By all accounts, fossil fuel subsidies are disastrous public policy. They encourage us to consume more carbon-intensive fuel and discourage investments in energy efficiency and renewables. They are an incredibly inefficient way to help poor households, as most subsidy benefits are captured by richer, urban households. And they wreak havoc on fiscal resources, sapping around 6.5 percent of global GDP.
Development researchers and practitioners have thus long discussed the benefits that could be created by eliminating these subsidies, freeing up fiscal resources for more worthwhile expenditures like education, infrastructure, and targeted social safety net programs. Yet attempts to shrink subsidies often trigger strong political backlash: The downfall of Suharto, the Saffron Revolution in Myanmar, and Occupy Nigeria have all been linked to attempts to raise fuel prices.
One reason may be that there is no guarantee that these potential gains will materialize for citizens. Once governments free up fiscal resources by reducing subsidies, they may spend the money on pet projects or transfers to favored clients rather than on areas with broad societal benefits. Or, governments may lack the administrative capacity to deliver on more complex areas of social policy. Subsidies require far less capacity to deliver compared to targeted cash transfers, for example.
A new study in Comparative Political Studies tackles these questions in the context of Indonesia’s efforts to reform fuel subsidies.
Subsidies and the social safety net in Indonesia
Administrative—rather than market-based—pricing for fuel has existed in Indonesia since at least the 1960s. At the time, government intervention in the pricing of consumer goods was common in Indonesia and elsewhere in Southeast Asia, particularly to stabilize (rather than subsidize) prices.
Rising commodity prices, increasing domestic consumption, and exchange rate fluctuations caused the fiscal burden of maintaining fixed fuel prices to balloon over time. By 2013, when the survey used in this article was fielded, subsidies on fuel and electricity accounted for 25 percent of government expenditures, exceeding expenditures on education, health care, and social protection combined. This trend is common across many developing countries: Programs initially intended to stabilize prices on basic commodities are often essential components of the social safety net, yet over time, price increases transform these programs from price stabilization programs into price subsidies.
Recent research by Michael Ross, Chad Hazlett, and Paasha Mahdavi shows that countries that fix commodity prices struggle the most with reform: Only a deliberate policy change can change prices, which can trigger political backlash. Indonesia falls into this category.
Corruption and support for fuel subsidy reform
Over the past decade, Indonesia has pioneered fuel subsidy reform, explicitly linking a series of fuel price hikes with targeted transfers for the poor. Yet, getting citizens behind reforms requires convincing citizens that the potential gains from new targeted transfer programs will actually reach them. Such skepticism is justified: Social assistance programs intended to help the poor often fail to reach intended beneficiaries.
Universal-access consumer subsidy programs, like automotive fuel subsidies, require relatively little administrative capacity to implement. There is no need to distinguish between beneficiaries and nonbeneficiaries, and national oil companies can handle distributing fuel across the country. Shifting to targeted transfer programs, by contrast, requires more information and more capacity. Targeting poor households means knowing who within each locality meets program eligibility criteria, locating targeted households, and delivering benefits to them.
Where the local officials responsible for identifying poor households and delivering benefits to them are corrupt, I argue, the government’s promise to replace fuel subsidies with targeted transfers is less credible. Where corruption is rampant, citizens have little reason to believe that the promised benefits of reform will materialize.
I tested this argument by linking household survey data with administrative data on targeted transfer programs in Indonesia. Administrative data tells us the total amount of benefits that arrive each month to a particular village. Using household surveys, I then estimated the total amount of benefits that actually reach households within a village. The difference between the two provides an estimate of how much of a village’s total benefit quota “goes missing” each month.
This proved a remarkably accurate estimation of whether or not poor citizens actually receive promised benefits from fuel subsidy reform. In a later survey conducted in the same villages, we asked whether citizens received the cash transfers linked with the 2013 fuel price hike: In villages with more missing quota, citizens were less likely to receive the cash transfer and more likely to report having to “donate” part of it to village officials.
Corruption among local officials strongly predicts whether or not poor citizens support fuel subsidy reform. When corruption levels are near zero, poor citizens are more than two and a half times more likely to support rather than oppose reform. As the share of missing quota approaches 100 percent, this support drops by 18 percentage points. This is true whether just controlling for a host of socio-economic factors that may also shape support for reform, or using matching methods to improve comparability between corrupt and non-corrupt villages.
The credibility gap does not just matter in Indonesia: I found that corruption drives resistance to fuel subsidy reform in Nigeria as well.
A way forward for fuel subsidy reform
This finding points to two ways forward for fuel subsidy reform. First, governments need to build local capacity. Local capacity is essential to delivering targeted social policy. This is a long-term process, yet central governments can empower citizens to pressure local governments for better service delivery even in the short term. For example, providing information on beneficiary status and intended program benefits on identification cards reduced local corruption in the implementation of targeted transfer programs in Indonesia. Crucially, if governments want to avoid political backlash, building capability in local institutions should precede fuel subsidy reform.
Second, in the interim, reforms can be designed with credibility in mind. For example, if citizens trust the institutions responsible for building public infrastructure more than those responsible for delivering cash transfers, then a reform program built around replacing spending on fuel subsidies with spending on infrastructure would be preferable and more likely to garner public support. Alternatively, more coarsened approaches to targeting (e.g., everyone within a village) would rely less on the discretion of local officials to implement and may be easier for citizens to monitor, even if it seems less efficient on paper.
Governments around the world face the challenge of how to reduce fuel subsidies and to ensure that social assistance programs reach intended beneficiaries. This research shows that these efforts are deeply linked.
Jordan Kyle is a Visiting Research Fellow in IFPRI’s Development Strategy and Governance Division. She was an Associate Research Fellow at IFPRI during part of the time that she was working on this project.