Fuel Subsidies: The World's Dumbest Transportation Policy?

There are plenty of transportation policy ideas which get my spider-sense tingling. But in most cases, I think it’s at least possible to form a coherent case in favor which doesn’t strain the basic tenets of logical argumentation. However, I am pretty much at a loss when it comes to government subsidies for transportation fuel, a strong candidate for the title of the world’s dumbest transportation policy.

In the developed world, governments often don’t tax fuel enough to make up for the externalities produced by driving. (Yes, United States, stop shuffling your feet and looking at the ground, I mean you.) But I’ve whined about that enough in the past.

In this post, let’s look at an even more egregious situation that is disturbingly prevalent in the developing world, especially in oil-producing countries (see this). Many governments not only do not tax fuel enough, but actually expend revenue to subsidize fuel and keep gas prices artificially low. In effect, they are paying people to drive.

According to a recent IMF study on which this blog post is based, as of 2011, $480 billion was spent subsidizing fuel. This is equivalent to 0.3 percent of global GDP, or 0.9 percent of worldwide government revenues, literally going up in smoke.

What are the many implications of this? To illustrate using a single nation, which is admittedly one of the more grievous offenders, I’m going to pick on poor Egypt. We hear lots about the conflict between Islamists and secularists there, but the backdrop for the current unrest, which threatens not just Egypt’s stability but that of the region, is an economy teetering on collapse.

Given the parlous position of Egypt’s government finances (its current budget deficit amounts to 13 percent of GDP, the worst of any country among the 42 in this week’s Economist, and three times the bad-enough figure for the U.S.), one would think Egypt would have better things to do than paying people to drive. But as of 2011, it was expending 30 percent of its government revenue subsidizing petroleum products, in order to keep the domestic unleaded gas price at about $1.14/gallon.

Statistics about budget deficits may leave you cold, but consider the opportunity costs, i.e. the other things that could be done with that money. Given widespread poverty, and unemployment north of 13 percent, surely Egyptians would be better off if nearly a third of their government spending went to things like education, health care, nutrition, social welfare, economic development, or even tax cuts.

In addition to the basic waste of revenue, additional budgeting problems arise from fuel subsidies. As we all know, the price of gas is very volatile. When global oil prices rise, so does the amount that subsidizing countries like Egypt have to spend to keep prices low. This creates a lot of uncertainty for governments and makes fiscal planning for the future very difficult.

Why else is this policy senseless? Let us count the ways.

Most basically, spending on fuel subsidies makes Egyptians, on the whole, poorer. The reason is that subsidies lead people to undertake activities for which the benefits are actually lower than the costs of doing them. For example, consider a cab ride which provides eight dollars of benefit to the passenger, but which would require inputs that are actually worth ten dollars (thanks to driver time, wear and tear on the vehicle, and of course fuel). In a subsidizing country, this ride may actually get taken, when otherwise the traveler would forego it if the government weren’t footing part of the bill. In this case, the cab ride destroys two dollars of wealth. This goes on in Egypt every day.

Also, on the macroeconomic front, for oil-importing countries (which Egypt is these days), encouraging fuel consumption and thus oil imports can exacerbate trade deficits and drain foreign exchange reserves. (Egypt’s have fallen by over 40 percent in the last two years alone.)

Also, when subsidies are off of the government’s budget, and are borne by energy companies, they make fuel production and refining less profitable and can discourage development in this sector. This will eventually harm the broader economy, and may in turn necessitate even greater subsidies.

Also, paying people to drive creates traffic congestion. I have not been to Egypt, but have been assured that Cairo’s traffic jams are of epic proportions. Does the government really need to spend itself into bankruptcy to make them worse?

Also, obviously this policy does no favors to air quality. Even if appeals for the future of the planet as a whole do not move the Egyptian government, fuel subsidies lead to more local air pollution, like ozone, which directly contributes to ill-health. Egypt is paying to poison its citizens, and, as the photo shows, it is in fact doing so quite successfully.

Egypt's Tax Dollars at Work (Photo: Vyacheslav Argenberg)

Also, subsidies harm efforts to economize on resources. Egypt’s are discouraging its consumers from buying more fuel-efficient vehicles.

Also, fuel subsidies ensure the accelerated depletion of what is, after all, a finite resource—oil. A world in which Egypt and numerous other countries pay people to consume fuel leads, unsurprisingly, to higher demand for oil and thus a higher global price, creating a drag on the world economy. Fuel is used inefficiently in Egypt when it could be used more productively elsewhere. The IMF calculates that if we begin phasing out fuel subsidies now, the price of oil will be 8 percent lower than it would otherwise be in the year 2050. 

