Monday, January 6, 2014

Estimating Costs Of Global Fuel Subsidies

There are costs, and then there are costs (abstract):

The Economic Cost of Global Fuel Subsidies
Lucas W. Davis

By 2015, global oil consumption will reach 90 million barrels per day. In part, this high level of consumption reflects the fact that many countries provide subsidies for gasoline and diesel. This paper examines global fuel subsidies using the latest available data from the World Bank, finding that road-sector subsidies for gasoline and diesel totaled $110 billion in 2012. Pricing fuels below cost is inefficient because it leads to overconsumption. Under baseline assumptions about supply and demand elasticities, the total annual deadweight loss worldwide is $44 billion. Incorporating external costs increases the economic costs substantially.

The equivalent of about 40% of the value of subsidies is effectively a deadweight loss – the efficiency loss associated with overconsumption due to market prices below the market-clearing level.

In addition, the paper estimates the costs arising from negative externalities, such as pollution, health costs and traffic congestion, which amount to USD1.10 per gallon, or approximately USD0.29 per litre. At today’s exchange rates, that’s about RM1.00 per litre, over and above the dollar cost of subsidies.

The total global economic cost of fuel subsidies therefore is USD44 billion plus USD32 billion in externalities for a grand total of USD76 billion – every single year.

Where does Malaysia stand? We’re in the top ten in the world in terms of the absolute value of fuel subsidies, and in the top twenty in per capita petrol consumption, which is amazing considering our demographic profile.

Neither mark is one to be proud of. Fuel subsidies simply have to go.

Technical Notes

Lucas W. Davis, "The Economic Cost of Global Fuel Subsidies", NBER Working Paper No. 19736, December 2013


  1. Fully agreed.

    Zuo De

  2. But the Oppo hasn't realised it yet.

    Sad, but there you go. It's an indicator of the "brainpower" that's available to the Oppo.

    But at RM25 billion and counting, the country just cannot afford subsidies. Apart from education and public health care.


    On to another topic. I wonder, Hisham, if you've read Laurence Kotlikoff's analysis of why the corporate tax should be abolished?

    If Malaysia were to abolish the corporate tax and close off all the tax loopholes, what would be the implications for the economy and government finances?

    To quote Kotlikoff: "Jobs don't grow out of thin air, especially well-paying ones. They require, among other things, companies that are willing to operate where you live.... I, like many economists, suspect that our (US) corporate income tax is economically self-defeating - hurting workers, not capitalists, and collecting precious little revenue to boot..... "

    1. @Corbulo

      Abolishing corporate income tax has been a long standing goal of the ideological right in the US. So while I haven't read Kotlikoff's work, I have a passing familiarity with the idea.

      In the face of it, it's theoretically sound. Given that both personal and corporate incomes are taxed, that amounts to double taxation of capital income, which isn't quite fair (which in fact contradicts Kotlikoff's point above). The points about reduced investment and employment are probably valid as well.

      The problem is that in practice, for mid-to-high income households it's a trivial matter to corporatise, which would allow those households to escape taxation entirely. The more dependent on capital income a household is, the more likely it will be able to reduce or nullify its tax liability, with obvious effects on income and wealth inequality.

      So I don't think the idea is workable in practice.

  3. Is there a breakdown of subsidy usage based on consumers and business? we know business consumes more subsidy than consumers but by how much?

    of course, one can argue that business subsidy consumption is akin to indirect consumer consumption. however problem with that view is that subsidy or cost savings may be used by business for profiteering. for example a Frap blended in Singapore cost between S$5.80 and S$8.20 while in Malaysia it is above RM10. with cheaper rental and subsidy, we are still pretty expensive. and this is true with locally made items like Chicken Rice (in Singapore you can find chicken rice in the SGD2-3, in KL it is hard to find one under RM4). and these dish uses price controlled items (rice, chicken)

    so, I suspect subsidy is being abused by businesses to profiteer.

    1. @anon 3.51

      There's no detailed breakdown by user that I know of. However, I wouldn't necessarily use retail prices as an indicator of abuse - power prices are a small portion of retail costs (labour and rental are much higher). I suspect most subsidies for businesses are consumed at the industrial level, or through transportation costs.

    2. It is hard to imagine any other reason why prices of even locally made items in KL or JB are higher than in Singapore. Our median wage is around RM1.5, Singapores's is around SGD7k. In terms of rental, it is alot more expensive down south. For retailers, power may not be the biggest cost but they do enjoy savings from price controlled items (chicken, rice, cooking oil). somehow the savings don't reach the consumers

      I suppose, it is possible the industry and transportation companies are not passing the savings to the retailers.

    3. @anon 3.04

      Gross operating surplus in Singapore is about 50% of GDP:

      In Malaysia it's more like 55%-60%, so you have a point.

    4. can you explain what GOS tells us?

    5. @anon 9.30pm

    6. Thank you for the link. I did check it out earlier. still digesting it!

  4. we should abolish fuel subsidies once and for all and introduce petrol tax (or don't exempt them from GST?). to lessen burden of middle income group govt can give them cash rebate just like what they did in 2008.

    1. @Norman

      Absolutely agree - tax should be between RM0.30 to RM1.00 above market price, depending on which assumptions you use.

    2. Totally agree with this. Just afraid whether the rebate is enough tide over the cost of living increase for the poor and middle class.

  5. Then why is Malaysia in fiscal deficit, when Singapore has a fiscal surplus, seeing as how both are running a GOS of 50 per cent+?

    Are subsidies and the notorious "leakages" to blame?

    1. @Hari Potter

      Gross operating surplus refers to private sector profits, not government revenue.

    2. @Hari Potter,

      BTW, Singapore's government attains a fiscal surplus by spending less on everything, including education and healthcare.

    3. That's an interesting comment.

      Do you have the stats on per capita expenditure on education and health care for Malaysia and Singapore?

      Arguably, Singapore being a rich and developed country can afford to spend more on education and health care than other countries in Asean.

    4. @anon 5.03

      In absolute terms (even on a per capita basis) public spending on education and health is higher than ours. However, in percentage of GDP (i.e. relative to their income level), Singapore is the worst among advanced economies, and suffers by comparison against many developing economies too. In those terms, Malaysia spends about double Singapore's level.

      Much of the expenditure on health and education has to be borne by Singapore citizens privately.

    5. For health:

      For education:

  6. Anon 5.03,

    You may want to read this blog to understand the Singapore's expenditure on health & education,