Subsidies: Gifts, Crutches, or Smart Investment?
Lakshmi is a farmer's wife in Telangana. Every six months, a truck arrives at the local cooperative society with bags of urea — the nitrogen-rich fertilizer that her husband spreads on their two acres of cotton and rice. The government price is Rs 266 for a 45-kilogram bag. The actual cost of producing and importing that bag is over Rs 2,000. The difference — more than Rs 1,700 per bag — is paid by the government. This is a subsidy.
Lakshmi does not think about the economics. She thinks about the cotton crop. Without affordable fertilizer, the crop would be smaller, the cotton thinner, the income lower. Her two children are in school because the farm produces enough. If fertilizer cost its real price, the arithmetic of her life would change completely.
Twelve hundred kilometers north, in a farmhouse outside Ludhiana, a wealthy farmer with 200 acres uses the same subsidized urea — hundreds of bags every season. He also receives subsidized electricity to pump groundwater for irrigation (in Punjab, farm electricity is free). He sells his wheat to the government at the Minimum Support Price, which is itself a form of subsidy. He drives a large SUV. His children study abroad. The subsidies he receives, in absolute terms, dwarf what Lakshmi's family gets.
Both are beneficiaries of the Indian subsidy system. Both receive exactly the same per-bag subsidy on fertilizer. And this is the central paradox of subsidies: a policy designed to help the vulnerable often helps the prosperous even more.
This chapter is about subsidies — what they are, why they exist, when they work, when they fail, and the difference between a subsidy that lifts people up and one that merely transfers public money to those who do not need it.
Look Around You
You probably receive subsidies without knowing it. Does your family use cooking gas? The LPG cylinder you buy has been subsidized for decades (though subsidies have been reduced). Does anyone in your family buy grain from a ration shop? That is the food subsidy. Do you use public transport? Many state transport corporations sell bus tickets below cost, subsidized by state budgets. Does your child attend a government school? The tuition is free — subsidized by taxes. Make a list. How many subsidies touch your daily life?
What Is a Subsidy?
A subsidy is a payment from the government that reduces the price of something for the buyer or increases the income of the seller. It is, in essence, the government using public money to make certain things cheaper or certain activities more rewarding than they would otherwise be.
The logic can be straightforward: some goods and services are considered so important — food, education, healthcare, energy — that the government does not want their price to be a barrier. If the market price of rice is Rs 40 per kilogram but poor families can only afford Rs 20, the government can either give the family money (an income subsidy) or sell the rice at Rs 20 and absorb the difference (a price subsidy).
But subsidies serve other purposes too. Governments subsidize industries they want to develop. They subsidize exports they want to encourage. They subsidize farmers to keep food production high and food prices stable. They subsidize research in areas where private companies would not invest enough — because the benefits are too distant, too uncertain, or too widely shared for any single company to capture.
The three largest subsidies in India's central budget are:
Food subsidy: The government buys wheat and rice from farmers at the Minimum Support Price and distributes it to nearly 800 million people through the Public Distribution System at highly subsidized rates — Rs 2 per kilogram for wheat, Rs 3 for rice (under the National Food Security Act, made free during and after COVID). The annual cost exceeds Rs 2 lakh crore.
Fertilizer subsidy: The government controls the retail price of urea and pays the difference between the controlled price and the actual cost to manufacturers. It also subsidizes non-urea fertilizers. Total cost: over Rs 1.5 lakh crore annually.
Fuel subsidy: Though reduced in recent years as fuel prices have been partly deregulated, the government still absorbs some costs related to LPG and kerosene. In past years, this subsidy was massive — exceeding Rs 1 lakh crore.
Together, these three subsidies consume a significant share of the central budget — money that could alternatively fund healthcare, education, infrastructure, or debt reduction.