Also, fuel subsidies create an incentive for smuggling, from high-subsidy countries to low-subsidy ones. This is widespread in many regions. In the case of Egypt, such smuggling has been widely blamed (including by the former regime) for its recent chronic fuel shortages. The disappearance of gas from the pumps—at any price—was a major cause of the unrest leading to the military takeover.

Also, there is the issue of income distribution. I suppose it is possible to make a case for subsidizing, say, bread, which is truly a necessity and where the tax dollars expended would benefit the poor far more than the rich.

But who are fuel subsidies flowing to? I doubt the 40 percent of Egyptians who live on $2 a day or less are much worried about gassing up their Volvos. The IMF calculates that, for a middle-income country, 61 percent of fuel subsidies flow to the top 20 percent of the income distribution, even taking into account the fact that subsidies reduce the prices of goods that the poor consume. Do we really need policies that transfer funds from the legions of the desperately poor to the elites? If we care about basic fairness, how about expanding free education, providing subsidized health care, or making direct, means-tested, welfare payments?

I could go on, but at this point the wear on the “A,” “L,” “S,” and “O” keys on my keyboard is getting pretty bad. So, to be fair, let’s switch to the good aspects of fuel subsidies.

Uh, well, uh
, hmmmm. Oh wait… no, forget it. To be honest, for once I’m at a loss for words. I can barely think of a few arguments in fuel subsidies’ favor, and these are very weak. So for fun, I’ll give you all a chance to prove you’re more clever than I. In the comments section, let’s see if anybody can write a succinct and cogent defense of this policy. To the talented sophist out there who can make tenable the untenable, I will present a coveted piece of Freakonomics swag. Good luck—I think you’ll need it.


Caveat-you should mention that you are just talking about subsidizing “oil” to be used for gasoline. What are the implication for subsidizing alternative fuels-natural gas, wind, solar etc.? Surely not all as negative as the effects you mention here. Would be very interested in a follow up.


Roads are subsidized too, with the general assumption that their cost is recouped by the numerous benefits they provide. I suspect the case is the same for fuel.

Whether or not the subsidies should be employed even though they pay for themselves is another matter; people would still likely drive and produce in their absence, and their behaviour may be altered by employing them (eg not buying fuel efficient cars, not taking transit). However, the fact that they shouldn't be employed doesn't change the fact that they pay for themselves by allowing to people to drive to their job and pay taxes.


Interesting subject. How do you feel about the blending tax credit for ethanol in the USA? How does a direct subsidy like you mentioned about Egypt compare?

Dave Witzel

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

e.g., in Nigeria (http://www.france24.com/en/20120103-lagos-nigeria-end-petrol-subsidy-riots-clashes-police) and Indonesia (http://www.nytimes.com/1998/03/20/news/20iht-jak.t_3.html). Can I have my swag now?


In the case of the Egyptian regime, the other things you suggest spending money on, like education, health care, nutrition, social welfare, and economic development, would largely show return at some point in the future. Given the political volatility in the country, it is unlikely the regime that implemented these changes will still be around when returns begin to be paid out.

Gas prices spiking if the 30% subsidy were dropped would be something Egyptian citizens would see immediately, and would ironically be adding fuel to the fire of political protest by means of subtraction of fuel. So the subsidy isn't necessarily there for the good of the taxpayers, but the good of the people employing the subsidy.


I agree that the fuel subsidy as a policy is beyond stupid. The reason I can give to defend it is the transitional gains trap. Now that the subsidy is in place, taking it away would have immediate negative effects even if in the long run it would be substantially beneficial. Given the fragility of politics in Egypt, suddenly eliminating a popular subsidy could lead to a popular backlash.

Also, even if all of the 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.

John Eberle

The good is not in the subsidies themselves, but in the value to the subsidizers.

In classic Freakonomics fashion - look for the reason behind the reason. If the act itself is not rational, then it must have a rational sub or secondary benefit.

In the case of fuel subsidies it is a transfer of wealth from a non-supporting group to a supporting group thus benefiting yet a 3rd party. So government subsidizes fuel and gets power, contributions or influence in return. Joi-La! Logic!


Maybe in the light of promoting infrastructure, say the govt is prepared to spend a lot of money to make sure there are companies that are providing the country with pipelines, pumping stations, a mobile population, a petrochemical industry, roads (via private investments),.. because it believes oil prices will go down and thinks it can fasten development or it wants to become the regions logistic hub and thinks this is a good way to make it happen .

I had to try really hard and the real reason probably is a mix between cronyism and populism, but it's not impossible to think of benefits, although I would agree the disadvantages are far greater.

