Tag: subsidies

Agricultural Subsidies: The Case of Georgia

Posted on March 17, 2025 | Policy Brief

Fresh apples, pears, and grapes at a local market benefiting from agricultural subsidies in Georgia.

This brief explores the role of government subsidy programs in Georgia’s agricultural sector, with a focus on grapes, apples, and hazelnuts. These subsidies play a significant role in providing social assistance to the sector and in supporting farmers; however, their long-term impact on industry growth remains a subject of discussion. Key challenges include ensuring product quality, enhancing productivity, and expanding market opportunities, particularly regarding export market concentration and infrastructure constraints.

Introduction

Governments have historically intervened in agricultural markets under the pretext of promoting food security. At first, interventions aimed to provide affordable food for rapidly growing urban populations, afterwards more emphasis was put on enhancing agricultural productivity. Nowadays, agriculture remains a priority for policymakers due to its role in promoting inclusive growth and reducing poverty. Additionally, renewed concerns about food security have further driven these policy efforts (Gautam, 2015).

One of the key instruments of these interventions are subsidies in different forms – such as various input subsidies, price supports, and trade interventions. While their use has been widespread, the economic effectiveness of subsidies continues to be heavily debated. Economic theory suggests that subsidies are useful in resolving market failures; however, even in this case, the actual effect of subsidies is highly dependent on the specific implementation. Further, in many other cases, subsidies have led to distortions and have been detrimental to countries’ own economic interests (Gautam, 2015).

Another important concern arises from the political economy of subsidies use. Widening rural-urban income disparities create political pressure to implement measures that support the livelihoods of the large agricultural population. Subsidies, due to their visibility, are a convenient instrument to increase political support from this population group. Further, subsidies offer immediate or near-immediate gains to recipients, whereas public capital investments take longer to deliver results, therefore subsidies are often used as a political instrument. Since political decision-making is typically driven by short-term considerations, often aligned with electoral cycles, long-term investments do not always align with political incentives (Gautam, 2015).

Box 1. Subsidies

Subsidies are financial assistance provided by governments to support or promote specific sectors, industries, or activities within the economy. They can take various forms, including direct cash payments, tax relief, low-interest loans, and in-kind support, such as the provision of goods and services at below-market prices. Subsidies play a significant role as a tool in government expenditure policy. They influence resource allocation decisions, income distribution, and expenditure efficiency (Schwartz & Clements, 1999).

In the case of Georgia, subsidies are the main instrument for support to the agricultural sector, with direct subsidies accounting on average 45 percent of total government expenditure in the sector (2014-2024). The government provides subsidies for most of the country’s main crops, including wheat, grapes, hazelnut, tangerines and apples.

Given the scope of this policy brief, only subsidies for major perennial crops – grapes, hazelnuts and apples – are discussed. This as as the wheat sector involves additional food security considerations and due to lack of data for tangerines. Among perennial crops grapes have the highest share of total production (46 percent, including both white and red grapes), followed by tangerines at 14 percent, apples at 10 percent, and hazelnuts at 8 percent (2023, Geostat).

This policy brief firstly explains the Georgian context in more detail, followed by sub-sections discussing each major perennial crop sector, ending with conclusions and policy recommendations.

The Georgian Context

Agriculture plays a crucial role in Georgia’s economy. As of 2024, 39 percent of the population resides in rural areas (Geostat, 2024), where agriculture serves as the primary source of income. The sector employs the largest share of the country’s workforce—17 percent (Geostat, 2023)—yet it contributes to only 7 percent of Georgia’s GDP (Geostat, 2023).  At the same time, the disparity in income, and other major socio-economic indicators between the rural (agricultural) and urban population is large. For example, in Tbilisi, the capital of Georgia, the average monthly nominal earnings are 78 percent higher than the average for the rest of Georgia. Additionally, Tbilisi accounts for 70 percent of the total value added generated in the country (Geostat, 2023).

In recent year, the country has undertaken significant efforts to modernize and improve the agricultural sector, yet significant challenges remain. Georgian agriculture is largely characterized by small, fragmented family farms focused on subsistence farming with restricted market access. They are highly vulnerable to weather conditions, yet there is little awareness of or adoption of insurance and risk mitigation measures (State Audit Office of Georgia, 2023). Traditional farming methods remain dominant, with limited use of modern technology. Additionally, most farmers operate on a small scale and lack cooperation and coordination, further hindering efficiency and competitiveness. As a result, they often struggle with low productivity and have difficulty producing high-quality products in stable quantities. Lastly, a high dependency on the Russian market for most agricultural products poses significant risks, as Russia is not a stable trade partner.

Given this context, agricultural subsidies are a highly important topic in Georgia. The Georgian government implements various subsidy programs to support agricultural sectors such as fruit production, viticulture, hazelnut farming, and wheat production. These initiatives aim to promote the sales of grapes, non-standard apples, and tangerines, enhance hazelnut production, and ensure food security by subsidizing essential staples like wheat, particularly during the Covid-19 pandemic.

Starting from 2014 to 2024 (Figure 1), the share of subsidies in total agricultural expenditure has followed an increasing trend, ranging from 21.4 percent in 2014 to peaking at 67.5 percent in 2021. In 2024 the respective share is 54.1 percent.  A decline occurred in 2022–2023, following the stabilization of the Covid-19 pandemic. Apart from this, the share of subsidies within agricultural expenditures has been increasing over the last ten years.

Figure 1. Total and subsidy expenditures on agriculture, million GEL (2014-2024)

Source: Geostat, 2025.

