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Corrosive Subsidies in MENA

Shanta Devarajan's picture

Air pollution in Cairo Half the world’s energy subsidies are in the Middle East and North Africa Region.  These subsidies have been criticized on grounds that they crowd out public spending on valuable items such as health, education and capital investment.  Egypt for instance spends seven times more on fuel subsidies than on health.  Furthermore, the allocation of these subsidies is heavily skewed towards the rich, who consume more fuel and energy than the poor.  In Yemen, the portion of fuel subsidies going to the richest quintile was 40 percent; the comparable figure in Jordan was 45 percent and in Egypt, 60 percent.
 

These criticisms, while valid, may be understating the real damage done by these subsidies to the economies of the MENA region.

Growth.  By their sheer magnitude (5-10 percent of GDP), energy subsidies may be undermining economic growth in MENA.  There is a positive and statistically significant association between per-capita GDP growth and gasoline prices in the MENA region between 1998 and 2012.  By contrast, in the Europe and Central Asia (ECA) region, where fuels are taxed rather than subsidized, the relationship between per capita growth and fuel prices is negative. These findings suggest that in MENA, there are efficiency gains from raising fuel prices to market levels, whereas in ECA, increasing these prices increases the distortions from taxation.

Employment.  The MENA region has the highest unemployment rate in the developing world.  While there is a host of reasons for this, energy subsidies may be a contributing factor.  Energy subsidies help energy-intensive firms.  These firms tend to be more capital-intensive, larger and older.  But productive jobs are created by young, dynamic, small firms—which are solely lacking in the region.  In other words, energy subsidies are a tax on labor.

Road safety.  The MENA region has some of the highest rates of road accidents in the world.  While there is variation across countries in the region, there is a negative and statistically significant relationship between fuel prices (both gasoline and diesel) on the one hand and road death rates and road injury rates on the other.  Low fuel prices are an incentive to drive more and possibly faster. 

Air pollution.  Urban areas of MENA have some of the world’s highest rates of air pollution in general, and motor vehicle air pollution deaths in particular.  Both common sense and measured elasticities of demand indicate that fuel subsidies contribute to more vehicle-kilometers traveled, more trips, and less use of alternate modes, such as walking, cycling or public transport.  In short, low gasoline prices encourage fuel consumption that, in turn, generates air pollution.

Water. At 500 cubic meters per capita per annum of renewable water, MENA is the most water scarce region in the world.  Renewable water resource availability is below 30 cubic meters per capita per annum in Kuwait, UAE and Qatar, followed by Yemen.  Only a few countries in MENA, such as Iraq, Iran and Lebanon, have more than 1,000 cubic meters per capita. Renewable water availability has also been declining over time, with a rate of decrease of 35 percent over the last decade. For some countries, such as UAE and Qatar, the rate of decrease has been as high as 75 percent.  Even more troubling, the ratio of water withdrawn to availability is highest in MENA, amounting on average to just below 400 percent. In other regions they range from 6 to 54 percent. Countries such as Egypt and Jordan are reaching the 100 percent threshold. Lebanon, Morocco and Algeria are the only countries where water withdrawal is less than 50 per cent of availability.

By making it cheaper to pump water out of the ground, fuel subsidies contribute to this water depletion.  Globally, countries with lower than average diesel prices are characterized by higher (and statistically significant) water depletion than those that have increased diesel prices. In MENA, the gap is much higher. 

Most water is used for agriculture, a sector whose productivity is low compared to other countries as well as other sectors in the region.  MENA countries use groundwater for irrigation to a greater extent than any other region. The evidence suggests that countries with lower than average diesel prices are characterized by much higher (and statistically significant) harvested irrigated crop area and irrigation water requirements than those that have increased diesel prices.

In Yemen, energy subsidies account for 9 percent of GDP, most of which is used for diesel to power electric generators.  Although Yemen is one of the most water-scarce countries in the world, pumping for irrigation and drainage accounts for 28 percent of total electricity and diesel consumption, a share much higher than the 6 percent average for the MENA region.  The ground waters on which more than half of agricultural output now depends are almost fully exploited and reserves are being rapidly depleted. Behind this depletion lies specific crop selection. In particular, qat - a stimulant widely chewed by Yemenis – accounts for about 40 percent of total water resource use. While profitable at current (subsidy-included) prices, qat crowds out production of food or export crops, and its consumption creates both social and health problems.

In sum, the debate on energy subsidies in MENA needs to go beyond the drain on public resources and the skewed allocation to the rich—to the corrosive effects of these subsidies on economic growth, employment and the health and livelihoods of the people of the MENA region.
 

