Trillions Sitting on the Sidewalk? How to Reform Fuel Subsidies Without Depriving the Poor

Energy subsidies are one of the few domains where there is a near full-throated consensus among progressives, governments, and economists over the need for reform. Energy subsidies are wasteful, polluting, and unfair. Nearly everywhere, energy subsidies are regressive, vastly favoring the car- and energy-consuming parts of the population that are the least in need.

And yet, despite the myriad of problems that fossil-fuel subsidies cause, most governments avoid reforming their system. This is because political opposition to energy subsidy reform can be ferocious. The fall of the Suharto regime in Indonesia, Myanmar’s Saffron Revolution, France’s gilets jaunes protests, and the ousting of Sudan’s Omar al-Bashir were all triggered by failed attempts to cut consumer energy subsidies. Even where state stability doesn’t come under threat, countries that attempt subsidy reforms face strong opposition from the public, often leading to a reversal or rollback of the reform.

Analysts often attribute these strong reactions from civil society to political opposition that opportunistically uses post-reform price increases to encourage protests. But the protestors have a point. While in absolute terms most benefits from energy subsidies go to better-off households, subsidy removal is likely to have the greatest adverse impact on the poor. For people near or below the poverty line, removing an energy subsidy does not just mean, “drive less.” It can mean, “eat less.”

Policy makers are aware of these problems. Most programs for energy subsidy reform include communications and outreach to explain the reasons for the forthcoming reforms. Increasingly, they also include a cash transfer program to offset the impact of rising energy prices on those below the national poverty line. However, even with outreach programs and targeted social safety nets, subsidy reform programs continue to generate popular opposition that leads to rollbacks or cancellations. Is something still missing from the analysis?

To address this question, we took a deep dive into a series of country case studies using Pathfinders’ “Recognition” framework to see what else could explain the difference between success and failure. We look at contrasting pairs of failed and successful reforms. We drew three key lessons from our analysis that are of use for the Pathfinders inequality action program:

1. Subsidy removal hurts poor, near-poor, and lower-middle-income households. Mitigating the impact of subsidy removal requires broad-based targeting.

The successful country examples recognized that an excessive focus on the poverty line is misleading as a guide to assessing impacts. Their programs ignored it. The successful cash transfer program in Jordan, which was set up to mitigate the impact of their subsidy reform, reached 70% of the population. In Indonesia, the government targeted 35% of the population, more than double the number of households living below the poverty line.

2. Timing is critical — price increases should not come before cash-in-hand.

Cash transfer programs must be ready and start on the same day as the price increases. The promise of a future transfer is not sufficient. This is especially true for governments with low trust between citizens and the state. Citizens, particularly the poor who need to work each day to pay for their food, are unlikely to be convinced by future promises or long-term economic arguments — no matter how effectively such messages are communicated. Instead, seeing is believing. Indonesia (in 2005), Dominican Republic, and Iran (in 2010) ensured that cash transfers started at the same time as energy price increases.

3. Cash transfer schemes should identify where the shoe pinches.

Cash transfer programs should include groups at extra risk of losing out from subsidy reform, as was not the case in Iran and Ecuador’s failed plans in 2019, where the government failed to address redistribution problems among minority groups. By contrast, in the successful Dominican Republic case, the government recognized the economic impact of price increases on the livelihoods of public transport drivers — and developed a unique mitigation plan to support them.

Reforms to energy subsidies, if done correctly, are as close as we can get to a large-scale, small cost reform that makes economic and social sense. Reducing or ending energy subsidies will free up large amounts of money that can be spent on pro-poor investments, such as better health, housing, or education — areas that Pathfinders has flagged as key to reducing inequality. Properly priced energy will also provide strong incentives for improving industrial and transportation efficiency, cutting back on pollution and stimulating the adoption of better technology.

But while many people benefit from subsidy reform, its costs should not end up further disenfranchising the poor and near-poor. Governments and donors have come a long way from the days when economic reforms could simply be forced through by authoritarian leaders. At present, few countries and little of the economic advice adopt the two variables our analysis showed to be key to distinguishing success from failure, broad-banding eligibility and timing the release of benefits to precede or coincide with the reforms.

As the great Persian poet Sa’adi reminds us, “all things are difficult before they are easy.” In the era of accelerated climate change, it is more urgent than ever to learn from past challenges in phasing out energy subsidies and to find ways to do it in an equitable and politically feasible manner.

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