While these programs are designed to assist farmers and increase sales, how these subsidies support in addressing the mentioned structural challenges – therefore advancing the effectiveness of the sector – is under question.

The Grape Subsidy Programs

The grape subsidy programs in Georgia are primarily aimed at supporting viticulture in key wine-producing regions, such as Kakheti, Racha-Lechkhumi, and Kvemo Svaneti. These subsidies were designed to stabilize farmers’ incomes and ensure smooth harvests, to guarantee that even lower-quality grapes will be sold, particularly for grape varieties used in wine production. In general, the government uses two types of subsidies: direct and indirect. Direct subsidies involve paying farmers a certain amount of money per kilogram of grapes. Indirect subsidies are implemented through state-owned companies that are responsible for purchasing grapes from farmers.

Georgia’s grape subsidy program (direct subsidies) was introduced in 2008 and has been implemented every year except for in 2018 and 2019. Starting from 2014, the government provided substantial direct financial support to grape producers. However, starting in 2017, direct subsidies began to decline sharply, and by 2018–2019, the government announced that it would no longer directly subsidize the grape harvest. However, during this period, the state’s grape purchasing program remained in place, purchasing any surplus grapes left on the market after private acquisitions.

The Covid-19 pandemic in 2020 prompted a renewed surge in subsidies, with financial support reaching its highest levels in years. This elevated support continued until 2022 but was significantly reduced again in 2023 (by 63 percent), following a decline in production (Figure 2).

Figure 2. Grape production, subsidies and wine exports (2014-2023)

Source: Geostat, 2025.

Grape production has generally followed an upward trend, with record harvests in 2019 and 2020. Given the absence of direct subsidies in 2017 and 2018, the effect of subsidies on production levels is questionable. In more recent years, production has become more volatile, displaying a noticeable decline by 2023.

Wine exports, a crucial part of Georgia’s economy, have grown steadily, with volumes peaking in 2022, and persisting at high levels ever since. Export revenues have also increased consistently, reaching an all-time high in 2024, according to preliminary data.

The main destination for the Georgian wine sector is CIS countries. Russia accounts for the largest share among the CIS, with an average of 75.4 percent, between 2014-2024. Russia’s share has been increasing in recent years, reaching 85.8 percent in 2024 (among CIS countries). The average share of exports to the EU of total exports is 10 percent (Figure 3).

Figure 3. Wine exports by country groups (2014-2024)

Source: Geostat, 2025.

Although subsidies played a key role in revitalizing Georgia’s wine industry following the collapse of the Soviet Union, especially as grape production and processing have increased over the years, their long-term impact have been problematic (Ghvanidze, Bitsch, Hanf, & Svanidze, 2020). Since subsidies were introduced in 2008, Georgia’s grape market has become heavily distorted, with prices shaped by government support rather than supply and demand dynamics.

Even though a significant portion of government funding for the sector is allocated to subsidies, the way in which subsidies affect grape production levels is not obvious. Other sector insufficiencies, such as quality issues and exporting market diversification are inadequately addressed. Grape quality remains a key issue, as farmers lack incentives to improve production practices, knowing that the government will purchase their yield regardless. Additionally, Georgia’s heavy reliance on its main export partner, Russia, poses significant risks, and the share of exports to EU countries has not seen substantial growth. Overall, since the subsidies aim to stabilize producers’ income rather than to address structural issues in the sector, they may be considered social support.

The Apple Subsidy Program

The apple subsidy program in Georgia was introduced in 2014 to support the sale of non-standard apples after market prices dropped to a record low 0.02 GEL. Non-standard apples are damaged fruits that fall from trees due to wind, hail, or other natural factors. Typically unfit for direct consumption, these lower-quality apples are primarily used by factories to produce apple concentrate. The program aimed to stabilize prices and provide financial relief to farmers. Processing companies received financial support for each kilogram of non-standard apples purchased.

The program was discontinued between 2015 and 2019, before it resumed in 2020. The number of companies involved in purchasing non-standard apples for further processing ranges from 12 to15 over the years.

As for apple production levels, although there were significant production surges in 2016, 2018, and 2020, these increases have been volatile and unstable.

Figure 4. Apple production, subsidies and exports (2014-2023)

Source: Geostat, 2025.

In terms of exports, the volume increased sharply between 2018 and 2019, reaching its peak in 2021 before gradually declining. Most apple exports are directed to CIS countries, with Russia accounting for an average of 94 percent between 2018 and 2024. In contrast, the EU’s share remains minimal, averaging less than 1 percent, with no exports recorded to the EU in half of the considered years.

Figure 5. Apple exports by country group (2014-2024)

Source: Geostat, 2025.

While apple production is highly vulnerable to weather conditions, the adoption of insurance remains low. The provided subsidy program supports farmers in producing lower-quality non-standard apples, thus limiting the incentives to enhance product quality, productivity, or production practices, as farmers rely on the government to purchase their produce regardless. Similar to the grape industry, government support in the apple market functions more as a social assistance rather than a tool for industry advancement.

The Hazelnut Subsidy Program

Georgia introduced the Hazelnut Production Support Program in 2022 to enhance competitiveness, assist farmers, and improve disease management. The program registered hazelnut orchards in a national cadaster, enabling better monitoring and targeted support, to subsidize the purchase of pesticides and agrochemicals essential for hazelnut care and cultivation. The program has continued in 2023 and 2024, with subsidies amounting 22 and 22.6 million GEL, respectively.

Hazelnut production in Georgia has been highly volatile in the past decade. The sector experienced its most severe crisis in 2017-2018 when fungal diseases and an Asian stink bug (Pharosana) invasion devastated yields. Consequently, both the quantity and quality of hazelnut production declined. In 2019, the production began to recover, peaking in 2021. However, unfavorable weather conditions resulted in a decline in 2022, with only a partial rebound in 2023.

