Subsidies are easy to roll in but difficult to roll back. The vexed issue of tackling subsidies comes to the fore in difficult times and hence this topic assumes importance in a low oil price situation. According to International Monetary Fund (IMF) estimates, GCC countries will spend roughly $60 billion (Dh220.38 billion) on energy subsidies in 2015. While subsidies fall into various categories, the most significant one is always energy subsidies. High amounts of energy subsidies in the GCC have led to wasteful consumption, which is reflected in the high per capita burden of these subsidies.
This issue is important not only to the GCC, but also to the wider Middle East and North Africa (Mena) region. Arab countries spend nearly 7.2 per cent of their GDP on energy subsidies (pre-tax), while the comparative figure for advanced economies is just 0.03 per cent and about 0.9 per cent for emerging markets. Hence, the scale of subsidies is too large to ignore. In addition, given the high subsidy rate in the GCC (averaging nearly 70 to 80 per cent of the cost), it often promotes wasteful consumption and encourages energy intensive industries rather than labour intensive industries.
Before we tackle the subject of how to reduce the impact of subsidies, it is important to understand the context of subsidies in the GCC vis-a-vis other Arab countries. In the GCC, subsidy is a form of “wealth distribution,” while in other Arab countries it is a form of support to poorer people, as a poverty-alleviation tool.
Therefore in the context of the GCC, where subsidy is more of a wealth-distribution mechanism, the factor of demography plays an important role. In economies like the UAE, where expatriates are dominant as a share of total population, the role of “wealth distribution” takes a back seat, but this may not be the case in other GCC economies where the share of expats is more or less balanced.
Hence, it is no wonder that UAE recently launched the bold initiative of ending energy subsidies. In July 2015, the UAE announced that it would link gasoline and diesel prices to global oil markets starting in August 2015. It became the first country in the GCC to remove transport fuel subsidies. The move is expected to result in a savings of about $7 billion for the UAE. Given the large expatriate population of over 90 per cent, the burden of such roll back on nationals can be minimal. Hence, we must not assume that all other GCC countries will follow a similar path.
While the intention behind energy subsidies is to relieve the burden on the poor, such an argument may not be valid for the GCC given the high per capita income and the classification of the GCC as rich rather than poor. It is important to note that in the context of other Arab countries, though subsidies are directed to help the poor, it is often the wealthiest in society who benefit from them.
What steps should the GCC take now?
It is not a question of “if”, but rather a question of “how” to reduce subsidies and gradually lessen its impact on the fiscal situation. The following can be proposed as ways to tackle this vexing situation:
1. Find alternative methods to distribute wealth: In the GCC, subsidies are not used as a poverty-alleviation mechanism, therefore, alternative methods of wealth distribution should be considered in the first instance, with the view to replacing such methods gradually over time to reduce the burden of subsidies. Direct cash transfers are being proposed by some scholars as one such solution; the advantage would be that they shift the burden of rational decision making from the state to individuals and families directly.
2. Introduce innovative strategies: GCC states could introduce various concepts surrounding the subsidies rather than the straitjacket approach of providing the service almost free of charge. The concept of “tiered subsidies” linked to consumption (low price up to a certain point and high price thereafter) can reduce wasteful consumption. “Smart subsidies” can link subsidies to certain key performance indicators such as national employment or training new graduates. “Targeted subsidies” could be trialled when promoting certain sectors, or small-to-medium enterprises for example, becomes more important and therefore linked to subsidies provided. Innovation in subsidies can produce better results.
3. Aim for efficiency in production: The subsidy burden is simply the difference between price and cost of production. While the suggestions in introducing innovative strategies work on the price side, it may also be a good idea to focus on how to reduce the cost of production by improving the efficiency of the production of energy. Development of alternative sources of energy fits nicely into such a scheme.
4. Launch effective communications: The factor of high subsidies in the present can disproportionally increase the burden on future generations. An effective communications strategy which explains the long-term burden of high subsidies, and how they crowd out investment in infrastructure, can further awareness and support for the concept of gradual subsidy reduction over the long term.
— M.R. Raghu, is a member of CFA Society Kuwait