Abolishing Fuel Subsidies: Lessons From Indonesia

From the East Asia Forum (excerpt):

Time for a new approach to Indonesia’s energy subsidies
Authors: Stephen Howes and Robin Davies, ANU

Indonesia’s new president, Joko Widodo (Jokowi), will face many challenges but none more pressing and immediate than dealing with Indonesia’s energy subsidies, which this year will constitute a quarter of total government spending…They were 20 per cent of expenditure when President Yudhoyono (SBY) came to power, and they will be almost 25 per cent when he leaves office later this year….

…A more radical reform program is needed: instead of one-off increases, a time-bound program with an upfront agreement that the end result would be the elimination of energy subsidies within, say, three or four years….

…Whether Jokowi will deliver remains to be seen….

Short, sweet, and straight to the point.

In case you hadn’t heard, Malaysia is mulling over a scheme to revise the existing petrol and diesel subsidy, replacing the current blanket approach with a targeted scheme based on income levels. The details – at least what’s been leaked already – sound needlessly complicated.

From my perspective, such a scheme also misses the point – the fuel subsidies are there to help lower income families with the cost of living. You can achieve the exact same result (in fact, a superior result, because families can then choose what they want to spend their money on instead of getting support in kind), by getting rid of fuel subsidies entirely and using some of the proceeds to fund social transfers. In other words, just give them cash. The mechanism for that is already there, no matter what else you may think of BR1M.

Putting in a targeted subsidy scheme sounds nice in principle, but could be a nightmare to manage, not to mention the necessity of setting up another administrative system that has to be manned and paid for. Once in place, it’s going to be really hard to get rid of. There’s also the teensy, weensy issue of over-consumption and negative externalities that would be completely ignored (again) with the implementation of such scheme.

A couple of other notes: Indonesia has already implemented an income-based quota approach to fuel subsidies. It hasn’t noticeably reduced the burden of subsidies on the government. They’re also contemplating a shift to a fixed-subsidy system rather than a fixed price system, something I think we’re looking at as well. That sounds better as pump prices will move with the market and the government will only have to pay out a relatively fixed amount as the subsidy bill will vary only with consumption, instead of with both consumption and market prices.

But niggly little details like that don’t offset the main rationale of subsidy reform, which is to remove distortions from the economy, reduce government expenditure, and improve economic efficiency. Let’s get rid of these subsidies entirely and just move on, for crying out loud.