Defending the Indefensible: Your Thoughts on the Benefits of Fuel Subsidies

(Photo: Tony Martin)

Last post, I wrote about how many nations in the developing world, such as Egypt, subsidize gasoline and diesel fuel to keep the price at the pump artificially low. There are many ways in which this policy is ineffective, counterproductive, and just plain dumb: it wrecks the public finances of cash-strapped countries in order to create traffic congestion and air pollution, raises the world price of oil, and transfers money from the poor to the wealthy.

In fact, writing about this folly got me pretty irritated, and I’m ashamed to admit I decided to take out my frustration on you readers. So I challenged you to come up with arguments in favor of fuel subsidies, manipulatively using the siren’s song of a prize of Freakonomics swag to get you to twist your brains into pretzels.

Thanks to those of you who gamely tried; many of you confessed it wasn’t easy. For example, poor reader Rob complained that “I’m getting a brain cramp trying to think of a defense for Egypt’s policy.” Rob, I apologize and recommend sitting in a dark room while listening to a CD of soothing ocean sounds for awhile.

However, you guys collectively came up with most of the plausible arguments in support of this policy. The most popular point, summarized by reader Dave Witzel, is that:

  • I suspect “avoiding riots” is one of the better arguments for maintaining a fuel subsidy.

Of course, in Egypt this strategy doesn’t seem to be working so well. But some of the other nations that have tried to eliminate their fuel subsidies have experienced mass unrest. Consider, for example, Nigeria, Indonesia, and Venezuela (arguably the world’s worst subsidizer, with more than 8 percent of GDP dedicated to keeping gas prices under ten cents a gallon). Some countries that have tried to cut fuel subsidies have had to backtrack because of this.

Why does removing these subsidies bring people into the streets, despite the fact that the benefits of the policy flow disproportionately to the economically well-off? Reader Brendan (and several others) noted that:

  • The other things you suggest spending money on, like education, health care, nutrition, social welfare, and economic development, would largely show returns at some point in the future. …Gas prices spiking if the 30 percent subsidy were dropped would be something Egyptian citizens would see immediately…

And Shane L pointed out that:

  • The Romans had difficulty repealing the grain dole, once the people got used to it. Daniel Kahneman’s Thinking, Fast and Slow said that people are loss averse. Once we have something, we dislike losing it. People enjoying subsidies are [made] much more angry by their removal than [people who would benefit from their removal would be made happy].

Hence, it may make sense to keep fuel subsidies because, regardless of their demerits, people seem to like them. While admitting that “I have been to Egypt and the roads and traffic are the worst I’ve ever seen,” reader fobwngua says:

  • Fuel subsidies are a smart policy because the people have decided that’s what they want as their policy. End of story… The Egyptians have decided to spend their money there making [fuel] accessible to all… Everyone thinks they know how everyone else should run their lives. Egyptians clearly know how to demand change in government. We should let them decide for themselves.

Reader greenoacean pointed out that fuel price hikes would feed inflation. This is an argument that must be taken seriously; we have seen firsthand in the developed world, in the 1970s, that sudden fuel price spikes can wreck havoc on the economy.

Readers Todd Sullivan, Francisco Arias, and Kayode raised related arguments, maintaining that despite the fact that the poor are unlikely to be driving in most subsidizing countries, fuel price hikes would feed into the goods they consume, like bus transport, housing, and food. In the next post, I will maintain that it would be better to subsidize those things directly, rather than through an indirect and leaky channel like giving away gas, but this raises an issue pointed out by Warren:

  • Even if all of [Egypt’s] fuel subsidy were suddenly transferred to eliminate poverty, I am highly skeptical that the money would actually go to eliminate poverty. I speculate it would mostly go to corrupted bureaucrats. At least this way if you buy gas, you get something. In conclusion, it is an inane policy but eliminating it could lead to more political unrest and the money would be funneled to more corruption. But in the long run, it would be better.

This argument is not lost on the public in many subsidizing nations, who are skeptical that if fuel subsidies are lifted the money will instead subsidize villas in Spain or offshore accounts in the Cayman Islands. As a couple of readers pointed out, dealing with this perception is particularly important in oil-producing nations, which tend to be the heaviest subsidizers; in these countries, cheap gas is intended to show the populace that they are receiving at least some of the benefits from the nation’s oil wealth (although, ironically, many of these nations, such as Iran and Nigeria, are actually paying retail prices on the world market for the gasoline they are giving away because they lack adequate domestic refining capacity).

