Ending fossil fuel subsidies

(January 19, 2022)

We posed a few questions to Dr. Neil McCulloch, Director of The Policy Practice, about his new book on ending fossil fuel subsidies. Besides solid academic credentials, Dr. McCulloch brings substantial policy reform experience from across the world.

1. What is the approximate magnitude of fossil fuel subsidies in the latest available data? Have they increased over time?

The latest estimate from the Fossil Fuel Subsidy Tracker is $732 billion in 2021. The figure for 2022 is likely to be much higher, given the support programs introduced in many countries to counter the price increases due to the war in Ukraine. The total amount has fluctuated over time, primarily with the oil price (many subsidies are due to governments setting prices below the cost of supply which is determined by the oil price, so when oil prices are low, subsidies are lower too). However, the current figure is the largest since the huge surge in subsidies between 2012-2014 (again because of high oil prices).

2. What types of countries are more likely to have large fossil fuel subsidies?

Oil exporting countries are much more likely to have high fossil fuel subsidies than importing countries. This is, in part, because it is cheaper for them to supply fuel cheaply to their populations (e.g. Saudi Arabia), but also because fossil fuels are part of the social contract in such countries and so populations expect that government will give them cheap fuel as part of sharing the natural resource rents of the country. However, it is important to recognize that almost all countries have fossil fuel subsidies and these are very significant in lots of countries. For example, 74 countries have subsidies that amount to 1% of GDP or more; in 40 countries subsidies are more than 2% of GDP. In some countries they are huge. For example, in Uzbekistan, they are 15% of GDP.

3. How do the proponents of subsidies manage to sustain them politically?

Subsidies serve a political purpose. As noted above, they are part of the social contract between leaders and those they rule over. They are popular (people like cheap fuel and electricity) and so very difficult to remove because people get angry if prices are increased. Often people don’t believe that the resources will be used for more developmental purposes (and, of course, they may be right) and so prefer getting cheap fuel to the promise of something better. Large price increases are a gift for the opposition and can trigger riots, so, unsurprisingly, politicians are very wary about removing subsidies.

But subsidies also serve vested interests. For example, if fuel is cheaper in your country than the neighbors, this encourages smuggling. This can be very lucrative. Often those involved in smuggling are politically connected. And there are other ways of siphoning off subsidies into private hands with suitable contributions to political parties or politicians. Consequently, major vested interests often oppose subsidy reform.

4. Are there good examples of countries that have successfully reduced or eliminated these subsidies?

Yes (Chapter 6 of the book is all about this). But usually the experience is mixed. For example, India successfully removed its subsidies on diesel and petrol. Indonesia did a major reform in 2014 that initially eliminated subsidies (although it then let them come back later). Iran did a dramatic subsidy reform in 2010 that was successful – but then again allowed subsidies to come back. El Salvador reformed its LPG subsidies successfully – and changed public opinion on the topic in the process. UAE reduced subsidies successfully over a period of a few year. So there are lots of examples and useful lessons to be learned about how to reform and also how not to do it.

5. What is the best way to move forward and eliminate subsidies? Perhaps there is a blend of policies on the national and the international level?

The single most important thing to move forward on subsidy reform is to recognize that this is a difficult domestic political problem. There have been many international initiatives on subsidy reform, but they have made little to no progress, because individual countries are ultimately swayed by their voters/citizens. Therefore, to do successful reforms, it is necessary to really understand the nature of the local political context, identify what is and what is not possible and help reformers to charge a course that is both technically sensible and also political feasible in that context.

Of course, international initiatives are also useful. There is great work on standardizing data collection so that we can see the size of the problem. And the G20, G7 and the WTO are trying to get their members to commit to taking the issue seriously. But the real work has to be at the country level, supporting local advocates of reform to craft something that will work in their countries. The final chapters of the book describe a new way in which the international community might support such efforts through ‘thinking and working politically’ on the topic.

The book - a brief, very interesting, and useful read on the subject - can be obtained here.

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