THE SUBSIDY FLOW: WHO PAYS, WHO BENEFITS
TAXPAYERS & BORROWING
(The source of all subsidy money)
│
v
┌─────────────────────┐
│ GOVERNMENT BUDGET │
│ │
│ Total subsidies: │
│ ~Rs 4+ lakh crore │
│ (~10% of budget) │
└────────┬────────────┘
│
┌────────┴─────────┬──────────────────┐
│ │ │
v v v
┌──────────┐ ┌──────────────┐ ┌──────────────┐
│ FOOD │ │ FERTILIZER │ │ FUEL / LPG │
│ ~Rs 2LCr │ │ ~Rs 1.5LCr │ │ ~Rs 0.5LCr │
└────┬─────┘ └──────┬───────┘ └──────┬───────┘
│ │ │
v v v
┌──────────┐ ┌──────────────┐ ┌──────────────┐
│ WHO GETS │ │ WHO GETS │ │ WHO GETS │
│ IT? │ │ IT? │ │ IT? │
│ │ │ │ │ │
│ Poor: YES│ │ Small farmer:│ │ Middle class:│
│ Rich: YES│ │ some │ │ YES │
│ (less │ │ Rich farmer: │ │ Poor: │
│ targeted │ │ MORE (uses │ │ some (LPG │
│ than it │ │ more bags) │ │ adoption │
│ should be│ │ │ │ varies) │
└──────────┘ └──────────────┘ └──────────────┘
THE CORE PROBLEM: Universal subsidies benefit
everyone — including those who don't need them.
The more you consume, the more subsidy you get.
Think About It
If the fertilizer subsidy is the same per bag for every farmer, who benefits more — a farmer with 2 acres who uses 3 bags per season, or a farmer with 200 acres who uses 300 bags? Now multiply that across millions of farmers. Where does most of the subsidy money actually go?
When Subsidies Help
Let us be honest about what subsidies have achieved. They have, in some cases, literally kept people alive.
India's Public Distribution System, for all its flaws — and there are many — has been one of the largest food safety nets in human history. During the COVID-19 pandemic, when millions of workers lost their jobs overnight and migrated back to their villages, the expanded PDS (Pradhan Mantri Garib Kalyan Anna Yojana) provided free grain to 800 million people. Without it, many would have starved. The system was imperfect — some grains were diverted, some eligible people were excluded, some states delivered better than others — but the sheer scale of the intervention prevented what could have been a humanitarian catastrophe.
The fertilizer subsidy, whatever its distortions, helped fuel the Green Revolution. In the 1960s, India was a food-deficit country that depended on American wheat shipments (PL-480) and lived, as it was humiliatingly said, "ship to mouth." The combination of high-yielding seeds, irrigation, and subsidized fertilizer transformed Indian agriculture. By the 1980s, India was self-sufficient in food grains. For a country that had experienced devastating famines under colonial rule, this was not just an economic achievement. It was a matter of national survival.
The LPG subsidy helped millions of Indian households switch from wood, dung, and kerosene to clean cooking fuel. Indoor air pollution from traditional cooking fires kills an estimated half a million Indians every year — overwhelmingly women and children. Every household that switches to LPG is a household where a mother and her children breathe cleaner air. The Ujjwala scheme, which provided free LPG connections to poor households, was explicitly a health and gender intervention funded through subsidy.
"No policy instrument is inherently good or bad. It depends on what it is used for, how it is designed, and who it reaches." — A principle too many policy debates forget
When Subsidies Hurt
But the same subsidies that save lives can also destroy them — slowly, invisibly, through the distortions they create.
The fertilizer subsidy distorts agriculture. Because urea is far more heavily subsidized than other fertilizers, Indian farmers use too much nitrogen relative to phosphorus and potassium. The ideal ratio of nitrogen (N) to phosphorus (P) to potassium (K) is roughly 4:2:1. In many Indian states, the actual ratio is 10:3:1 or worse. This overuse of nitrogen degrades soil quality over time. It pollutes groundwater. It reduces long-term productivity. The subsidy that helped create the Green Revolution is now contributing to the degradation of the very soil that feeds the nation.