Figure 6. Hazelnut production and exports (2014-2023)

Source: Geostat, 2025.

Hazelnut is mainly exported to EU countries, with an average share of 65.3 percent, between 2014 and 2024. The share of CIS countries in this period is 20.2 percent. However, the share exported to EU countries has been declining 2023 and 2024, to 52.4 and 56.7 percent, respectively.

Figure 7. Hazelnut exports by country group (2014-2024)

Source: Geostat, 2025.

The subsidy scheme in the hazelnut sector seems to be more targeted at the issues the sector is facing, compared to the other discussed programs. The effects are however yet to be explored as the program began in 2022. However, several challenges remain, such as insufficient technical facilities for drying and storing goods essential for ensuring the quality of products (Gelashvili, Deisadze & Seturidze, 2023).

Conclusion and Recommendations

Although the government of Georgia provides substantial support for the agricultural sector, it still suffers from various challenges. Product quality, high vulnerability to weather events and export dependency on unstable partners are major issues for the grape and apple sectors. Further, the effectiveness of the direct financial support and the corresponding incentives within these sectors can be questioned.

For these crops, the subsidy programs seem to function more as social assistance rather than tools for industry development. In the grape sector, guaranteed government purchases reduce incentives for farmers to improve grape quality. Similarly, the apple subsidy program encourages the cultivation of non-standard apples, as farmers rely on state-backed purchases rather than market-driven quality improvements. Apple production has also shown significant volatility over the years, further highlighting the sector’s instability.

Additionally, heavy dependence on Russia as a primary export market for these crops presents economic risks. Diversification, particularly to the EU, has remained limited.

As for the hazelnut sector, the subsidy program aims to address some of the structural challenges, while this sector also relies less on the Russian market. However, some issues with infrastructural equipment remain unresolved.

Overall, the share of subsidies in agriculture is very high; further, the design of the programs mainly prioritizes short-term income stability for farmers rather than long-term market competitiveness and sectoral development. To address the discussed systemic challenges, it is essential to develop targeted policies tailored to the specific needs of each sector. While the priorities may differ across each crop, several key areas require focused attention:

  • Quality of Products – Enhancing product quality through ensuring food safety standards, improved farming and manufacturing practices, and better regulatory frameworks can help increase competitiveness in both domestic and international markets.
  • Market Diversification – Strengthening ties with new international partners and improving branding strategies can help industries access new markets and reduce risks associated with economic or political fluctuations in dominant trade partners.
  • Infrastructure Development – Poor infrastructure remains a challenge for the sector. Investments in post-harvest drying and storage facilities, as well as modern machinery and equipment, will enhance efficiency, reduce losses, and improve product quality.
  • Adoption of innovative farming practices– Adopting innovative farming practices boosts productivity, lowers costs, and enhances sustainability. It helps farmers adapt to changing weather conditions, making agriculture more efficient, environmentally friendly, and resilient.

By addressing these fundamental issues, policies can play a role in contributing to the long-term stability and growth of the agricultural sector, ultimately strengthening the economy and increasing global competitiveness.

References

  • Gautam, M. (2015). Agricultural Subsidies: Resurging Interest in a Perennial Debate. Indian Journal of Agricultural Economics.
  • Gelashvili, S., Deisadze, S., & Seturidze, E. (2022). An Overview of the Georgian Wine Sector.
  • Gelashvili, S., Deisadze, S., & Seturidze, E. (2023). Overview of the hazelnut sector in Georgia: past trends and the way forward. Tbilisi: ISET Policy Institute.
  • Ghvanidze, S., Bitsch, L., Hanf, J. H., & Svanidze, M. (2020). “The Cradle of Wine Civilization” – Current Developments in the Wine Industry of the Caucasus. Caucasus Analytical Digest, 117, 9-15.
  • Jayne, T., & Rashid, S. (2013). Input Subsidy Programs in Sub-Saharan Africa: A Synthesis of Recent Evidence. Agricultural Economics, 44, 547-562.
  • Schwartz, G., & Clements, B. (1999). Government subsidies. Journal of Economic Surveys, 13(2), 119-148. doi:10.1111/1467-6419.00079
  • State Audit Office of Georgia. (2023). Audit Report on the Development and Management of the State Agricultural Insurance Program.

Disclaimer: Opinions expressed in policy briefs and other publications are those of the authors; they do not necessarily reflect those of the FREE Network and its research institutes.

On Economics of Innovation Subsidies in Russia

Posted on October 9, 2017 | Policy Brief

20171008 On Economics of Innovation Subsidies in Russia Image 01

Following the general agreement that innovation is a source of economic growth, the Russian government has provided various stimuli to foster domestic innovation. One of the mechanisms of innovation policy is research subsidies. This policy brief starts off with a discussion of the theoretical predictions and empirical evidence, which relates the economic incentives of research subsides to innovation and growth. We then address the potential adverse effects of focusing innovation subsidies mainly on large public companies in Russia. Finally, we attempt to establish a link between the innovation rate and market competition within Russian industries.

Overview

According to data from the Russian Statistical Agency, the R&D intensity – measured by R&D expenditure as percent of sales – increases with company size. Companies with 50 to 500 employees spend 1% of their sales on R&D, while the R&D intensity varies from 2 to 5% of sales for larger businesses (see Figure 1). The size non-neutrality of R&D in Russia contradicts the findings in the theoretical and empirical literature, which hold for companies in the developed countries (Cohen, 2010). An explanation may be the excessive government support to public companies in Russia, and in particular, to larger public corporations. A positive consequence of such policies is that public corporations come ahead of private companies, not only in R&D intensity, but also in innovation rates (see Figures 2–3).

