Monday, April 23, 2012

Elite capture of fuel subsidies

There is a long running debate over elite capture of blanket, across-the-board subsidies in developing countries. Subsidies are primarily meant for people who cannot afford basic necessities or are targeted to those who are below the poverty line. However, there is a danger of elite capture as is seen in fuel subsidies, relief program for rural households, payment for employment schemes, etc. Almost all developing countries subsidize fuel costs to stabilize prices and to help poor households cope with fuel price volatility. However, fuel subsidy is not targeted and widespread leakage is common. Even though the targeted group get subsidized fuel in the market, a large proportion of it is consumed by the elite (because their consumption demand is higher—so will be subsidy). It puts strain on fiscal deficit and trade deficit.

A recent study in seven African countries shows that on average the richest 20% receive over six times more in subsidy benefits than the poorest 20%.

Expenditure data for seven African countries show that the distribution of these subsidies is disproportionately concentrated in the hands of the rich.  Richer households spend a larger amount on fuel products, and, consequently, benefit more than poorer households from any universal subsidy on these products. On average the richest 20% receive over six times more in subsidy benefits than the poorest 20%.


More here.

The high share of income spent by poor households on fuel relative to well off households means that if fuel subsidies are taken off, then it would hurt poor the most. The poor’s demand for fuel is more price inelastic than rich’s demand for fuel.

Results of simulating the short-term (assuming no substitution away from fuel) direct impact of a 20 percent increase in energy prices (using SHIP data) show that both rich and poor households would see a substantial negative impact on consumption: a decline of nearly 1 percent for the top quintile and of 0.5 percent for the bottom quintile. Other studies estimate that the total impact—direct and indirect—of higher fuel prices as a percent of consumption is about the same across income quintiles

For nine African countries the average short term direct and indirect welfare impact of a $0.25 per liter increase in fuel price is estimated to be 2 percent and 3.8 percent of per capita consumption respectively. Unlike the rich, the poor have very limited capacity to offset the effects of the price shock on overall consumption by borrowing or drawing on savings.

The figure below shows size of fuel price subsidy (% of GDP) in select SSA countries.

What is the solution to this? Well, there is no easy fix:

Removing subsidies and raising prices needs to be well managed. For one thing, social assistance programs need to be strengthened so as to help poor and vulnerable households weather the price shock. Another is to increase public understanding and support for subsidy reform by having a transparent and evidence-based discussion and scrutiny of subsidies: the full cost of the subsidy, the distribution of the subsidy and who is benefiting from the subsidy, and the implications for public spending on priority areas.