Making Subsidy Reform Stick

Motorists in Indonesia line up at a gas station before the fuel-price hike takes effect in June 2013.

Fossil-fuel subsidies impose a significant economic and environmental burden around the world, distorting markets and draining national budgets. In recent years, the total cost of fossil-fuel consumption subsidies worldwide has ranged from $480 billion to $630 billion per year, plus more than $100 billion spent every year in production subsidies.

These subsidies are damaging for countries individually and the world. They deprive countries of vital resources that could be invested more productively to drive economic growth and provide social goods and services. On the whole, these subsidies are also highly regressive, with the top income quintile capturing six times the benefit of the bottom quintile. Moreover, they drive climate change by encouraging the consumption of polluting fuels while tilting the playing field against renewable power and energy efficiency: Fossil-fuel subsidies are five times greater than renewable energy subsidies, and they inflate domestic demand and discourage energy efficiency through artificially low energy prices, undermining the energy security of fossil-fuel importing countries.

Despite the efforts of more than two dozen countries that made some degree of progress on this challenge last year, fossil-fuel subsidies have not only endured but have grown increasingly costly.  However, the price of oil has now decreased, tumbling 47 percent from its peak of $114.29 per barrel in June 2014. For countries that subsidize fossil fuels, this market shift provided a budgetary windfall, as the planned expenditures needed to keep fuel prices artificially low were suddenly unnecessary. The International Energy Agency, or IEA, quickly slashed its subsidy forecast for 2020 by more than $110 billion.

Nevertheless, this temporary relief is not the same as durable, successful reform. The demand for subsidies has momentarily gone dormant but will return unabated when oil prices rise—as they surely will if the right steps are not implemented to preserve reform. The governments of Jordan, Yemen, and Sudan all recently had to contend with mass public protests after they tried to scale back fuel subsidies amid rising fuel prices. In 2012, Nigeria attempted to reform its subsidies for transportation fuels, which cost the government $8 billion per year. After the government ended the fuel subsidies, prices for gasoline and other goods more than doubled, with gasoline jumping from $1.70 per gallon to $3.50 per gallon. In response, the country’s labor unions organized strikes across Nigeria, and tens of thousands of protesters marched in opposition to the price increases. People died, the country was paralyzed, and the government restored the subsidies in short order.

In order to achieve lasting subsidy reform, governments need a constituency of support strong enough to withstand the calls to resume subsidies once oil prices begin to rise. This can be built by investing the savings in national priorities right now while clearly communicating to the general public that the new investments—regardless of whether they fund a new school, hospital, bridge, direct cash transfer, or subway line—are made possible because of subsidy savings. Much as signs across the United States remind Americans that highway construction and other infrastructure projects were funded through the American Recovery and Reinvestment Act to put Americans back to work during the recession, governments must help the public understand what they gain in return for subsidy reform. In this way, governments can increase support for reform and build a constituency that holds its leaders accountable.

Indonesia is executing such a strategy. The government has been clear about its intention to invest 60 percent of the $18 billion that it will reap annually from fossil-fuel subsidy reform into much-needed infrastructure programs. Highlighting these priorities, Indonesia’s energy minister announced that by “shifting the subsidy from consumption into more productive spending … [in] 2015, the public works, the transportation sector and the agriculture [sector] will double the[ir] capital expenditure budget.”

To maximize the climate benefits of subsidy reduction, however, the international donor community and international financial institutions should provide support to ensure that new investments promote clean economic growth and resilience whenever possible. For instance, public investments that enhance energy efficiency or that promote switching to renewable fuels would help buffer consumers from fluctuations in future fuel costs while also driving deeper greenhouse gas reductions than subsidy removal alone. The World Bank’s Climate Investment Funds and the new Green Climate Fund are both designed to support countries in such efforts.

At the same time, climate resilience needs to be factored into all major new infrastructure projects in order to preserve these investments in the longer term and produce a range of other benefits. For instance, many countries are investing in clean water access, irrigation, and sanitation projects to support public health and economic development. Water infrastructure is an essential investment for any country seeking to modernize, but this infrastructure is particularly vulnerable to increased flooding and droughts caused by climate change. Projects that combine national resources with international development initiatives such as the World Bank’s Water Global Practice or the Asian Development Bank’s Water for All program could leverage additional investment in the future resiliency of vital infrastructure.

To capture all of these benefits, however, countries must act now to reform fossil-fuel subsidies. Until then, they will remain helpless passengers on the oil market rollercoaster.

Pete Ogden is a Senior Fellow and the Director of International Energy and Climate Policy at the Center for American Progress. Ben Bovarnick is a Research Assistant with the Energy Policy team at the Center. Thank you to Alex Tankou, who is an intern at the Center, for his assistance with this column.