The Devil Called 'Energy Subsidies'

FOR decades, governments from Egypt to Indonesia have subsidised the price of basic fuels. Such programmes often start with noble intentions—to keep down the cost of living for the poor or, in the case of oil-producing countries, to provide a visible example of the benefits of carbon wealth—but they have disastrous consequences, wrecking budgets, distorting economies, harming the environment and, on balance, hurting rather than helping the poor.

Emerging markets are not the only places that distort energy markets. America, for instance, suppresses prices by restricting exports. But subsidies are more significant in poorer countries. Of the $500 billion a year the IMF reckons they cost—the equivalent of four times all official foreign aid—half is spent by governments in the Middle East and north Africa, where, on average, it is worth about 20% of government revenues. The proceeds flow overwhelmingly to the car-driving urban elite. In the typical emerging economy the richest fifth of households hoover up 40% of the benefits of fuel subsidies; the poorest fifth get only 7%. But the poorest suffer disproportionately from the distortions that such intervention creates. Egypt spends seven times more on fuel subsidies than on health. Cheap fuel encourages the development of heavy industry rather than the job-rich light manufacturing that offers far more people a route out of poverty.

How to save $500 billion and the planet

For all these reasons the benefits of scrapping subsidies are immense. Emerging economies could easily compensate every poor person with a handout that was bigger than the benefits they got from cheap fuel and still save money. In the process, they would help the planet. According to the International Energy Agency, eliminating fossil-fuel subsidies would reduce global carbon emissions by 6% by 2020.

Some emerging-market governments are persuaded by these arguments, and are getting serious about reform (see article). Indonesia raised petrol prices by more than 40% last year, and the front-runner in the upcoming presidential election says he will consider a more comprehensive fuel-subsidy revamp. Iran has just begun the second phase of a big subsidy overhaul, raising the price of petrol, gas and electricity. Egypt’s new president is being pushed towards tackling energy subsidies by a gaping budget deficit. Morocco and Jordan have cut subsidies in the past couple of years. Even Kuwait announced this week that it plans to scrap diesel subsidies.

Yet the politics of reform are exceedingly difficult. Politicians are loth to antagonise the urban elite; insiders benefit (often corruptly) from cheap fuel; ordinary citizens do not believe they will be compensated. Many previous attempts to cut subsidies have been abandoned in the face of popular protests or rising global oil prices. Experience suggests that any attempt to cut subsidies needs to be accompanied by a public-education campaign to explain the costs and inequities of subsidies, to have a clear timetable for gradual price increases and to be supported by targeted transfers to counter the effect of higher fuel prices on poorer people.

Even with better politics and the best-laid plans, it would be a mistake to expect too much too fast. Entrenched subsidies anywhere are devilishly difficult to get rid of. If the oil price rises, so too will the pressure on emerging economies to “protect” their citizens from dearer fuel. But, for the moment, there seems to be a chance to accelerate reform. It is an opportunity not to be missed.

ECONOMIST