Time to End Fuel Subsidies

Oil Refinery Pipelines In Marcus Hook Pennsylvania  1/23/2015
Oil Refinery Pipelines In Marcus Hook Pennsylvania 1/23/2015

Every year, governments in the developing world spend half a trillion dollars making energy cheaper for their citizens--they subsidize the consumption of oil, natural gas, coal, and other fossil fuels. This is bad for social equity, for economic growth, and for the environment. But they do it anyway--a kind of fiscal aberration that has lasted for decades. The recent fall in oil prices is a golden opportunity to end it.

What's wrong with using tax-payers' money to make energy more affordable for everyone? The first problem is that not "everyone" benefits equally. In the average developing country, two-thirds of gasoline subsidies go to the rich--they have the cars--and only 3 percent go to the poor--they rely on public transport, where it exists. Something similar happens with electricity and natural gas--who owns the larger houses? These gifts to the well-off come at the expense of more and better services to people in need: a typical oil-importing nation could easily double its budget for public healthcare if it did away with fuel subsidies. Not that the amount of driving, lighting, or heating done by the rich would change much if they had to pay the full cost of the energy they consume--they are just happy to pay less and pocket the difference. It is difficult to imagine a more regressive way to spend public funds.

This points to the second problem with fuel subsidies: they are not very effective at spurring economic growth. Governments in oil-exporting developing countries lose, on average, the equivalent to 3 percent of GDP in those subsidies. But research suggests that a dollar spent on public infrastructure or on cash transfers to the poor generates more private investment and consumption than a dollar spent subsidizing gasoline or electricity. In other words, letting the price of energy reflect its cost would generate large fiscal savings (a.k.a. "fiscal space"), which could then be used to stimulate the economy--an attractive proposition at a time when other tools, like record-low interest rates, have proven insufficient.

And of course, making fossil fuels artificially cheap is a sure--and shameful--way to accelerate the degradation of our natural environment. Think of climate change and rising sea levels, and think of local traffic and air pollution: they all worsen when prices at the pump are kept artificially low. The International Energy Agency estimates that removing subsidies to the consumption of fuel would, by 2020, cut carbon-dioxide emissions by 7 percent--roughly the same as the current emissions of the European Union.

So, if fuel subsidies are that bad, why haven't they been dismantled already? Because raising prices is never popular and can lead to major social unrest--as Nigerians found out in early 2012. But, with sound planning, lots of communication, and a mechanism to compensate the poor, it can be done--as Indonesia, Iran, Malaysia, and Morocco, among others, have shown. In fact, the time has never been better to do it. The fall in international oil prices--from over $100 per barrel last year to just above $50 now--has made it possible to reach a new social contract on fuel prices. Consider this: if your government was a year ago selling oil products at half their international value--not an unusual case--ending the subsidy today would imply almost no increase in price for the consumer. The key is to do it openly and prepare public opinion for the days when oil prices rise again--something that the World Bank's macroeconomists expect by 2018. When that happens, political pressure to go back to subsidization will mount. That is why this reform must be accompanied by programs to shield the poor from its impact. The good news is that, in most countries, those programs already exist and expanding them is far less expensive than fuel subsidies. Bottom line: we can build fairer, richer, and greener societies and still save money--a win-win-win opportunity that comes around once in a generation. We should seize it.