However, government support towards innovation does not necessarily have a positive impact on overall economic activity. The purpose of this brief is to discuss the unwanted effects of the government policy in the form of research subsidies, both in theory and in an application to public companies and corporations in Russia. We base our analysis on the outcomes of the 2014–2017 micro surveys by the Analytical Center under the Government of the Russian Federation.

The role of government

Fighting under-provision of innovation

According to the seminal paradigm of the endogenous growth models with technological change, companies are engaged in quality competition, and their innovations are explained by a rational decision to raise profits through expanding the markets for existing products or entering markets for new products (Schumpeter, 1942; Romer, 1990; Grossman and Helpman, 1991; Kletter and Kortum, 2004). The innovation becomes one of the causes of economic growth, which is proved in empirical applications for developed countries, such as the U.S., Japan and the Netherlands (Akcigit and Kerr, 2010; Lentz and Mortensen, 2008; Grossman, 1990).

Figure 1. Innovation rate and R&D intensity by company size (number of employees)

Source: Indicators of Innovation in the Russian Federation: 2017. Tables 2.4, 2.16, Data for 2015. Innovative rate is % of companies involved in innovative activity.

However, the technological change is closely linked to knowledge disclosure, which means that new products become vulnerable to imitation, and that the non-rival character of knowledge causes an under-provision of innovation on the market (Arrow, 1962). The argument supports the cause for government policies through the system of intellectual property rights on the legal side, and research subsidies as an economic mechanism (Rockett, 2010; Hall and Lerner, 2010). Research subsidies are expected to have a positive effect on innovation rate, as is empirically shown for the U.S. in Acemoglu et al. (2016) and Wilson (2009). However, the impact on economic growth is ambiguous (Acemoglu et al., 2013; Grossman, 1990).

Figure 2. Innovation rate and R&D intensity by ownership

Source: Indicators of Innovation in the Russian Federation: 2017. Tables 2.6, 2.17, Data for 2015, public corporations are different from organizations by regional/federal government.

Figure 3. Share of public funds in R&D financing, % of company budget

Notes: Indicators of Innovation in the Russian Federation: 2017. Table 1.13; Innovation Development Programmes of Russian State-Owned Companies, Fig.4.

Unwanted effects of subsidies

Two concerns are associated with subsidization of innovation. First, while research subsidies may stimulate innovation among the targeted companies, the growth effect is likely to be heterogeneous across companies in the industry or economy, leading to a neutral or even negative overall effect. For instance, the increased innovation rate in subsidized large incumbents may curb entry of new (and more productive) firms, so the net outcome is deceleration of growth in the economy (Acemoglu et al., 2013). Research subsidies may even cause a shrinking of the high-tech sectors: if skilled labor moves from manufacturing to research labs, manufacturing may experience a shortage of labor, resulting in the net effect being a decrease in production (Grossman, 1990).

Another extreme of subsidizing entrants, in view of antitrust policies, occurs when former entrants change their market status to incumbents: now they face lower profits relative to newer entrants and hence, become less incentivized in their economic activity (Segal and Whinston, 2007).

Second, innovation policy (for instance, in the form of subsidies) may sometimes not even increase the innovation rate. Indeed, incumbents have no incentives to innovate in order to keep their market power or to prevent entry of higher quality firms in industries with non-perfect competition (Rockett, 2010; Qian, 2007).

Both mechanisms are likely to hold for Russian industries, where the protection of large public corporations has led to low competition, various forms of distortions on the market and hence, weak incentives to innovate.

Potential adverse effects in Russia

Large companies are likely to attract public attention owing to their obvious advantages in spreading fixed costs of innovations (Cohen,

2010). Russia is no exception to the phenomenon, so public corporations, which are commonly of a large size, received government subsidies. However, the subsidy is primarily used for acquiring new technologies and perfecting design, rather than conducting R&D (See Figure 4 with comparison available for communications and IT industry). The fact points to a possibility of a small effect of innovations on growth of public companies. Only if the research subsidy is spent on delegating the R&D research to specialized firms, with a subsequent acquiring of the resulting technology, the existing policy of supporting public corporations may induce their growth and/or growth of the corresponding industry.

Figure 4. Structure of spending the research subsidy in communications and IT in 2013, %

Notes: Indicators of Innovation in the Russian Federation: 2017. Table 1.134 Innovation Development Programmes of Russian State-Owned Companies, Fig.3.

In an attempt to formally assess the effect of innovation subsidies on company growth, we focus on the time profiles of the common proxies for company size: sales, profits and employment (Akcigit et al., 2017; Akcigit and Kerr, 2010; Acemoglu et al., 2013). The macroeconomic literature predicts that innovation becomes one of the channels for an increase of each of the three variables through a rise in quality. Motivated by this literature, the micro-data analysis “On the Interaction of the Elements of the Innovation Infrastructure”, conducted by the Analytical Center under the Government of the Russian Federation (2014), asked companies to assess their changes in sales, profits and employment in response to the innovation subsidy. As a result, the outcomes of the above analysis allow for a comparative assessment of the impact of the government’s innovation subsidy for public and private companies.

In particular, the results point to higher growth across private companies owing to research subsidies: the percent of private companies with new employees is higher than that of public companies. Similarly, the percentage of private companies that increased market share or raised profits/export due to subsidies exceed those of the public companies (see Figure 5). Here, we interpret new hires as employment growth and increase of market share as a potential indicator of sales growth.

