## Subsidies—Love Them or Hate Them, It’s Better to Target Them

_IMF Blog, May 10, 2011_

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## Bibliographic details
- Authors: Masood Ahmed
- Published: May 10, 2011

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### Overview
- For decades, countries in the Middle East and North Africa have relied heavily on food and fuel price subsidies as a form of social protection.
- Governments have recently raised subsidies in response to hikes in global commodity prices and regional political developments.
- Author: Masood Ahmed. Date: May 10, 2011.

### Costs and scale
- The region accounted for almost two-thirds of petroleum price subsidies worldwide in 2009 (International Energy Agency estimate).
- Estimated regional subsidy cost in 2010: around $200 billion—equivalent to almost 8 percent of regional production.
- Share of subsidy types in that estimate: About 15 percent reflected the cost of food subsidies; the remainder were subsidies on fuels and electricity.

### Key drawbacks of universal price subsidies
- Are not cost-effective or do not target those most in need.
- Encourage overconsumption and waste, particularly for subsidized energy.
- May lead to damage to the environment, inefficient investment choices, and competitiveness problems.
- Can strain public finances and worsen debt levels.
- Encourage socially wasteful activities, such as smuggling and black-market dealings.
- Examples:
  - In the United Arab Emirates and Iran, energy consumption (adjusted for income differences) is more than 50 percent higher than in the United States.
  - In Egypt, price subsidies have reportedly led to the use of bread as animal and fish feed.

### Targeting and alternatives to universal subsidies
- Price subsidies enjoyed by all are typically poorly targeted and should be regarded as stop-gap measures.
- Example of poor targeting: In Jordan, the poorest 40 percent of the population receives less than a quarter of total spending on fuel subsidies.
- Cash transfers and other forms of income support can be better targeted.
  - Well-designed cash transfer systems can typically result in about 50–75 percent of spending reaching the bottom 40 percent of the population.
- Faster-to-implement targeted measures: school feeding programs; waiving fees for public services for the poor (health, education, public transport); labor-intensive public works.

### Case studies and lessons
- Indonesia:
  - More than doubled fuel prices in 2005.
  - Increased fuel product prices by 25–33 percent in 2008.
  - Budgetary savings were used to finance a cash compensation program to 15.5 million poor families.
- Jordan:
  - Started reforms in 2005, gradually phased out fuel subsidies.
  - By February 2008, domestic fuel prices followed international prices via a monthly automatic pricing regime.
  - Automatic fuel adjustment was temporarily suspended in January of this year due to social pressures.
  - Reforms were supported by measures to ease adjustment, including cash transfers to low-income households and increased allocations to the National Aid Fund.
- Lesson: Effective social safety nets as part of price subsidy reforms reduce the odds of reform reversal in case of sudden shocks.

### Political economy and implementation considerations
- Subsidy reform is technically and politically complex; public buy-in is crucial.
- Sources of resistance:
  - Creation of vested interests.
  - Perception of cheap energy as an entitlement in oil-producing countries.
  - Broader weaknesses in public services—middle-income households may rely on subsidies as tangible benefits in lieu of quality public healthcare, schooling, or utilities.
- Important implementation elements:
  - Develop a comprehensive communication strategy and build political support.
  - Tell the public how much subsidies really cost and who benefits.
  - Compensate those hardest hit by introducing or strengthening measures to protect the poor, including those living slightly above the poverty line.
  - Strengthen public sector governance and accountability; net savings from subsidy reforms should be transparently allocated to high priority projects.
  - Improve targeting gradually; narrow subsidies first to products most important for the poor.
  - Ultimately replace price subsidies by price-indexed cash transfers.
  - Use automatic pricing mechanisms to help depoliticize price setting.
  - Move regionally, if possible—a broader or coordinated regional effort could help ease resistance.

### Key recommendations
- Regard universal price subsidies as temporary stop-gaps, not long-term social protection.
- Prioritize building and expanding well-targeted cash transfer systems and other targeted social programs.
- Ensure transparency about subsidy costs and distributional beneficiaries.
- Use savings from subsidy reforms transparently for high-priority public spending.
- Sequence reforms with compensatory measures and communication to secure public support.

*Source: IMF blog page “Subsidies—Love Them or Hate Them, It’s Better to Target Them” by Masood Ahmed, May 10, 2011.*

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## Content in this bundle

- **051011a**
  - [051011a (PDF)](/external/arabic/np/vc/2011/051011a.pdf){rel="external" type="text/html; charset=utf-8"}
- **Regional Economic Outlook: Middle East and Central Asia - April 2011**
  - [Regional Economic Outlook: Middle East and Central Asia - April 2011 (Markdown version)](/external/pubs/ft/reo/2011/mcd/eng/pdf/mreo0411.pdf.md){rel="alternate" type="text/markdown"}
  - [Regional Economic Outlook: Middle East and Central Asia - April 2011 (PDF)](/external/pubs/ft/reo/2011/mcd/eng/pdf/mreo0411.pdf){rel="external" type="application/pdf"}

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## References

- [we estimate](http://www.imf.org/external/pubs/ft/reo/2011/mcd/eng/mreo0411.htm)

_Source: https://www.imf.org/en/blogs/articles/2011/05/10/food-and-fuel-subsidies_