TCS Daily

Costly Populism

By Christopher Lingle - March 10, 2005 12:00 AM

Indonesia and many other Asian governments offer subsidies to hold down energy costs. Despite the declared intentions to keep prices low in order to contribute to economic growth, there is no evidence that such actions do so. In fact, these supports were mostly possible due to higher rates of economic growth than experienced in other parts of the world.

The good news is that Indonesia's President Susilo Bambang Yudhoyono has sensibly moved to reduce the amount of subsidies on fuels. And it is a good thing too since Indonesia has become a net oil importer. It turns out that the cost of fuel subsidies in 2005 could have exceeded 70 trillion rupiah ($7.8 billion) that would force a reduction in spending on social programs and causing greater fiscal imbalances and rising public-sector debt.

As they are, such subsidies are little more than a populist ploy to induce low income citizens to support leaders that take credit for spending money taken from taxpayers.

It turns out that leaders of groups claiming to speak on behalf of the poor protested the 29 percent increase in pump prices. This was ironic given that almost 80 percent of subsidy payments go to those in middle and higher income brackets. And the rising costs of crude oil meant these fuel subsidies created unsupportable budgetary problems.

The tragedy is that once these populist measures are in place, it is extremely difficult to muster the political will to end them. Previous attempts by the political leadership in Jakarta to increase fuel prices were met with protests and agitation by political opponents that delayed the inevitable.

Running away from these problems is a classic instance of politicians choosing political expediency over economic reality. Faced with costs in the short-run, politicians inevitably avoid immediate pain even when long-run gains for the entire community are substantial.

From a political perspective, fulfilling these populist promises places an enormous strain on state budgets while also opening up opportunities for corruption. And the economic effects caused by oil subsidies involve distortions that interfere with communicating the full costs of energy use to both consumers and producers.

Businesses and manufacturers are less likely to invest in fuel-efficient equipment. This latter point is supported by the fact that production in Asia consumes more energy per unit of output than in other parts of the world.

Indonesia's fuel subsidies kept petroleum fuels as much as 60% below world prices. This meant that government spending in 2004 on fuel subsides exceeded spending on both health and education.

With international oil prices bouncing around $50 per barrel, much of this largesse went to fuel smugglers and corrupt officials. Large price differentials in neighbouring countries allowed smugglers to buy at low subsidized prices and sell offshore for considerable profits. It is bad enough that smuggling benefits corrupt officials and criminals, such operations result in domestic taxpayers extending a subsidy to (richer) foreigners!

Since reducing subsidies for any goods or services always creates a problematic political issue, they should never be implemented. In the first instance, the primary beneficiaries of are not the poor. Indeed, many the beneficiaries are those whose income places them well in the middle class or higher. However, the largest amount of financial gains from subsidies goes to industrial users.

Keeping prices for motor vehicle fuels artificially low also has serious environmental consequences. Much of the air pollution that plagues large cities arises from low prices that encourage waste and create dependency on private vehicles instead of encouraging use of public transit systems.

Subsidies on fuel offer an object lesson in the corrosive effect of populism as a tactic of looting the public treasury for the purpose of buying votes. This is evident in the fact that fuel subsidies have the perverse effects of rewarding the wealthy, reducing costs for rich enterprises, and providing benefits to foreigners at the expense of locals.

Christopher Lingle is Global Strategist for eConoLytics.


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