Figure 5. Economic activity owing to research subsidies, % of companies

Source: Analytical Center under the Government of the Russian Federation, 2014. Fig.22

The innovation activity in private Russian companies lead to a higher prevalence of new products in comparison with public companies. The fact goes in line with a more important role of research and development in the innovative activity of private Russian companies (see Figure 4).

Finally, we attempt to establish a link between the innovation rate and market competition at the level of Russian industries. For this purpose, we use the results of the annual surveys “An assessment of the competitiveness in Russia”, conducted in 2015–2017 by the Analytical Center across 650–1500 companies from 84 Russian regions. The respondents were asked if they implemented R&D as a strategy for raising their competitiveness. We use the percentage of firms doing R&D as a proxy for the innovation rate. Competition in the industry was evaluated by respondents on a five-point scale (no competition, weak, median, high and very high), and we combine the prevalence of the two top categories as a proxy for competition in the industry.

Figure 6. Competition and R&D in Russian industries, % of firms

Source: Analytical Center under the Government of the Russian Federation, 2017, pp.8, 18.

The results show that innovative activity in the form of R&D or product modification is observed in industries with relatively high competition in Russia – for instance, in machinery and electric/electronic equipment (Figure 6). At the same time, industries where competition is not as high (e.g. woodworking, construction) show absence of either type of innovation. The findings go in line with the economic theory about market competition being a prerequisite for the rational choice of companies about innovation. Moreover, if the purpose of government subsidies is to foster innovation, the effective allocation of subsidies would imply the focus on Russian industries with high competition – here various forms of innovation do play a role in the company strategy on the market.

Conclusion

Our analysis outlines the theoretical foundations for the potential adverse effects of innovation policies in the form of research subsidies. The unwanted outcomes may relate to heterogeneity of companies and absence of the association between innovation activity and growth on non-competitive markets.

We offer the empirical evidence, which points to the undesired effects of subsidizing public companies in Russia. For instance, compared to the overall Russian sector of communications and IT, the innovative activity in public corporations has a weaker association with research and development. Additionally, compared to private companies, the innovations may result in smaller prevalence of increased exports, profits or new hires, as well as in a less frequent development of new products by public companies in Russia.

References

  • Acemoglu, D., Akcigit, U., Bloom, N., Kerr, W. R., 2013. “Innovation, reallocation and growth”, National Bureau of Economic Research Working paper, No. 18993.
  • Acemoglu, D., Akcigit, U., Hanley, D., Kerr, W. (2016). Transition to clean technology. Journal of Political Economy, Volume 124(1), pages 52-104.
  • Akcigit, U., Kerr, W. R., 2010. “Growth through heterogeneous innovations” National Bureau of Economic Research Working Paper, No. 16443.
  • Analytical Center under the Government of the Russian Federation, 2014. “On the Interaction of the Elements of the Innovation Infrastructure”, Analytical report, in Russian.
  • Analytical Center under the Government of the Russian Federation, 2015-2017. “An Assessment of the Competitiveness in Russia”, Analytical reports, in Russian.
  • Arrow, K., 1962. “Economic welfare and the allocation of resources for invention”, In The Rate and Direction of Inventive Activity: Economic and Ssocial Factors, Princeton University Press, pages 609-626.
  • Cohen, W. M., 2010. “Fifty years of empirical studies of innovative activity and performance”, Handbook of the Economics of Innovation, Volume 1, pages 129-213.
  • Grossman, G. M., Helpman, E., 1991. “Quality ladders in the theory of growth”, The Review of Economic Studies, Volume 58(1), pages 43-61.
  • Grossman, G.M., 1990. ”Explaining Japan’s innovation and trade”, BOJ Monetary and Economic Studies, Volume 8(2), pages 75-100.
  • Hall, B. H., Lerner, J., 2010. “The financing of R&D and innovation”, Handbook of the Economics of Innovation, Volume 1, pages 609-639.
  • Indicators of Innovation in the Russian Federation: 2017. N. Gorodnikova, L. Gokhberg, K. Ditkovskiy et al.; National Research University Higher School of Economics, in Russian.
  • Innovation Development Programmes of Russian State-Owned Companies: Interim Results and Priorities, 2015. M. Gershman, T. Zinina, M. Romanov et al.; L. Gokhberg, A. Klepach, P. Rudnik et al. (eds.), National Research University Higher School of Economics, in Russian.
  • Klette, T. J., Kortum, S., 2004. “Innovating firms and aggregate innovation”, Journal of Political Economy, Volume 112(5), pages 986-1018.
  • Lentz, R., Mortensen, D.T., 2008. “An empirical model of growth through product innovation”, Econometrica, Volume 76(6), pages 1317–1373.
  • Qian, Y., 2007. “Do national patent laws stimulate domestic innovation in a global patenting environment? A cross-country analysis of pharmaceutical patent protection, 1978–2002”, The Review of Economics and Statistics, Volume 89(3), pages 436-453.
  • Rockett, K., 2010. “Property rights and invention”, Handbook of the Economics of Innovation, Volume 1, pages 315-380.
  • Romer, P. M. (1990). Endogenous technological change. Journal of political Economy, 98(5, Part 2), S71-S102.
  • Segal, I., Whinston, M.D., 2007. “Antitrust in innovative industries”, American Economic Review, Volume 97(5), pages 1703-1730.
  • Schumpeter, J., 1942. “Creative destruction”, Capitalism, Socialism and Democracy, pages 82-83.
  • Wilson, D. J., 2009. Beggar thy neighbor? The in-state, out-of-state, and aggregate effects of R&D tax credits. The Review of Economics and Statistics, Volume 91(2), pages 431-436.

