The case for removing fuel subsidies

• Author: Robert Gillingham
• Position: IMF Fiscal Affairs Department
• Pages: 1-15

Page 1

Developing countries often impose controls on petroleum products to shield the poor from sharp price increases. What actually happens, says a new IMF Working Paper, is that the wealthy reap the largest benefits and the subsidies drain substantial resources from more productive uses. A more effective way to help the poor, the paper argues, is to remove the subsidies and put in place well-targeted social assistance measures.

Page 14

Rethinking fuel subsidies

Developing country governments commonly resort to controlling the prices of petroleum products, at least in part to protect low-income residents. But how effective are these subsidies? A new IMF Working Paper-drawing on poverty and social impact analyses in Bolivia, Ghana, Jordan, Mali, and Sri Lanka-underscores how expensive and poorly targeted energy subsidies are. There are more effective ways, it argues, for governments to help shield the poor from high energy prices.

Developing countries intervene in energy markets in a variety of ways. In oil-importing countries, some governments directly control quantity, distribution, and prices. Others allow the private sector to import and distribute petroleum products freely, but set price ceilings and compensate private sector distributors to cover any losses. In oil-exporting countries, governments often set domestic prices below world levels, imposing an opportunity cost on its suppliers.

Although politically popular, subsidized fuel prices have significant downsides. For governments, the subsidies may direct public expenditures away from more productive uses, reduce revenues from domestic production, or contribute to unsustainable budget deficits. At the household level, low fuel prices also encourage inefficiency in the use of energy.

And, as a means of shielding the poor from rising petroleum costs, universal energy subsidies are simply not cost-effective, because they inevitably entail a substantial leakage of benefits to higher-income groups.

Gauging the cost of subsidies

Because most countries are either net exporters or net importers of petroleum products, the appropriate reference price in measuring the extent of subsidy is the relevant border price-that is, the world price adjusted for trade and transport costs to the country's border. For an exporting country, the border f.o.b. (free on board) price minus trade...