from Development Channel

How to Make Fuel Subsidy Reform Succeed

August 12, 2014

Anti-government protesters march during a demonstration to denounce fuel prices hikes in Sanaa, Yemen, August 4, 2014 (Courtesy Reuters/Khaled Abdullah).
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A few weeks ago, Yemen’s government took the bold – some might say foolhardy – step of winding down a fuel subsidy program that was costing it billions of dollars. Overnight, fuel prices in the country nearly doubled, sparking violent riots. For average Yemenis, the sudden end of one of the few tangible benefits they get from their government is bitter indeed, especially since 54.5 percent of the population lives below the poverty line. It’s no surprise that thousands of protesters have taken to the streets. But the change in policy didn’t have to occur this way.

Fuel subsidies in Yemen have consumed more than 20 percent of government spending in recent years, straining public finances. The need to scale back the subsidy has hardly been a secret. But the government has done almost nothing to prepare the people for this change, to explain why it’s important, how grossly inefficient fuel subsidies are as a poverty alleviation tool, how regressive they are too, and to put in place alternative means of compensating those most hurt by the change.

Yemen is not alone. Governments around the world are simply scared of leveling with their citizens about the true costs of fuel subsidy programs. The fear of consumer anger spooks them into inaction until fiscal pressures force them to remove price supports. But, as I argue in a new CFR publication, “How to Make Fuel Subsidy Reform Succeed,” there is an alternative.

Rather than delay reforms until crisis erupts, governments should lay the groundwork for reform by directly communicating with citizens about the unintended consequences of fuel subsidies: about how they distort markets, strain government budgets, encourage overconsumption, foster corruption, and harm the environment. Perhaps most important from the perspective of the poor, governments should underscore that fuel subsidies do little to remedy inequality or stimulate development. While fuel subsidies are usually packaged as pro-poor, they are in fact highly regressive. The richest 20 percent of households in low- and middle-income countries use six times more subsidized fuel than the poorest 20 percent. To prepare for change, governments should clearly outline to consumers how they will implement alternative anti-poverty measures, such as targeted cash transfers, that can better protect the poorest in society from the hardships of higher fuel prices at much less cost.

Having a targeted communications campaign to support reform plans is critical to the success of those plans, according to a 2013 International Monetary Fund study. Iran, which reformed its subsidy program in 2010, conducted a broad public relations’ campaign before reforms took effect; the government explained how consumers would be compensated for higher energy prices and the overall benefits to the country. Ghana’s efforts to phase out fuel subsidies were helped by publicizing an independent study that showed how the poor would benefit.

The reality is that far too few governments recognize the value of laying the groundwork for reform. Moreover, there is no place for them to turn for a solution that combines technical expertise with marketing capabilities. This is reason to support the creation of a new public-private partnership, the Global Subsidy Elimination Campaign (GSEC). The agency would work with governments to execute country-specific communication programs to build the case for fuel subsidy reform among citizens; it could be housed within the World Bank but have its own board and budget – a model similar to that of the Consultative Group to Assist the Poor, giving the agency access to the Bank’s research capabilities while allowing it to act nimbly and independently.

Over time, the GSEC’s marketing campaigns could be instigated by the World Bank in consultation with client governments or commissioned on a fee-for-service basis by richer countries. The U.S. should jump-start the establishment of the GSEC by providing half its initial funding. After all, curtailing subsidies is to the United States’ strategic benefit. Geopolitically critical countries such as Yemen and Egypt will not see robust economic growth and political stability in the absence of successful fuel subsidy reform.

Funding could also come from others interested in the enormous potential of fuel subsidy reform. Such donors—including other countries, NGOs, the World Bank itself, and private foundations — should be motivated by an interest in poverty reduction and economic development, environmental concerns and strategic considerations. Host countries should be required to contribute at least 10 percent of their specific marketing campaigns as buy-in to the process.

Of course, public awareness campaigns will work only if matched by credible government action to replace subsidies with other more effective investments, such as targeted cash transfers and productive health and education spending. But with governments spending more than half a trillion dollars a year on fuel subsidies, the upside of fuel subsidy reform is enormous. Even a 5 percent reduction in fuel subsidies would free up billions of dollars of public spending for more effective anti-poverty measures.

The time is ripe to help governments make the case directly to citizens for fuel subsidy reform. To learn more, read “How to Make Fuel Subsidy Reform Succeed.”