There is a related argument here that none of you mentioned; even if governments are not dishonest, administering a fuel subsidy is comparatively simple, while something like making direct welfare payments to legions of poor individuals, or undertaking big infrastructure projects, is not. So even an honest government in the developing world might see fuel subsidies as a reasonably practical, if imperfect, method of channeling money to the poor.

And the winner of the competition? I’ll have to reward reader Jeff, who opined:

  • One argument in favor of a subsidy would be if the activity generates positive externalities. Subsidized gasoline should result in people traveling more. Here are some possible positive externalities generated by people traveling more:
    • People become more familiar with cultures other than their own.
    • It is easier for inventors to collaborate (I think there has been research showing that people who work in dense cities are more productive because it is easier for them to have face-to-face interaction with people in related fields).
    • As long as the public reaps some benefit from the inventions, a positive surplus.
    • Social interaction is encouraged. For example, when I go to a bar, the other people at the bar benefit from my witty comments. Thus, I’ve created a positive externality for all the other bar patrons.

This argument is a worthy one, and in my opinion it is one that is understudied in the transportation field, where overwhelmingly the focus is typically on transportation’s external costs (like pollution) and not on its external benefits. Even I have to admit that in this blog I’ve harped far more on transportation’s negative externalities than its positive ones, and I consider myself much better disposed towards travel and mobility than many people in my field.

To make this case, you have to keep in mind here that the external benefits must be kept separate from internal ones. So inventors who get rich thanks to in person meetings should pay for their own travel, but if other firms use their ideas without paying for them, society might have some interest in paying for the inventors’ gas.

Good point, Jeff. Clearly your employment of your famous wit isn’t restricted to the lucky people who sit next to you in bars, and for sharing it you get a free piece of swag. Consider this a subsidy toward paying your internet bill, thus compensating you for the external benefits of your post to the Freakonomics readership.

Thanks to all who posted; you covered most arguments in favor of fuel subsidies I could think of. But overall, despite the intellectual somersaults you were turning, most of you held your noses while defending this policy. Even Jeff, winner of the award for best advocate, started his post with:

*Insert obligatory statement about how gas subsidies are terrible and that I’m just playing devil’s advocate here*

So next post, I’ll address why the problems raised here are overblown, why fuel subsidies are anyway a poor way to address them, and how we could implement subsidy reform without bankrupting the poor or getting the presidential palace burned to the ground.

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  1. Sam says:

    2 things.

    As for Jeff’s argument, it’s witty yes, but also wrong. When we subsidize fuel, we also subsidize suburbanization and automobile or (as in Indonesia) motorbike-oriented development patterns. The need for cars to reach people begets the need for more space to accommodate those cars (as anyone who has seen Jakarta’s traffic problems will attest to) and this pushes people further apart, meaning that people meet and collaborate LESS as reaching others becomes more difficult and meeting people serendipitously becomes increasingly rare.

    Also, I just got back yesterday from a few months working with an anti-corruption NGO in Indonesia, a country with not only a subsidy but a very tight price control on fuel. Essentially all gas stations are state-owned and prices are state-mandated. When the prices go up, the government rolls out a program called BLSM which transfers money to the poor to help with the new prices (they’ve done this a few times now). There are a number of problems with the way that BLSM (among other anti-poverty programs in Indonesia) are dolled out, the least of which is incredibly poor data, collected only every 5 years, that leads to the wrong people getting the transfer payments. The corruption in Indonesia is what really kills these programs, in some administrative areas local capture takes over half of the federal transfer payments according to research from the NGO I was working with has found.

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  2. MIV says:

    you mention how abrupt cancelation of fuel subsidies would provoke unrest and how that is the reason they should be kept.

    however, wopuldn’t it be more prudent to abolish it gradually:
    1) by lowering the subsidy by e.g. 5% per month – you could be done with it in 2 years. or 2% per month (done in 4 years)

    2) giving the poor vouchers to buy cheaper fuel. (e.g. a debit card of some sort that covers a part of the price of gas). divide and conquer. first the middle class would lose this privilege, and it would be hard for them to mobilize the poor because of the middle class’ predicament. after a while you can reduce the subsidies for the poor by either employing the method in point 1) or by abolishing eligibility for different classes of the poor one by one.

    granted, the second method requires some administrative capacity on the part of the government.