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Fiscal Redistribution in Belarus: What Works and What Doesn’t?

Posted on September 30, 2017 | Policy Brief

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Belarus proudly calls itself a social state. Indeed, Belarus boasts one of the lowest poverty and inequality levels in the region. Fiscal policy in Belarus is equalizing and pro-poor, effectively redistributing income from rich to poor. As in Russia and many other Post-Soviet states, the equalizing effect of the fiscal policy in Belarus is mostly attributable to the pension system. Some of the other social policies are highly inefficient, failing to redistribute income. The prominent examples are utility subsidies and student stipends, which mainly benefit the upper part of the income distribution. The lack of adequate unemployment benefits is an opportunity to improve the efficiency of the social support system in Belarus.

The Constitution of Belarus characterizes Belarus as a social state, and Belarus takes its social state status seriously. The economic growth in the beginning of the 2000’s was strongly pro-poor (Chubrik, 2007). Poverty according to the national definition (calorie-based poverty line, which in 2015 corresponded to $10.67 PPP per day) declined from 42% in 2000 to 5.7% in 2016, while the poverty according to the international threshold of $3.1 per day in PPP terms is fully eradicated. Belarus also has one of the lowest levels of income inequality in the region with a Gini coefficient of only 0.27 (UNDP, 2016).

How much of the pro-poor and equalizing effects could be attributed to the government policy? Probably it is impossible to give a complete answer to the question. Many non-formalized and not easily quantifiable government policies lead to the decrease in poverty and inequality. For example, the policy of support to state-owned enterprises might have redistributive effects through job creation. However, the absence of access to relevant data makes it impossible to estimate the effects of the policy.

Some of the government policies, on the other hand, are easily quantifiable with available data. Bornukova, Chubrik and Shymanovich (2017) analyze the redistributive effects of fiscal policies in Belarus using the Commitment to Equity methodology (Lustig, 2016). The authors find that the direct taxes and transfers in Belarus (taxes, transfers, and subsidies) are equalizing and pro-poor, lowering the national poverty headcount by 17 percentage points and the income Gini coefficient from 0.41 to 0.27. The high equalizing effect of the fiscal policies in Belarus surpasses those in other developing countries, including Russia where the direct taxes and subsidies reduced the income Gini coefficient by 0.13 (Lopez-Calva et al., 2017). The remaining discussion in this brief is based on the results from Bornukova, Chubrik and Shymanovich (2017), if not otherwise stated.

Fiscal policies and their redistributive effects

Taxation

The two types of direct personal taxes – the personal income tax and the social contributions tax – are both almost flat in Belarus. To fight tax evasion, the Belarusian authorities introduced flat tax rates in 2009, following a successful experiment in Russia. The personal income tax has some small exemptions for families with children, while the social contributions tax has a lower rate for agriculture employees. However, the effect of these deductions is relatively small: the direct taxes decrease the Gini coefficient by only 0.015.

The indirect taxes – the value-added tax, the import duties, and the excises – are weakly regressive, putting the burden of taxation on the poor. This is particularly true for the alcohol and tobacco excises. Again, the main purpose of these taxes is to penalize unwelcome behavior, and not to redistribute income, hence the result is not unexpected, and common for many countries. Overall the indirect taxes in Belarus increase the Gini coefficient by 0.05.

Direct transfers

Direct transfers are responsible for most of the equalizing effects of the fiscal policies. This is not surprising, given that the main purpose of the direct transfers is to fight poverty and provide support for those in need. However, most of the transfers are not need-based or targeted to the poor. Instead they are assigned to households based on their socio-economic characteristics aside income, such as age and maternity status.

Pensions are the main factor of reducing poverty and inequality. They reduced the Gini coefficient by 0.11 and decreased poverty (according to national definition) by 19 percentage points. The incredible effectiveness of the pensions is largely explained by the absence of other sources of income of the retirees. The majority of them does not work, and have no other pension savings or passive income. Pensions in Belarus are also redistributive in nature since they only weakly depend on one’s income during the working life.

Different benefits and privileges also decrease poverty and inequality, but at a much smaller scale. The childcare benefits (for families with children aged 0-3 years) contribute most to the effects, decreasing the Gini coefficient by 0.013 and poverty by 3 percentage points. The variety of privileges does not contribute much due to their relatively small size.

Subsidies

Utilities and transport subsidies are also important elements of the social support system, and their existence is usually justified by the necessity to support those in need. Since the utilities subsidies are incorporated into tariffs and available for everyone independent of need, they are in fact benefitting the rich (i.e. people with big apartments and houses).

Figure 1. Incidence of utilities subsidies by income deciles

Source: Bornukova, Chubrik and Shymanovich, 2017

As seen on Figure 1, upper deciles receive more support through utilities subsidies, and this support is quite substantial, often surpassing $1 per day in PPP. However, as a share of income the utilities subsidies are still progressive, and they in fact decrease the Gini coefficient by the tiny amount of 0.006, and decrease poverty (as any handout). The same is true for transport subsidies.

What could be improved?

Due to the flat nature of direct taxation and an absence of well-targeted needs-based transfers, some of the people in need still fall through the cracks. 1.9% of the population actually becomes poor after we account for the direct taxes and transfers. This headcount increases to 3.3% if we account for indirect taxes.

