Developing countries often see that fossil fuel subsidies are an effective panacea for poverty alleviation. However, instead of combating poverty, such subsidy policies can, to some extent, transform into disasters.
In many developing countries, the provision of fossil fuel subsidies seems to be mandatory. In general, the subsidies aim to control prices so that people can afford basic needs like food, fuels, and power. Subsidies are also often justified as constitutional obligations (Chelminski, 2016) and political tools (Skoovgard & van Asselt, 2018) for states struggling with social problems, especially poverty and unemployment.
However, examples from the past, including the fall of Indonesia’s economy in 1998 and the Venezuela’s in 2018, show how the excessive and mismanaged subsidies can become a significant factor in a failing national economy.
Developing countries, like Venezuela and Indonesia, have a somewhat similar history of such subsidy policies. Both established an era of massive subsidies during the ‘glory of the petroleum era’. Their subsidy regimes were, therefore, built on their then abundant oil reserves.
For example, in Indonesia, the subsidy regime was masterminded by Soeharto’s administration which made oil the central pillar of the state finances (Chelminski, 2016). At that time, Indonesia was one of the largest global oil producers, a status that led it to become a member of OPEC.
Without mindful navigation, however, instead of alleviating poverty, the policy simply enabled people to afford more necessities. Subsidies did make people feel happy with the government’s performance, but the effectiveness and efficiency of the policy had been, especially in terms of fighting poverty, poorly navigated (Diop, 2014, OECD, 2019).
Studies found that once introduced and implemented, fossil fuel subsidies would slowly become deeply entrenched in national politics and economy, thus reforming them became an uneasy work (Skoovgard & van Asselt, 2018). As they keep leading people to overly consume fuels and become highly dependent on low prices, to some extent, the subsidies end up gravely disincentivizing a country’s economy.
Thinking about the subsidies, it reminds me of medicines, say, a pain killer. Most of us know that such medicines can come with unwanted side effects when consumed excessively. Just like the medicines, I see that the subsidies might heal, but they soon begin to show side effects as well as severe negative impacts, which will be explained later in this piece. For the moment, though, let us ask a simple question, is medicine always the solution to an illness? I have a simple story about this.
What’s important is not the medicine
When I was in New Zealand studying, my child, then about three months old, had a cough for a week. If we were in Indonesia, the quickest choice was to go straight to a local pharmacy and ask what medicine could stop the coughing immediately. Accordingly, we went to a local health center hoping to see a doctor and obtain medicine as soon as possible. When our child was examined, I asked, “Doc, what is the medicine for her?”
“Leave it alone. It will heal itself,” the doctor answered, which startled us. She continued to advise that we keep consuming clean and healthy food. She also advised us not to get stressed out too much, especially the mother, so that she could keep breastfeeding the baby well. We were a bit surprised to hear that. Is it true that my child can recover? As we followed the doctor’s advice, my daughter recovered within a week without any medicines.
I reflect that maybe people like my wife and I, in Indonesia, have been perceiving subconsciously that if we are sick, we should be given painkillers or any pills to feel that we are going to be healed. Meanwhile, from NZ experience, I realized that there are indeed other options to treat some illnesses. Instead of pills or painkillers, improvements in other areas like improving our food consumption and a healthy lifestyle, also our patience, can become the best cure for the illness.
I pondered that medicines to some extent are quite similar to subsidies. They may have been perceived mistakenly to make us feel okay economically. Subsidies indeed never cure the disease called poverty. Meanwhile, what is needed to fight poverty, like education, healthcare, and better investment environment is never seriously prioritized.
Side effects of subsidies: Indonesian experience
There are at least three side effects of prolonged fossil fuel subsidy policies that can cripple the ability of a country and its people to survive and advance economically. First, excessive and uncontrolled subsidies can deteriorate state finances. Second, subsidies disincentivize people and the government to be more productive. Third, they can become deeply entranced in the national political arena, because some political parties and politicians tend to see them as political commodities.
These side effects, among others, were arguably a strong impetus for the fall of Indonesia economy in 1998 (Chelminski, 2019) and more recently Venezuela’s (Ausman, 2019). The subsidies were distributed for mostly consumptive activities rather than productive ones, such as capacity development, education, healthcare, and infrastructure.
It is rather astonishing to see, for example, that the Indonesian subsidy funds spent on energy, including fuels, amounted to almost four times social assistance spending in 2019 (OECD, 2019). In the same year, subsidies are one-fourth of education spending. However, if we look at a longer period such as 1988-2019, the amount of subsidies is somewhat similar to the budget for education.
A simple interpretation of that budgetary situation is that Indonesia prefers to burn its money rather than spend it on progressive policies. Subsidies make domestic production activities in various sectors, like agriculture and petroleum, weak. Because food and fuel prices are relatively low in the market thanks to subsidies, there is no incentive for farmers or oil mining companies to work harder and innovate to increase production. At the end, when production declines, the government must import.
What is worse is that subsidies are often used by parties, such as politicians, as a political commodity (Rakhmanto, 2012; Victor, 2009). To be more specific, as low prices are communicated as a political goal, subsidies are politically promoted as the magic tool to reach that goal. Because it has become a political commodity, both low prices and subsidies continue to be the top request of the public and the opposition to the government. In the end, the provision of subsidies becomes a measure of whether the government is competent or not.
The government is deemed competent and successful if it were able to keep prices cheap and provide subsidies for the public, not based on whether the people are well-educated and are physically and mentally healthy. This all creates a complexity that contributes to the difficulty of reforming the subsidy policies.
This piece, of course, does not suggest that governments of developing countries promote market intervention. Instead, to advance, those governments should ensure that their people have equal access to quality programs in crucial aspects such as health, education, and civil services.
That endeavor should provide a social level playing field for the people before elevating to the free and open economic competition which has been considered as the strong impetus of economic growth (Lee, 2000). Many developing countries often refer to the value of equality for all, that in Indonesia is dubbed as ‘social fairness or justice for the people of Indonesia’ (Keadilan bagi seluruh rakyat Indonesia).
The sense of fairness and justice should not be seen as an equal distribution of wealth, which, in many instances, discourages advancement in many aspects (Lee, 2000). Instead, it needs to be referred to the equal enabling conditions and opportunities which are given to the people so each of them experiences the same economic freedom to advance.
In this sense, subsidies should be directed to such endeavors ensuring the availability and accessibility of such quality vital services. For example, the subsidy funds, instead of for lowering fuel or energy prices, should be spent on improving the capacities of local teachers, health workers, and government administrators, which their performances and services have been deemed far from excellent (Bangda Kemdagri RI, 2016).
Thus, the public should now be more mindful and critical when encountering politicians who use fuel subsidies and low prices as a political communication commodity.
The discussion above suggests that fossil fuel subsidies should not become a political gimmick debated by both the government and the opposition. Studies have found the economic and environmental benefits of phasing out subsidies.
Developing country leaders need to avoid these policies unless they are prepared with a robust plan on how to navigate and finally eventually reform them. Instead of keeping on ‘burning’ the government budget, leaders should consider spending their public funds on more productive and long-term oriented programs such as promoting research and development for a more productive society and a better investment environment, say, for the development of greener energy.
Muhamad Rosyid Jazuli is Researcher at Paramadina Public Policy Institute, Jakarta Indonesia. He can be contacted at email@example.com.