Comments

Submitted by Carolina Monsalve on

"There is a positive and statistically significant association between per-capita GDP growth and gasoline prices in the MENA region between 1998 and 2012. By contrast, in the Europe and Central Asia (ECA) region, where fuels are taxed rather than subsidized, the relationship between per capita growth and fuel prices is negative. "

Is this due to the fuel taxes and subsidies varying in the two regions, or the fact that MENA is net exporter of oil and gas, whereas in ECA the situation is different, with some energy exporting countries in Central Asia and Russia, but with many countries being net importers of energy?

Submitted by Shanta on

Caroina, thanks for the question. The main reason is the former, namely that in MENA, fuel is subsidized, whereas in ECA it is taxed. So an increase in the fuel price reduces the distortion in MENA, but increases it in ECA. The result should not depend on whether a country is a net exporter or importer. The deadweight loss associated with a subsidy is the same in either case.

Submitted by Tracy on

Shanta -- excellent blog, as always. The challenge is how can countries successfully wean citizens off of subsidies? Recently we've seen back-pedalling on subsidy reform in several of our MENA countries. The perception is that the IMF tells countries how much they need to change in terms of subsidies, rather than how to implement such changes. With most of these governments already on wobbly legs, there's no room for squandering political goodwill. How do we cultivate a recipe of communication and gradualism to support successful implementation of these reforms, and from where do we pull examples?

Submitted by adrien on

Maybe the IMF itself can provide part of the answer. They actually have a book on the topic, called 'Subsidy Reform in the Middle East and North Africa: Recent Progress and Challenges Ahead'. They provide some recipes for successful subsidy reform. The most promising one, if you ask me, is to take the money from the subsidies, and give it to the bottom 50% of the local population in the form of cash transfers, no string attached. The book states:

"Of the cases where cash and in-kind transfers were introduced, 100 percent were associated with a successful outcome, while only 17 percent of the [temptative energy subsidy reforms] where these transfers were not introduced resulted in a successful reform"

Submitted by Shanta on

Tracy, you've asked exactly the right question. The point of my blog (and the underlying report) was to shift the conversation on subsidies from one of public spending ("the IMF tells us to remove subsidies") to one of employment, health and water depletion. These are issues that citizens can relate to (fiscal balance is still something removed from their daily lives). By pointing out that the real reason to reform subsidies is that it will stimulate employment, clean the environment and promote agriculture, political support may grow. Shanta

Submitted by Caterina on

Shanta, thanks a lot for this very stimulating blog. Your point that recasting the discussion in terms of these less publicized harmful effects of fossil fuel subsidies should lead to greater political support for their removal is very interesting. I do wonder, though, about which considerations truly dictate political support– if you did not trust the government wouldn’t you prefer a tank filled with cheap petrol to a promise that the Government is going to invest in health and education? A lot of the political economy work in ECA suggests that often people resent tariff increases for networked utilities because they don’t trust the utilities and they don’t think higher tariffs would result in service improvements. So perhaps while we should continue documenting the breadth of distortions that fossil fuel subsidies generate we should be realistic on what that information alone can achieve.
It seems to me that what happens in terms of compensatory measures remains the key to shift the political acceptability of reforms. The Bank has been very involved on this front both at the country level and in international fora, dealing with the nitty-gritty of implementation that often escapes the IMF recommendations. A good example is the recent paper for the G20 on transitional policies to support fossil fuel subsidy removal, which we produced in collaboration with other IFIs (including the IMF) and reviews a lot of the recent literature. For now it is buried on the G20 website (https://www.g20.org/official_resources/current_presidency, look at the 3rd page of links), but it should be posted soon on our internal subsidy web page (incidentally, a great resource worth advertising: type “subsidy” on your intranet browser and look under “research” for a very useful collection of papers on this topic; there is also a Community of Practice on Fossil Fuel Subsidies, led by Morgan Bazilian, which is another great resource).

Submitted by Shanta on

Caterina, you're absolutely right. The key is whether people trust the government to do something useful with the money they save from subsidy reform. If they don't trust the government to do anything useful, then they won't support the reforms. A stark example is the Iranian case, where they transferred the money into people's bank accounts before reforming subsidies. People could see the transfer, but couldn't spend it until the subsidies were removed. This created a lobby to reform subsidies. While the reform in Iran has had many problems since, I think this particular idea could be replicated elsewhere.

Submitted by Amina Semlali on

Shanta - thank you for broadening the discussion on subsidies, making it less abstract and more tangible for the ppl affected by this dreadful waste of resources. Simply excellent how you tie it to road accidents/environment/water etc.

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