Another important issue is the efficiency of government transfers and subsidies in fighting poverty and inequality. It is not surprising that pensions have the largest equalizing contribution, as the government spends almost 11% of GDP on pensions. If we account for this fact and look at the efficiency (effect on poverty and inequality per dollar spent), pensions are not the leading program. It is in fact surpassed by different kinds of child support. Given that mothers in Belarus are allowed to take 3 years of unpaid maternity leave, which decreases household income, childcare benefits are relatively efficient.

The unexpected leader in efficiency is unemployment benefits, despite (or maybe due to) their negligible size. Shymanovich (2017) shows that unemployed face high risks of poverty, suggesting that an increase in the size of unemployment benefits and an easier access may bring huge benefits. The current minuscule size of the benefits (around $10-15 per month) is still enough to lift some people out of poverty, and has important equalizing effects, generating the biggest “bang for the buck” out of all benefits.

The student grants (stipends), the utilities subsidy and the transport subsidy have very low efficiency. These programs relocate a lot of funds to the upper deciles of the income distribution. Our calculations show that if all benefits, privileges and subsidies were not available to those in the top two income deciles, the Belarusian budget could save 1.4% of GDP.

Conclusion

Fiscal policies in Belarus are quite effective in redistributing income. Bornukova, Chubrik and Shymanovich (2017) show that the direct taxes and transfers in Belarus result in a decrease of poverty by 17 percentage points, and decrease the Gini coefficient of inequality from 0.41 to 0.27. The pension system has the most important contribution, decreasing poverty by 19 percentage points, and the Gini coefficient by 0.11.

However, the absence of a needs-based, well-targeted social support system leads to many inefficiencies. Direct and indirect taxes lead to impoverishment of 3.3% of population, which is not compensated by direct transfers.

The absence of targeting also leads to 1.4% of GDP redistributed towards the two upper income deciles through benefits, privileges and subsidies. This is, of course, highly inefficient. Better targeting could allow saving these funds or redirecting them to unemployment benefits – the most efficient but a very small benefits program so far.

References

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Green Transition: Adapting Markets and Policies

Posted on December 15, 2014 | Policy Brief

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This policy brief summarizes the discussion at the 8th annual SITE Energy Day conference, devoted to market adaptations and policies necessary to address the green transition. Recent energy trends with ever more green energy-mixes will have consequences for the functioning of related markets as well as implications for appropriate policy responses. New financial solutions, technological developments, international cooperation, and national policy initiatives in both developing and developed countries are examples of adaptations to this transition process. To discuss these issues, the conference brought together a group of distinguished experts from the energy industry, policy community and academia.

In December 2014, world leaders have gathered in Peru (Lima) for the 20th annual meeting of the United Nations Framework Convention on Climate Change. This convention has as an objective to “stabilize greenhouse gas concentrations in the atmosphere at a level that would prevent dangerous anthropogenic interference with the climate system” (see UNFCCC’s webpage). Even though the agreement to reduce emissions to a sustainable level may take years to be negotiated, at least 195 countries have ratified the UFCCC convention. The willingness to reduce environmentally harmful emissions has led to many countries changing their energy profile to include more green energy, a process that is often referred to as “green transition”.

It may be worth mentioning that the label “green transition” consists of two conceptual components. “Green” refers to the ability to generate environmentally friendly energy, which has become a key challenge for our society. Indeed, a majority of people now recognize the pressing need to cut pollution in the face of climate change and environmental degradation. The wording “transition” acknowledges that a shift toward a greener energy mix seems unavoidable, but this shift may not occur immediately or uniformly around the globe. The required time for change is long and the shift itself may not be smooth. To put it differently, the green transition has had and will continue to have wide-ranging consequences for businesses, governments, and the international community.

As a result, there is a need to carefully address the potential implications for the existing energy and related markets and market players, and for government policies, as well as new markets and new policies triggered by the green transition. These topics were the focus of the 8th SITE Energy Day, a half-day conference held at the Stockholm School of Economics on December 2, 2014.

Green Transition and the Energy Markets

The first panel focused on how energy markets have responded to green transition and how they may react in the future. Speakers from electricity companies, regulatory bodies and think tanks discussed how the green transition may affect the use of traditional financial instruments by energy companies; the choice of economically viable technology for producing green energy; and the way markets could be integrated to increase the efficiency of green energy.

As green transition almost always introduces more intermittent production, it is likely that market uncertainty will increase. This is one of the reasons why traditional financial instruments may not be fully adequate. The first speaker Laurent Cheval, Head of Nordic and Fuel Origination in the business division Asset Optimization & Trading at Vattenfall discussed this issue extensively. Energy companies face substantial financial risks since both prices and quantities may be highly volatile. To mitigate these risks, market participants may use an array of financial products. In mature energy markets, the products are fairly standardized. However, more complex and tailor-made financial products are required to face the ongoing changes in the sector. For example, the increased share of renewable energy combined with more interconnected markets create specific market risks. To hedge against risks associated with weather changes, future fuel costs, interest rates and so on, more and more energy providers trade customized derivatives “over-the-counter” (OTC) rather than through a centrally-cleared exchange. Another example is the development of decentralized power production and the rise of the “Prosumer” who simultaneously produces and consumes power. So far, the relevant regulation is underdeveloped and there is an additional demand for innovative financial solutions. Large energy companies such as Vattenfall are for instance offering a range of financial hedging solutions combined with actual physical handling and delivery of energy products.