Free or cheap electricity encourages over-extraction of groundwater. In states like Punjab, Haryana, and parts of Rajasthan, farmers receive free electricity to run tube wells. The result is predictable: with no cost to pumping, they pump as much as they can. Water tables have fallen catastrophically — by 20 to 30 meters in some areas over the past few decades. Punjab, one of India's most productive agricultural states, is facing a groundwater crisis that threatens its ability to grow food within a generation. The subsidy that was meant to help farmers is destroying the resource on which farming depends.
The food subsidy creates massive leakage. Despite improvements, studies have estimated that 30 to 40 percent of grain allocated to the PDS does not reach intended beneficiaries. Some is stolen. Some rots in inadequate storage — the Food Corporation of India's godowns have been notorious for rats, dampness, and decay. Some is diverted to the open market. The subsidy pays for grain that the poor never eat.
Fuel subsidies benefit the rich more than the poor. When diesel and petrol were heavily subsidized, the benefits accrued primarily to those who consumed the most fuel — car owners, not rickshaw pullers. A study by the International Monetary Fund found that globally, the richest 20 percent of households receive over 40 percent of fuel subsidy benefits, while the poorest 20 percent receive less than 7 percent.
What Actually Happened
India's fertilizer subsidy has grown relentlessly over the decades. In 2000-01, it was about Rs 13,800 crore. By 2010-11, it had reached Rs 62,000 crore. By 2022-23, driven partly by the global surge in fertilizer prices after the Russia-Ukraine conflict, it exceeded Rs 2.5 lakh crore. This is more than the government spends on health and education combined. The subsidy was originally designed as a temporary measure to support the Green Revolution. Half a century later, it has become a permanent fixture of the budget — difficult to reduce because millions of farmers depend on it, and no politician wants to be the one who raised fertilizer prices before an election.
Smart Subsidies vs. Dumb Subsidies
The question is not whether to subsidize. The question is how.
A dumb subsidy is one that is universal (given to everyone regardless of need), price-based (it reduces the price of a commodity rather than targeting specific people), and open-ended (it has no exit strategy and grows without limit). India's fertilizer subsidy is the classic example. Everyone gets the same cheap urea, regardless of whether they are a marginal farmer or a wealthy landowner. The more you buy, the more subsidy you receive. There is no mechanism to graduate people out of the subsidy, and no sunset clause.
A smart subsidy is targeted (directed at those who need it most), time-limited (designed to achieve a specific outcome and then phase out), and tied to outcomes (the subsidy continues only if certain conditions are met). South Korea's industrial subsidies, which we will discuss shortly, were smart. Companies received cheap credit, but only if they met export targets. Miss the target, and the support was withdrawn. The subsidy was a tool to build capacity, not a permanent entitlement.
The difference is not abstract. Consider two approaches to helping poor families eat:
Approach A (Price subsidy): Sell rice through the PDS at Rs 3 per kilogram to anyone with a ration card. Problem: the rich can also get ration cards, or buy from holders. Massive quantities of grain must be procured, stored, and transported by the government. Leakage is enormous. The government becomes the nation's largest grain dealer, with all the inefficiency that implies.
Approach B (Cash transfer): Identify poor households through a verified database. Send them money directly into their bank accounts. Let them buy rice — or whatever food they prefer — from any shop at market prices. Problem: you need accurate identification of the poor (hard, but possible with Aadhaar), functional bank accounts (the Jan Dhan initiative addressed this), and reliable transfer systems (UPI).
India has been gradually moving from Approach A to Approach B. The JAM trinity — Jan Dhan (bank accounts for all), Aadhaar (unique identification), and Mobile (phones as payment devices) — was designed precisely to make this transition possible. Direct Benefit Transfer (DBT) now channels over Rs 6 lakh crore annually in government payments directly to beneficiary bank accounts, reducing intermediaries and leakage.
