Do subsidies work?

By Shanon Shah
thenutgraph.com

Petrol prices are going up in MalaysiaON 4 June 2008, the Barisan Nasional (BN) federal government announced a 40.6% petrol price increase effective at midnight. Pump price went from RM1.92 to RM2.70 per litre. Barely a week later, the Pakatan Rakyat (PR) federal opposition launched its Protes campaign. Then PAS vice-president Datuk Husam Musa promised that if the PR managed to wrestle federal power, it could and would lower fuel prices despite a global increase in petroleum prices. Husam said the obvious solution was to increase the use of gas, as opposed to petroleum products, for domestic consumption, including for transportation.

The BN government's decision to decrease petrol subsidies was understandable. In 2007 alone, subsidies for petroleum products amounted to RM16.1 billion — or 37% — out of a total of RM43.4 billion in subsidies allocated to the rakyat. But was Husam's suggestion any more practical than the government's to cut petroleum subsidies? After all, in 2007, the Economic Planning Unit estimated Petronas's gas subsidies to be RM18 billion — or 41% — of the total amount of subsidies. And unlike petroleum subsidies, which are borne by the government and subjected to profit sharing agreements with other oil giants, gas subsidies come directly out of Petronas's pocket. In fact, Petronas says it has borne RM97 billion in gas subsidies alone since 1997.

So many questions arise just from a quick perusal of these figures. Was the PR misleading the rakyat with its call to lower fuel prices? At the same time, was the BN government justified in increasing fuel prices so drastically? Do subsidies harm or benefit the rakyat? What is a subsidy anyway?

Subsidies 101

Universiti Malaya's Prof Dr Edmund Terence Gomez tells The Nut Graph that there are different kinds of subsidies. "We must make a distinction between government subsidies for the poor, and subsidies that are meant to promote and develop domestic enterprises," he says in a telephone interview.

An example of a trade protectionist subsidy is how the US government protects its agricultural sector. Gomez feels that subsidies are necessary for both helping the poor and to nurture certain domestic sectors. "Otherwise, we will be too dependent on multi-national companies which might not operate in the rakyat's best interest," he says.

In the case of gas, it appears as though Petronas's subsidies are meant to be cross-cutting. Subsidies do not only go to natural gas for vehicles such as taxis, and the fishing sector, they also go to the power sector and other large consumers.

(pic courtesy of Piarapakaran Subramaniam)

Water and Energy Consumer Association of Malaysia secretary-general Piarapakaran Subramaniam says: "Cross-cutting subsidies intentionally creates a market that is not real, because the prices are then fake."

In a telephone interview with The Nut Graph, he says this creates a host of other problems. One, it means that in a subsidised environment, people cannot factor in true market prices when they make daily lifestyle decisions. For example, people continue to buy big cars and do not try to reduce fuel consumption. Two, when subsidies are cross-cutting, they tend to benefit larger companies rather than the deserving poor. Three, this could lead to irregularities in how subsidies are disbursed if there is a lack of transparency.

"For example at the moment, gas subsidies going to industry are higher than diesel subsidies going to fisher[folk]," he says.

In figures made available to The Nut Graph, the current subsidised price for diesel for the fisheries and transportation sector amounted to RM38.65 per million British thermal units (MMBTU). However, the subsidised price of gas supplied to the power sector was RM10.70 per MMBTU.

The October 2008 market price for gas going to the power sector, however, was RM38.87 per MMBTU, while the market price for diesel going to fisheries and transportation was RM54.26 per MMBTU. In effect, this means the subsidy for gas to the power sector amounted to RM28.17 per MMBTU, compared to only RM15.61 per MMBTU for fisheries and transportation. So Piarapakaran is right — the per unit amount subsidy given to the power sector is nearly twice the amount given to fisherfolk.

Alternatives and solutions

But does this justify the BN government's removal of subsidies — first of petroleum in 2008 and now of sugar, although there have been conflicting reports about the sugar subsidy? Asst Prof Dr Paul Barter of the National University of Singapore tells The Nut Graph he is not against subsidies in general, but that subsidies must be given more sensibly.

"As it is, with fuel subsidies, the people who benefit the most are the people who use the most fuel, and these are usually high income groups who drive big cars and so on," says Barter, who specialises in urban transport and public policy issues. Therefore, when fuel prices skyrocketed in June 2008, the rich were ultimately able to absorb the shock.

"The Malaysian government subsidises fuel, but in the 1980s and 1990s, they did not subsidise the growing public transport sector. With huge capital costs and potentially good long-term effects, public transport was actually the sector that needed subsidies," he says in a telephone interview.

(pic courtesy of Paul Barter | nus.edu.sg)

Barter also says that income for taxpayers could be used to subsidise healthcare for the poor, if the government's justification for subsidies is to help the underprivileged. "There are positive side-effects to keep people with lower income healthy. But why use taxpayers' money to subsidise people driving around in big cars?" he says.

Piarapakaran believes that a balance can be struck between lifting subsidies and helping the poor. He says subsidies could be more targeted at the poor by using per capita income as the main eligibility criteria.

"And if we want to subsidise certain business sectors, we can structure incentives such that they are given only to businesses that perform," he says. For example, he says promising start-ups can be given tax breaks for their first five years. "But we cannot keep giving incentives forever and ever," he says.

Ultimately, Piarapakaran says that with any economic policy geared towards helping the rakyat, the plan must be to make them independent and empowered. "This is so that when the government finally removes subsidies, they don't hold the rakyat by the neck," he says.