Green transition should in the long run lead to a domination of environment friendly energy. However it is important that only economically viable technologies subsist. It is therefore necessary to assess the cost of producing green energy. Lars Andersson, Head of Wind Power Unit at the Swedish Energy Agency, reported on an extensive study done by the Agency on this issue. Over the last five years, the production cost of wind power has fallen consistently and capacity usage has increased. This dramatic change in the wind power industry likely implies that the existing subsidies for building wind power plants gradually will be phased out. It is unclear how the industry will react to these cuts in subsidies. Furthermore, according to Andersson, wind production faces at least two challenges. Without developing the capabilities for energy storage, electricity markets will face more energy imbalances as the share of wind power increases. Additionally, the support from the local communities is needed to ensure an expansion of wind power. Addressing these issues requires the development of new regulation and defining a common goal which may promote cooperation between stakeholders.

Ultimately the green transition will end when and if the green energies are largely adopted around the globe. One way to accelerate this green transition may be to coordinate action and development of governmental policies. Martin Ådahl, Chefsekonom at Centerpartiet, and Daniel Engström, Programchef Miljö och Klimat at Fores, presented the current state of the international climate policy and discussed the benefits of linking carbon emission rights markets. Because of conflicting interests, the likelihood of reaching an agreement within the current United Nations climate negotiations is rather small.

However, Ådahl and Engström suggested that the focus should instead be on reaching agreements between big polluter countries that contribute the lion’s share of global emissions. Indeed, regional emission trading schemes already exist in the EU, the US and China, the three regions which together account for over 50 percent of global emissions. One potential shortcoming of this suggestion is that it may not be enough to stabilize greenhouse gas concentrations in the atmosphere. Thereby, Ådahl and Engström discussed the possibility to link current cap-and-trade markets, as a first step toward an international system with a more formal global agreement. Linking cap-and-trade markets has many benefits, especially in the form of efficiency gains. However, emission caps vary across countries and regions because of different political goals or priorities. When markets are linked, difference in abatement costs (or allowance prices) would lead to a flow of allowances and emissions from countries/regions with low abatement cost to countries with higher ones. Thereby prices would be equalized, benefiting entities with cheaper allowances. To avoid opportunistic behavior, countries would first have to agree ex ante on an exchange rate between different countries’ emission rights. Second, a clear regulatory framework is required. Both Ådahl and Engström emphasized the need of an international organization devoted to climate economics. Such an institutional body could not only regulate the links between cap-and-trade markets, but also provide concrete solutions and technical models to improve on the market design.

Environmental Policies: International Experience

The second panel focused on how governments may promote green transition. Anna Pegels, Senior Researcher at the German Development Institute (DIE), reviewed green policy initiatives in developing countries. Pegels argued based on evidence from e.g. India and South Africa that it is possible to combine substantial growth with green energy. This is good news since emerging countries are among the highest polluters. However, to change a country’s energy profile, governments need to intervene and develop new industrial policies.

Governments can set long-term goals, which are supported by short- and mid-term targets. However, given the large profits that are at stake, officials may likely be subject to the risk of capture and corruption. To limit such risks, Pegel emphasized the need to introduce competition in the energy sector as a whole. Subsidized feed-in tariffs for renewable energy for example should be only a first step, to reach a certain scale of production. But the technology is mature enough that producers should be able to bear some additional risk in their current activity. This should increase the scope for competition. Finally, it is essential that governments continuously engage in policy revision cycles and learn from other countries’ experiences.

Benjamin Sovacool, Professor of Business and Social Sciences at Aarhus University and Director of the Danish Centre for Energy Technologies, talked about the process of low carbon transition in the Nordic region. In spite of large investments into renewable energy, fossil fuels still dominate the consumption in the Nordic countries and considerable measures need to be taken in the decades ahead to make the transition to a greener energy mix. Sovacool highlighted four areas which could help reduce the carbon footprint of the Nordic countries: renewable energy, increased energy efficiency of buildings, transportation, and carbon capture and storage (CCS). In order to be successful, the green transition has to bring about a systemic change engaging actors across the economy, particularly including end-users. There should also be a focus on additional technological progress. Finally, Sovacool noted that a rapid emission reduction such as the one planned in the Nordic countries is unlikely to be followed on a global scale in the near future due to a lack of political feasibility.

Conclusion

The green transition is expected to have a profound impact on the functioning and structure of energy markets as well as the policies that facilitates this transition.

There is an ongoing process of decentralization in the energy sector, with the rise of “prosumer” market places that alter market dynamics. Moreover, market uncertainty is increasing due to more intermittent production (due to renewables) and a stronger interconnectedness between energy markets. It is likely that energy imbalances will be a major concern and that more and more energy trade will take place on real time markets (as opposed to e.g. on the day-ahead market). As markets’ linking becomes stronger, the interdependence between markets in terms of energy type and geographical location will be intensified. The need for coordination and international cooperation will be even more pressing. The uncertainty regarding the development of international cooperation, but also regarding national policy changes, may however disrupt energy markets. Measures such as withdrawing existing subsidies must be handled in a gradual and strategic manner so as not to discourage investment. A key issue for governments is to have a credible green policy in the long-term. Such credibility will also depend on the level of involvement of different actors in the green transition, including the necessity to have a multilevel engagement of the end-users.

References

  • Energimyndigheten, (2014), Produktionskostnads-bedömning för Vindkraft i Sverige, ER 2014:16
  • Pegels, A. (Ed.). (2014), Green industrial policy in emerging countries, Vol. 34, Routledge
  • Rutqvist, J., Engström, A.and Ådahl, M., A Bretton Woods for the Climate. Fores, 2010
  • SITE 8th Energy Day, http://www.hhs.se/en/about-us/calendar/site-external-events/2014/site-energy-day/
  • UNFCCC, (n.d). First steps to a safer future: Introducing The United Nations Framework Convention on Climate Change, http://unfccc.int/essential_background/convention/items/6036.php [8 December 2014]