The results have been significant. A study of LPG subsidy delivery through DBT found that it reduced leakage by roughly 25 percent. When cooking gas subsidies were transferred directly to bank accounts instead of being built into the price of cylinders, the government saved thousands of crores that had previously gone to "ghost beneficiaries" — fake ration cards, duplicate identities, and middlemen.
DUMB SUBSIDY vs. SMART SUBSIDY
DUMB SUBSIDY SMART SUBSIDY
┌─────────────────────┐ ┌─────────────────────┐
│ │ │ │
│ Universal │ │ Targeted │
│ (everyone gets it) │ │ (only those who │
│ │ │ need it) │
│ Price-based │ │ │
│ (cheaper goods) │ │ Cash/DBT-based │
│ │ │ (money to people) │
│ Permanent │ │ │
│ (no exit plan) │ │ Time-limited │
│ │ │ (has conditions │
│ Grows without │ │ and exit plan) │
│ limit │ │ │
│ │ │ Outcome-linked │
│ Benefits the rich │ │ (tied to results) │
│ more (they consume │ │ │
│ more) │ │ Benefits the poor │
│ │ │ more (directed at │
│ │ │ them specifically) │
└─────────────────────┘ └─────────────────────┘
EXAMPLES: EXAMPLES:
- Universal fuel subsidy - LPG subsidy via DBT
- Untargeted food PDS - Conditional cash transfers
- Free electricity for all - South Korea's export-
farmers linked industrial credit
When Rich Countries Subsidize and Poor Countries Suffer
There is a profound hypocrisy at the heart of the global subsidy debate, and it deserves to be named.
The United States spends approximately $20 billion per year in direct subsidies to its farmers. The European Union spends even more — over 50 billion euros annually through the Common Agricultural Policy. These subsidies allow American and European farmers to sell their products on global markets at prices below the actual cost of production.
Now imagine you are a cotton farmer in Mali, or a rice farmer in the Philippines, or a sugarcane grower in Brazil. You are competing against American or European farmers who receive massive government support. They can sell below cost because their government makes up the difference. You cannot. When their subsidized products flood global markets, your prices collapse. You cannot compete against the treasury of a wealthy nation.
This is not hypothetical. It has happened repeatedly.
American cotton subsidies devastated West African cotton farmers. The US produced cotton at a cost higher than African farmers, but subsidies allowed American cotton to be sold cheaply on world markets. African producers — who were more efficient but had no government subsidies — were priced out. An estimated 10 million cotton farmers in West Africa saw their incomes fall. The World Trade Organization ruled multiple times that US cotton subsidies were illegal under trade rules. The subsidies continued anyway.
European sugar subsidies had similar effects. The EU subsidized sugar production so heavily that Europe — which has no natural advantage in growing sugar — became a major sugar exporter, undercutting producers in the Caribbean, Brazil, and Africa.
"When America subsidizes its farmers, it calls it support for the backbone of the nation. When Africa tries to protect its farmers, it is told that subsidies distort markets and must be eliminated." — A common observation in trade negotiations, expressed by many African and Asian diplomats
This double standard — rich countries subsidizing their own industries while demanding that poor countries open their markets and eliminate subsidies — has been one of the deepest sources of anger in international trade negotiations. It is a reminder that the debate over subsidies is never purely economic. It is always, at its core, about power.
What Actually Happened
In the 2003 WTO negotiations at Cancun, Mexico, a coalition of developing countries — led by Brazil, India, China, and South Africa — refused to agree to new trade rules until rich countries agreed to reduce their agricultural subsidies. The talks collapsed. It was a watershed moment in global trade politics: developing countries, for the first time, had the collective power to say "no" to a deal they considered unfair. The subsidies were not significantly reduced. The Doha Round of trade negotiations, launched in 2001 with the promise of being a "development round," has never been concluded. Agricultural subsidies by rich countries remain one of the main reasons.
