Developing countries of Asia and Africa are coming under increasing pressure to balance their budgets by cutting fuel subsidies. Resource-rich countries, too, are pressed to end subsidies as they distort markets. Proponents of alternate energies blame fuel subsidies for discouraging development of new products.
Many in developing countries are living on a subsistence level of US$2 a day. About half of the world’s more than 7 billion people are in that category. For these, a rise in gas prices of, say 75 cents, could be catastrophic, triggering riots like recent ones in Indonesia and Nigeria. For middle-income people, such a rise is not a severe problem. They can afford it.
Yet, ending subsidies has an alarming effect on the poorest in developing countries—affecting every facet of life. Society today is so dependent on fuel that even the poor cannot simply abstain from use. They need it for heating, cooking, generators, crop transport, and motorbikes. Fuel is an absolute necessity for economic survival of the poorest.
Economics of Subsidies
Theoretically, taking away fuel subsidies would heighten prices on fuel and consumption will go down.
A vital economic argument against fuel subsidies is that they inflict a heavy burden on government budgets, add to global warming, pollution, and wasteful consumption in general. This, in turn, diverts much-needed resources from more pressing needs, such as health and education.
Practically, however, price elasticity on fuel is very small so that higher prices won’t mean a decline in consumption. For the poorest, fuel is a necessity they can’t be spared.
Rich people can compensate for higher fuel prices with saving less or changing consumption patterns, but they’ll probably consume the same amount of fuel overall. The subsidies are the only tangible benefit the poor can get in normal economies, especially in resource-rich developing countries.
Subsidies are essentially the government buying energy at market prices and reselling it back to citizens at lower prices. Fuel subsidies are generally only possible when a country has windfall revenue in either resources, such as oil in Nigeria, or in trade surpluses, such as China’s.
Countries having scant resources and trade imbalances, such as India, Vietnam, and Sri Lanka, however, run persistent budget deficits, reflected in consistently weakening currencies. They do this, of course, for political reasons.
China successfully uses fuel subsidies to keep its export machine humming, and continues to do so to ensure growth.
In India today, groaning under fuel subsidy of rupees 200,000 crore [in India the sum of ten million] (US$40 billion) enormous coal reserves in Bihar and Orissa states lie in the hands of the few. India recently took the highly unpopular step of raising gas prices in order to reduce its subsidy. Fossil fuel resources are fungible, and existent reserves of minerals should be utilized to address India’s endemic poverty issues.
In all, it’s estimated the developing world spends more than US$400 billion a year on fuel subsidies, according to the International Energy Agency in 2010.
In Western countries, energy costs are passed directly to the consumer, usually with considerable taxes added on, as in the case of the European Union, the United States, and Australia. These countries have higher GDPs than the developing world, and residents can absorb costs without seriously disrupting buying power.
In resource-rich countries, governments often grant foreign investors rights to exploit resources under production-sharing contracts, or PSCs, in oil or work contracts in mining.
Briefly written, the production-sharing contracts are made by the investors, typically oil companies, specifying that the sellers, typically developing countries, pay for expenses incurred by the investors in developing the oil fields. The effect of this is that the sellers are not interested in making big payments for other expenses unrelated to direct extraction, for example, education and training of employees.
PSCs today are largely banned in developed countries as an abuse of bargaining power by international oil companies against unsophisticated government officials.
Iran, for example, with the second largest proven oil reserves in the Middle East, refuses to use PSCs. In some places, such as postwar Angola or Kurdistan, oil interests dictate, via largesse to public officials, how new “investment” rules will be written.
Mining contracts require knowledge of ores and calorie content to be equitably enforced. Of course, mining companies know the legal requirements and their own operations capabilities, thus easily outmaneuvering officials and, in countries where China invests, paying off bureaucrats to look the other way. Corruption and patronage flourish with citizens shortchanged.
Countries facing burgeoning, youthful populations with scant job opportunities, but sitting atop minerals or fossil fuels, simply cannot afford these colonial-era economic models. Libya and Nigeria have met with political unrest due to enforcing the PSC model over their unemployed citizenry. Indonesia has recently endured mining strikes in Papua over subsistence wages.
Continued on the next page: Citizens as Owners