Steve Chappell

I would love some Freakonomics swag, I will do my best to defend this.

Fuel subsidies can be quickly implemented and the results of the policies are reflected on a product a people buy all the time. Politically it is an easy win and it is hard to defend the position that we should raise gas prices. That will require people to use logic and long term thinking. The substitutes you suggested take too long to see the results compared to Fuel subsidies.

Fuel subsidies are the best use of tax dollars in the current Political environment.


People are used to artificially low fuel prices produced by revenue not spent on public services. In politically unstable countries, like Egypt, or countries with politically oriented politicians, like the US, short term goals of a consistent level of political instability or reelection create an incentive to avoid issues that would prove to have long term social benefits and because of the short term personal costs to the countries leaders. Also, oil/gas companies have an incentive to lobby against any cut in fuel subsidies as the subsides increase the volume of their product the population consumes.


Fuel subsidies placate the masses. This is especially important in oil-producing countries in order to keep the citizens from feeling like foreign corporations are harvesting natural resources without any recompense to the locals.

Oil producing nations usually have state-owned oil companies (you can see a list from OPEC here: http://www.opec.org/opec_web/en/360.htm and note also Pemex in Mexico). Sales from these national oil companies go into the country's coffers. The non-monarchy oil producing countries are generally perceived to have a high level of corruption as seen in the Corruption Perception Index: http://cpi.transparency.org/cpi2012/results/. This means that the oil revenues may not filter down to the people.

Subsidizing fuel is a way of demonstrating to the citizens of oil-producing nations that they aren't being screwed by their government. It also helps satisfy the notion that they are able to directly benefit from the main resource of their country (and usually the single most dominant export).

The subsidies may not seem economically rational on their face, but if you view them as a bribe to keep the poor happy so that the politically powerful can continue to personally profit from oil revenues, it makes sense.


Citizen John

"The World’s Dumbest Transportation Policy"... Let's see. Why "dumb"? You start from the assumption that governments make policies on the best interest of the people... If that were the case, you're right. Egypcians policy makers would we very, very dumb. But do you really think they are so dumb that nobody notices how destructive this policy is?
Problem is a deficient democratic system, corruption and fierce lobbying. Which often translates into benefits for a few, at the cost of the majority's welfare.
So, IMHO, the title is misleading. How dumb this policy is, is not the point. The point is how corrupt and how "lobbyed" are certain goverments, and how this undermine the whole country.
(Excuse my english, not my native language)


This is a defenseless policy in the economic sense- most subsidies are. But the rationale for subsidozong fuel in oil-producing countries is based on the public perception in many of these countries that oil is a common good that belongs to all the people, and that they are entitled to it for free/low cost/subsidized prices. That they would have to pay perceived "profit cost" that is, oil companies or the government making a profit off the backs of it citizens, would be unbearable. In many of these countries, water and electricity are also considered common goods that no one should have to pay for. It's similar to how Americans perceive clean public restrooms and water fountains as a right, even though someone has to pay to keep those restrooms clean and the water flowing. That the Egyptian government is footing the bill for cheap oil is probably considered exactly what it should be doing by most Egyptians.



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

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.



Instead of offering swag, how about you all finally try to fix the forum, so it doesn't randomly ask you to "Please enter a valid email address" before erasing my post, WHEN I HAVE ENTERED MY EMAIL ADDRESS.

As to the benefit of fuel subsidies, the Romans would have understood. It's just the 21st century equivalent of keeping the mob pacified with bread & circuses.


I know it's easy to hammer out words when one's feathers are so ruffled, but it is ill-advised to start every paragraph with the same word- also.


Travel by car/truck is the worst and best solution to meeting the transportation needs of our society. Does subsidizing fuel encourage the movement of people, thus encouraging trade and the exchange of information/ideas?

Be mindful, we haven't all morphed into a telecommuting future where goods are traded via 3D printing.

Francisco Arias

I live in Ecuador, where gasoline and gas have strong subsidies. The main reason why those subsidies are still in place is because they lower the distribution costs. Those costs represent about 50% of the price of the goods that satisfies the basic needs of the people with low income. Cutting down fuel subsidies would lead to an increase of prices and to a reduction of purchasing power for the bottom 20 percent of the income distribution.


Eliminate the words "Fuel" and "Transportation" from the title of this article and you still have a statement that's hard to refute. I'm getting a brain cramp trying to think of a defense for Egypt's policy on any grounds other than purely political.


Potential policy proposal: Retract subsidies to oil producers, replace with subsidies to efficient users of gasoline (public transit, bus companies, etc.).