Industrial Subsidies: How South Korea Built Samsung
Not all subsidies are about keeping food cheap. Some are about building the industries of the future.
In the 1960s, South Korea was one of the poorest countries in Asia. It had no significant industry, few natural resources, and a population devastated by war. The government of Park Chung-hee decided that Korea would industrialize — not gradually, not by following market signals, but deliberately, through state-directed industrial policy.
The tools were subsidies — but subsidies with teeth.
The government selected strategic industries: first textiles and light manufacturing, then steel and shipbuilding, then electronics and automobiles. It directed cheap credit from state-controlled banks to companies it chose to develop these industries — Samsung, Hyundai, LG, Daewoo. Interest rates for these "policy loans" were sometimes negative in real terms — the companies were effectively being paid to borrow.
But there were conditions. Companies that received subsidized credit had to meet export targets. They had to invest in research and development. They had to hire and train Korean workers, not just import foreign expertise. Performance was monitored closely. Companies that met their targets received more support. Those that failed had their subsidies withdrawn and, in some cases, were allowed to go bankrupt.
This was not welfare for corporations. It was a bargain: the state invested in your company, and in return, your company had to deliver results. The state was not picking winners blindly — it was creating conditions for success and then holding firms accountable.
The results speak for themselves. Samsung, which in the 1960s was a small trading company dealing in dried fish and noodles, became one of the world's largest technology companies — a global leader in semiconductors, smartphones, and displays. Hyundai went from being a construction company building barracks for the US military to one of the world's largest automakers and shipbuilders. Korea's transformation from a war-ravaged agricultural country to the world's twelfth-largest economy is one of the most remarkable economic achievements in history. And subsidies were central to it.
"The Korean miracle was not a triumph of the free market. It was a triumph of strategic government intervention — subsidies with discipline." — Alice Amsden, Asia's Next Giant
The Indian Experiment: JAM Trinity and DBT
India's most ambitious recent experiment in subsidy reform involves three letters: J, A, and M.
Jan Dhan Yojana (2014) opened over 500 million bank accounts for the previously unbanked, ensuring that nearly every Indian household had access to the formal financial system.
Aadhaar (launched 2009, expanded subsequently) enrolled over 1.3 billion Indians in a biometric identification system, creating a unique digital identity for each person.
Mobile connectivity expanded rapidly, with over 800 million smartphone users by the mid-2020s, enabling digital payments through the Unified Payments Interface (UPI).
Together, these three pillars — JAM — created the infrastructure to deliver subsidies directly to beneficiaries, bypassing the layers of intermediaries that had historically siphoned off a large share of public spending.
The impact has been measured and significant. The government claims to have saved over Rs 2.7 lakh crore through DBT by eliminating fake beneficiaries and reducing leakage. LPG subsidies, once delivered as below-market cylinder prices (which benefited anyone who bought a cylinder, rich or poor), were converted to cash transfers to the bank accounts of identified poor households. Fertilizer subsidies are being gradually linked to Aadhaar authentication. MGNREGA wages are paid directly to bank accounts rather than through village-level intermediaries.
The system is not perfect. Aadhaar authentication failures leave some genuine beneficiaries unable to access their entitlements. Bank account access in remote areas remains patchy. Not all schemes have been converted to DBT. But the direction is clear: India is moving from subsidizing commodities to supporting people, from universal price subsidies to targeted cash transfers.
This is, in principle, the move from dumb subsidies to smart ones. Whether it succeeds will depend on execution — a word that, in India, carries the weight of a billion complications.
Think About It
A politician promises free electricity to all farmers. An economist suggests instead giving cash transfers to poor farmers and charging market rates for electricity. Which approach is better? Consider: the political appeal of "free," the environmental consequences of unlimited pumping, the fairness of giving the same benefit to rich and poor farmers, and the administrative challenge of identifying who is poor and who is not.