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    • Dwight K Schrute says:

      on the second point noted above, that’s kind of like food stamps where its a debit card now, not paper. Fox news had a recent story on the “marketing” and abuse of food stamps. Their theory was that expanding this creates a class of voters beholden to the current government. “Fuel stamps” would create another favor

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      • MIV says:

        true. however, even if you stop at ‘fuel stamps’ you would still reduce the number of people who would consume this subsidized fuel. in the article it is mentioned that the middle class is the major beneficiary of this policy. with ‘fuel stamps’ you would at least cut the middle class off from subsidies.

        then in the second round you can do other stuff, for instance calculate the amount you spend on fuel subsidies and distribute that money to the poor in cash. that way a lot of it probably won’t be spent on fuel. and you can make it conditional. e.g. only families whose children attend school regularly get the money. and make reimbursments on some place where men are unlikely to go. that way the money ends up in women’s hands…

        anyway, my point is, there keeping the subsidies is worse than redirecting it somehow. patrons still keep their clients, the poor still get something but you get to reduce the traffic jams and energy consumption…

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  3. James says:

    While Jeff’s argument sounds plausible on the surface, I suggest that a bit of thought will find numerous flaws. While some inventors may profit from transportation-facilitated face-to-face collaboration, my own experience is that many others lose useful thinking/working time because they’re driving places (or flying to meetings, etc) instead. In addition, those face-to-face meetings tend to be dominated by a few loudmouths, who use persistence & volume to talk down the perhaps more useful ideas of those of us who have better manners.

    I would also suggest that (since this is an economics blog), a future post might address greenoacean’s claim that “fuel price hikes would feed inflation”, by pointing out the difference between price changes due to supply & demand factors, and inflation created by dilution of the money supply. Also, I was around in the 1970s (though young), and if memory serves the economy was already in pretty bad shape before the Arab oil embargo.

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  4. J1 says:

    “Why does removing these subsidies bring people into the streets, despite the fact that the benefits of the policy flow disproportionately to the economically well-off?”

    Because they don’t care if most benefits flow to the well off, as long as some of those benefits flow to them. Most people don’t have the obsession with inequality that academics do, and in many (most?) cultures, this type of inequality is assumed in any case.

    You should have stopped with Dave’s comment, because he’s right. You’re overthinking this one.

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  5. Octave C. Crow says:

    I lived in Venezuela for two years in the early 1980′s and saw this firsthand.

    My perception is that the subsidy was perceived as a not-for-profit distribution of a natural resource. Granted it could have been sold abroad. But the inexpensive gasoline was seen as a sort of “profit sharing”. And of course the cash generated by the international sales of petroleum definitely did not get into the pockets of the average person in Caracas. On that level there was a great deal of corruption. In contrast the domestic sale of gasoline seemed like it was simply a reward for living in the country. Anyone with a motorcycle could benefit.

    Compare that with other subsidies where the government would have to purchase food and coffee abroad. And these were things that could have been grown domestically. The price of a cup of coffee was very low, as was bread. The government mandated sale prices meant that it was better for landowners to allow farmland sit fallow rather than grow wheat, or coffee beans, etc.

    Then there is this:
    http://transitions.foreignpolicy.com/posts/2013/06/17/this_is_why_there_is_no_toilet_paper_in_venezuela

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  6. Roger says:

    Sri Lanka does something different. Fuel prices are subsidised. Bringing in a new vehicle to the country involves an import tax roughly proportional to the expected lifetime subsidies. The calculation isn’t quite as simple as that, and some vehicles have minimal tax (eg intended for farms). This does lead to cars that would cost $25k in the US being around $100k there. (Second hand prices are similarly disproportionate.)

    In theory everything should work out in the wash with the poor benefiting. In practise my middle class friends try to get cars with the smallest engines (tax calculation is based on engine size) but delivering the best performance. That is something the Germans do very well, especially VW.

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  7. Cristao says:

    Very simple in the case of Nigeria – corruption. Removal of the fuel subsidy should free up more money for government to do other projects, right? Well wrong in Nigeria. More money is created for the lootacracy to divide among themselves. Fuel subsidy is/was the only avenue for government to at least provide some service to the people as the government remains unable to provide the basic amenities – power, water etc.

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  8. Mike B says:

    Two other important points.

    1) People have made long term decisions assuming the subsidy will be in place like getting a car with poor millage or living in a location with poor transit. Businesses may have long term contracts that make similar assumptions about fuel prices.

    2) The fuel subsidy may be used instead of spending on public transport, which Cairo seems to completely lack due to its world leading traffic jams. Imagine if New York City decided to close down the heavily subsidized subway system.

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