Should government continue to subsidise fuel?

Introduction
Crude oil is an internationally traded commodity with prices determined by external
forces of demand and supply. Governments of many developing countries attempt to
cushion the effects of crude oil price fluctuations on their citizens particularly the poor
by instituting social intervention measures common among which is the subsidisation
of refined products. A petroleum or fuel price subsidy is usually the variance between
the reference price and the actual (selling) price of the product. Depending on the
petroleum import/export position of the country, the reference price would usually be
the world market price plus the transport cost to border (import price) or world price
minus transport cost to border (export price) or the marginal cost of domestic
production. The actual or selling price refers to the ex-pump prices at which various
products are sold to final consumers. The total amount of subsidies paid by
government is estimated by a summation of the product of unit subsidy and total
units consumed per product for all subsidised products. This essay seeks to evaluate
the feasibility of continued subsidisation of fuel prices by the government of Ghana.
Should fuel subsidies be removed?
Advocates of fuel subsidies cite several reasons in favour of the continuous
application of subsidies predominantly in less developed economies. Key among
these is the objective of curtailing the adverse consequences of fuel price hikes on
poor households and promotion of social equity. Research has revealed that
although a significantly lower percentage of subsidies benefit the poor, withdrawal of
subsidies in Ghana has witnessed a decline in real income for the poorest 20% of
consumers by as much as 9.1%, the highest among five countries studied (Coady et
al. 2006). It has also been argued that since evidence shows fuel price increases are
followed by rising prices of most products and services, subsidies could be used to
reduce inflationary pressures. Fuel subsidy reforms have also been observed to
encourage poor households to switch to fuel wood thereby depleting forests and
other natural resources. Although not usually explicitly stated in the discourse on fuel
subsidies, the avoidance of labour agitations and political unpopularity often
underline the reluctance of governments to remove fuel subsidies.
Many more reasons than outlined in support of subsidies make it more expedient for
government to withdraw subsidies. The effectiveness of other social intervention
policies relative to fuel subsidies, achieving fuel consumption efficiency, reducing
government spending, mitigating the impact of climate change are some arguments
in support of subsidy reforms. A number of studies have proven that other mechanisms of achieving social equity are more effective (Coady et al. 2006; Bacon
and Kojima 2006; Beaton and Lontoh 2010; Sumedh 2011). Alternatives that have
been identified include cash transfers, coupons, smart cards, vouchers, removal or
reduction of fees and charges on social services such as health, education and
transport. Beaton and Lontoh (2010) for example observed significant successes
with the implementation of cash transfer scheme in Indonesia in 2005. In Ghana, the
removal of subsidies has a potential to drive transfers aimed at improving the
Community Health Improvement Services (CHIPS) and other healthcare services for
the poor, „Capitation Grants? and elimination of fees for government basic and
secondary schools and mass transport systems. Such programmes have been
proven to cover significantly larger proportions of the poor population in developing
countries in comparison with fuel subsidies. Evidence from five countries including
Ghana has suggested that between 75% and 85% of the total benefits from fuel
subsidies accrue to the richest 60% of the population. A separate simulation
conducted for Ghana indicated that 65% of transfers would benefit the poorest 40%
of households compared to a corresponding 40% for kerosene subsidies (IMF 2006;
Coady et al. 2006). For such alternative programs to achieve significant success
however, they need to be underpinned by effective planning, organization and
monitoring mechanisms and prevent leakage of benefits to non-targeted groups.
Removal of fuel subsidies have also been regarded as a means of attaining
consumption efficiency. In cases where tax on products such as gasoline and diesel
have been used to cross-subsidise other products like LPG and Kerosene, it has
often resulted in inefficient substitution of kerosene to adulterate diesel and gasoline.
Empirical studies have also revealed that households become less efficient in using
subsidised petroleum products (Coady et al. 2006). Smuggling of subsidised
products to neighbouring countries where prices are relatively higher has tended to
defeat the objectives of subsidies. Under extreme circumstances, subsidies have led
to acute shortage of petroleum products as a result of the inability of government to
reimburse Bulk Distribution Companies (BDCs) as recently witnessed in Ghana in
June 2014. Such inefficiencies and buying of subsidised products for unintended
purposes can be avoided through the elimination of subsidies.
High subsidies divert government spending away from more productive and
potentially more beneficial sectors. This has consistently resulted in substantial
budget deficits which could have been financed by relatively effective petroleum
taxes as demand for petroleum products is inelastic. Subsidies have imposed a
major drain on Ghana?s economy as Tema Oil Refinery (TOR) debt reached 7% of
GDP in 2002 whiles throughout 2004, 2.2 % of the country?s GDP was spent
subsidising fuel in the run-up to the general elections (Laan et al. 2010).Conclusions
From the discussions, it is evident that fuel subsidies exert a huge burden on public
expenditure but a greater chunk of the benefits accrue to high income groups, a
situation which defeats the essence of subsidisation. Removal of petroleum
subsidies would free the needed funds for social equity programmes in health,
education and transport albeit proper planning, implementation and monitoring are
essential prerequisites. These programmes not only capture large proportions of the
poor at lesser costs but also address the inefficiencies associated with subsidisation
and cross-subsidisation. An independent price-setting regime should replace fuel
subsidies but as Laan et al. (2010) observed, this “can only be as robust as the
political will behind it”.


Author: Gyeyir M. Denis
Email: [email protected]