The Politics of Subsidies
Here is the hardest truth about subsidies: once created, they are almost impossible to remove.
A subsidy creates beneficiaries. Those beneficiaries organize. They vote. They protest. They form interest groups that lobby for the subsidy's continuation. Any politician who proposes cutting a subsidy faces immediate, visible, and vocal opposition from the people who lose it. The benefits of cutting the subsidy — more money for other priorities, reduced distortions, better long-term outcomes — are diffuse, invisible, and felt by people who may not even know they are benefiting.
This is a fundamental asymmetry in democratic politics. The costs of a subsidy are spread across millions of taxpayers, each paying a tiny amount. The benefits are concentrated among specific groups who receive a lot. The concentrated beneficiaries have every reason to fight for the subsidy. The dispersed taxpayers have little reason to fight against it.
This is why India still subsidizes urea at prices set decades ago, even though the subsidy distorts agriculture, degrades soil, and costs the budget enormously. It is why Punjab still provides free farm electricity even though it is draining the state's aquifers. It is why American cotton subsidies continue even though the WTO has ruled them illegal. It is why European agricultural subsidies persist even though they make food more expensive for European consumers.
Subsidies are easy to create and almost impossible to kill. The best subsidy, therefore, is one that is designed from the start with an exit strategy — conditions under which it will end, benchmarks that trigger phase-out, sunset clauses that force periodic review. But such subsidies are rare, because politicians gain more from announcing new subsidies than from designing ones that expire.
"Government programs, once launched, never disappear. Actually, a government bureau is the nearest thing to eternal life we'll ever see on this earth." — Ronald Reagan
Reagan was exaggerating, but his point has a grain of truth — especially when applied to subsidies.
The Bigger Picture
We started with Lakshmi in Telangana, buying subsidized urea for her two acres, and the wealthy farmer in Ludhiana buying the same urea for his two hundred. We traced subsidies from the budget to the field, from the ration shop to the global cotton market. We saw how subsidies can save lives and how they can distort economies, how they can build industries and how they can destroy foreign competitors.
What have we learned?
First, that subsidies are not charity. They are policy instruments — tools that governments use to achieve specific goals. Like any tool, their value depends entirely on how they are used. A subsidy that feeds hungry children is a civilized act. A subsidy that enriches wealthy farmers at the expense of taxpayers is a failure of design.
Second, that the design of a subsidy matters as much as its existence. Universal subsidies that reduce prices for everyone are inherently regressive — the more you consume, the more you benefit. Targeted subsidies that reach specific populations, with conditions and exit strategies, can achieve their goals without the waste and distortion.
Third, that India's JAM trinity represents a genuine innovation in subsidy delivery — the ability to put money directly into the bank accounts of the people who need it, bypassing the layers of corruption and inefficiency that have plagued traditional subsidy systems. It is not perfect, but it is a significant step from dumb subsidies toward smart ones.
Fourth, that the global subsidy landscape is deeply unfair. Rich countries subsidize their agriculture and industry while telling poor countries to open their markets. This hypocrisy costs millions of farmers in the developing world their livelihoods. Subsidies are never just domestic policy. They are instruments of global power.
And finally, that the hardest problem with subsidies is political, not economic. Everyone knows which subsidies are wasteful. Economists have written papers about it for decades. But removing a subsidy requires political courage that is in shorter supply than any commodity. The beneficiaries fight. The politicians calculate. And the subsidy endures.
Lakshmi needs subsidized fertilizer. Her family's survival depends on it. But the system that delivers it to her also delivers far more to those who need it far less. The challenge — for India, and for every country — is to redesign the system so that Lakshmi keeps her support while the wealthy farmer pays his own way. It sounds simple. It is anything but.
"The art of taxation consists in so plucking the goose as to obtain the largest possible amount of feathers with the smallest possible amount of hissing. The art of subsidies is the reverse: distributing the feathers to those who need them most, while the others hiss." — Adapted from Colbert, with a subsidy twist