, or
targeted, as in the case of PDS. Apart from bleeding public finances, universal subsidies distort
the incentives for producers and consumers. Targeted subsides fail in precisely that—targeting. It
also creates dual-price markets—government delivers goods and services at subsidized prices to
certain citizens, whereas others purchase the same at its regular market price.
The most widespread cause of inefficiency related to subsidies is dual-price markets. In many
cases, there exists a considerable price differential between the two distribution channels. This
price differential naturally generates far-reaching incentive distortions. In the case of goods, such
distortions are manifested as illegal diversion of supplies, adulteration, and the emergence of
parallel markets. In services, it creates middlemen and encourages bribery to access the service
illegitimately.
Price caps on tariffs and user charges adversely affect the finances of the entities producing these
goods or services. Utility service providers—electricity, water and sewerage, and public
transport—are the worst affected. This is symptomatic of the finances of most utility service
providers across the country. They have little incentive to invest in new technologies and
productivity improvements. Consumers have even less incentive to optimize their consumption.
Inefficiencies abound everywhere.
It is the prerogative of governments to determine whether to subsidize a good or a service.
However, such interventions have to balance the often conflicting requirements of fairness and
efficiency. A sense of fairness requires that public policy should intervene to ensure that certain
essential goods and services, which are otherwise expensive in the market, be made available at
affordable prices for the poorest. This has to be weighed against the demands of efficiency,
which stipulate that the same objective be achieved at the lowest cost and with the least
distortion. Subsidies should deliver bang for the buck. Unfortunately, far too often, in the pursuit
of the former, the latter is overlooked.
There are no easy or magic-bullet solutions to ensuring both fairness and efficiency in the
delivery of subsidies. Fundamentally, any policy that seeks to achieve this objective should be
designed to align incentives of all stakeholders so as to moderate the possible distortions arising
from subsidized delivery.
For example, harassment corruption in the delivery of statutory services can be mitigated by
differential pricing of service delivery—higher fee for faster and door-step service. This helps
institutionalize and legally capture bribes. Water and electricity services should be metered with
increasing block tariffs, with a generous tariff for initial basic consumption. Cash transfers are
more effective in targeting most product subsidies. Replacing ownership with rental vouchers
can reduce the distortions in the urban housing market. Labour market distortions can be
minimized if wage guarantees are replaced with unemployment insurance.
The most effective approach to minimizing such distortions is to eliminate price subsidies and
replace them with direct equivalent cash transfers. The preferred categories of citizens will be
provided additional purchasing power to buy these products from the regular market. This cash
can be transferred through vouchers, either directly to the beneficiary’s account or as a back-end
subsidy to the seller. If dual-price markets have to be retained, as would still be the case with
certain products and services, it requires rigorous and foolproof targeting.
BIBLIOGRAPHY:

References:

https://www.oecd.org/env/outreach/energy_subsidies.pdf

http://vmpu.in/pdf/apr2020/econtent/Ghazala%20Shaheen%20Dual%20Pricing
%20%20BBA%20Sem-II%20Managerial%20Economics.pdf

https://www.livemint.com/Opinion/R5HPdO8rpa9a8jPYwiTFSP/Subsidies-and-the-
pricing-problem.html

https://openknowledge.worldbank.org/bitstream/handle/10986/28926/121475-ESM-
PUBLIC-ESRAFReportNotev.pdf