Subsidy Reform: Same Problems Worldwide, Same Solutions?

File under the to-do list for after the election (whenever that happens to be):

Costly Mideast Subsidies Need Better Targeting
IMF Survey online

• Generalized price subsidies are often costly, inefficient
• Targeted social safety nets give better support, allow more priority spending
• Subsidy reform should be among steps to cut poverty, boost inclusive growth

Many governments across the Middle East and North Africa (MENA) provide substantial energy and food price subsidies to their populations to offer some relief from high commodity prices or to share the wealth from natural resources.

These well-intended social protection policies are increasingly weighing on government budgets and debt levels and are not necessarily the most efficient way to channel aid to the most vulnerable, participants at a recent IMF seminar said…

…According to the International Energy Agency, the MENA region accounted for almost two-thirds of petroleum price subsidies worldwide in 2009…

…Oil-exporting countries fare the worst, since cheap fuel is seen as an entitlement in light of the natural resource wealth of these countries…

…Social safety net instruments, which better target the poor, and social insurance play less of a role in the region. In particular, cash transfers and other forms of direct income support are not used widely and, where they exist, are underfunded.

Across MENA, generalized price subsidies are not very effective in helping the poor, who end up receiving a relatively small portion of spending on subsidies…

,,,There was consensus among panelists on the need to replace wasteful price subsidy regimes that benefit mostly the wealthy with targeted social safety nets that better protect the poor. Social safety nets are more cost effective, they concurred, and thus leave more fiscal resources for other priority spending such as investment in infrastructure, education, and health, which would benefit populations at large…

Malaysia's level of subsidies don't quite approach the largesse lavished by Middle Eastern governments on their populaces; we spend somewhere around half their level relative to GDP. On the other hand, so’s our income level.

But the takeaway from this article is less the need to replace subsidies with better targeted social protection systems, but some of the experiences others have had trying to do the same.

Further on in the article:

Many countries rely on targeting by social category, such as limiting benefits to children or pensioners, or to households in certain geographical regions. Alternatively, coupons can be allocated to target households to allow them to consume a certain “lifeline” amount of subsidized food or fuel products.

“There are many ways to target the poor, either by subsidizing the goods that poor people consume, targeting regions where the poor people live, or by providing lifeline tariffs and cash transfers,” said Shafik.

Jordan, for example—as part of its food subsidy reform in the early 1990s—rationed sugar, rice, and powdered milk at low, administered prices through the introduction of a coupon system.

In Mexico, the Tortivales scheme introduced in 1990 allowed urban low-income households to receive 1 kilogram of tortillas every day by using “smart” cards, issued on the basis of a means test. Later, the program was phased out and integrated into Oportunidades, a conditional cash transfer program.

In Turkey, generalized price subsidies were eliminated gradually starting in the 1980s and ending in early 2000 in the context of a broader macroeconomic adjustment agenda. “We taxed fuel very heavily and used the revenues to spend on education, health care, and cash transfers to the poor,” said Mehmet Şimşek, Turkey’s Minister of Finance.

In Iran, the government designed a cash compensation scheme to be rolled out in conjunction with a sharp rise in fuel prices. The cash transfer was originally intended for a target group composed of poor households, but was later extended to the whole population to increase the chance of success of the reform.

According to seminar participants, subsidy reform should be part of a broader economic reform strategy…

According to Şimşek, Turkey had large and chronic deficits and high debt levels in the 1990s partly because of the costly price subsidy system…Reforming the subsidy regime ultimately helped bring the budget deficit close to zero, reduce the debt-to-GDP ratio significantly, and provide more support to the poor…

…Panelists agreed that successful subsidy reform calls for a public communications campaign that highlights the advantages of the reform, creates political momentum, and establishes realistic expectations about what can be achieved.

An important message to send to the population at large is that budgetary savings will be used for everyone’s benefit, for example, in protecting or expanding existing public spending on education, health, and infrastructure.

I like the Turkish solution – by all means, let’s not only get rid of fuel subsidies, but start taxing fuel use instead. The additional revenue can be used to support the poor, as well as fund other needed social programs.