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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.