REFORMING SUBSIDIES IN MENA

Paolo Verme

World Bank and Department of Economics, University of Torino

“International Experts Conference on Measurement and Policy Approaches to Enhance Equity for the New Generations in MENA”

Rabat 22-23 May, 2012

SUBSIDIES AS % OF GDP

WHAT IS WRONG WITH SUBSIDIES?

Financially unsustainable Inequitable Pro-rich Distort market functioning Constraint supply More expensive that social transfers Increase fiscal risk for governments Encourage black market

=> If subsidies are bad why keeping them?

WHO IS INTERESTED IN KEEPING SUBSIDIES?

Government: Politically sensitive, Arab spring Perceived as a basic right in many countries Buy political consensusFirms: Reduce production costs Benefit established monopolies/oligopolies They can make export-oriented firms more

competitive in the short-termHouseholds: Benefit the poor Benefit the middle-class Reduce financial risks for households

REFORMING SUBSIDIES – 3 PILLARS

Budgetary (Government benefit) Fiscal savings More investments From regressive to progressive expenditure

Economic (Firms’ benefit) Price liberalization Improved competition Incentives to domestic production

Social (Households benefit) Increase in social assistance program Establishment/improvements in targeting

mechanisms Conditional programs

THE CASE OF IRAN

BACKGROUND

Extensive subsidy program, between US$90 billion and US$100 billion per year, 29% of GDP

Large number of products, from basic foods (flour, bread, sugar, rice, cooking oil, milk) and petroleum products to electricity, water, and postal and transportation services

70% of subsidies went to the richest 30%.

Energy intensity 10 times higher than other countries with a similar population

MOTIVATION

The stated goal of the subsidy reform is to:

Rejuvenate Iran's economy and bring it out of the slump it has been in for so long;

Increase productivity;

More equitable distribution of income. Reduce the Gini index from the historical 0.40-0.45 to 0.35;

Reduce energy intensity in the economy;

and…. International sanctions and the budget crisis.

PREPARATION

State Owned Firm to manage the reform A massive and sophisticated public information

program: “The Petroleum Dividend”, improve energy efficiency, people manage the dividend,

Demonstrations strongly “discouraged” Little legislative details, government free to adjust Cash benefits deposited in banks prior to reform

(80$/person=2 months) with locked bank accounts Universal program, voluntary registration Stockpiling of essential food items in case of

shortages Budget savings: 50% to households, 30% to firms,

20% to the budget.

IMPLEMENTATION

61 million Iranians (out of a total population of 74 million) registered and the national banks opened 19 million bank accounts for them to receive their cash transfers.

Each person is entitled to US$40/month in compensation for the fuel subsidy removal and US$4/month for the removal of bread subsidy.

The payments are made on a bimonthly basis to heads of households. Originally, up to 6 members of the family could be claimed

All subsidies removed at once with a late night announcement from the President (December 10, 2010)

Unlock of bank accounts (December 11, 2010)

PRICE EFFECTS Gasoline from 10 US cents to 60-70 US cents/ liter,

close to the world price. Gas for home heating and cooking gas usage, 5

folds increase. Water and electricity, 3 folds increase with block

tariffs starting at no or low cost for low consumers. Wheat flour 44% increase. Consequently, the price

of all four types of commonly consumed breads is rising.

CPI inflation rates have accelerated from an average of 10.5 percent in the first 9 months of 2010/11 to 15.8 percent in January 2011, 18 percent in February, and 19.9 percent in March, before slightly declining to 19.7 percent in April 2011.

OTHER EFFECTS

Sharp reduction in energy consumption Sharp increase in use of public transport Short-term negative effects on production Poverty reduction (short-term), from 12%

to 2% at the $2 per day rate (Djavad Salehi-Isfahani)

Drop in inequality from 0.40 to 0.37 (Djavad Salehi-Isfahani).

Development of the banking sector, millions of new bank accounts

Normalization of markets

CONCLUSIONS

Motivation Budget crisis: Governments reform

subsidies when they have no other choice Energy efficiency/productivity/inequality

Key ingredients: Strong public debate and public

information campaign Compensations for stakeholders:

Government, firms and households Credible and transparent implementation

mechanism Moderate legislation

THE CASE OF ELECTRICITY IN JORDAN

BACKGROUND

Electricity system relatively new

Production and distribution publicly managed until 2005

Privatization process 2005-2009

Increase in the number of producers

Increase in the number of suppliers

Total cost = total revenues (2007-2010)

2011-2012 BUDGET CRISIS

Arab spring: disruption of gas supply from Egypt

Electricity producers shift from gas to oil supply

3-4 folds increase in the cost of production of electricity

Surge in current deficit and cumulated debt of the public electricity company

ELECTRICITY SUBSIDIES CRISIS

 Jan. 2010

Jan. 2011

Dec. 2011

Dec. 2012 (Est.)

Subsidies(m. JD) 148.7 613.1 1,200 2,200

% govt. exp. 2.6 9.6 17.0 32

% of GDP 0.8 3.1 5.5 10

SOME FACTS

Electricity prices have sharply increased with the privatization process

Electricity tariffs in Jordan are comparable to EU prices

Six tariffs blocks, but two blocks capture 88% of consumers

First block has very low tariffs but all consumers benefit from these tariffs

Rich benefit more from subsidies than the poor

Relative expenditure on subsidized products is larger for the poor

HOUSEHOLD CONSUMPTION OF ELECTRICITY BY TARIFF BRACKET (KWH)

0-160 161-300 301-500 501-750 751-1000

02

04

06

08

01

00

Hou

seh

old

(%

)

0 200 400 600 800 1000kWh

SIMULATIONS OF TARIFFS INCREASES

   Poverty headcount

increase (%) Revenues Increase  Quintiles +30% tariffs +60% tariffs +30% tariffs +60% tariffse=-0.3 1 0.00 0.00 430,838 388,228  2 0.08 0.27 575,581 518,655  3 0.80 2.34 778,808 701,783  4 0.86 2.71 1,025,069 923,689  5 0.00 8.47 1,954,052 1,760,794  Total 0.32 1.45 4,764,348 4,293,149e=-0.6 1 0.00 0.97 388,228 303,007  2 0.27 2.18 518,655 404,804  3 2.34 5.67 701,783 547,733  4 2.71 8.28 923,689 720,928  5 8.47 12.17 1,760,794 1,374,278  Total 1.45 4.02 4,293,149 3,350,751

SIMULATIONS OF TARIFFS RESTRUCTURING

  kWh kWh

Current Tariff

Structure Reformed Tariff Structure

Decile (kWh)Brackets

ThresholdsTot. Elec.

Cons. Tot. Elec.

Exp.Tot. Elec.

Exp.Revenues increase

1 200 17,600,000 651,389 580,950 -70,4402 231 22,500,000 973,487 1,095,897 122,4103 258 24,800,000 1,151,561 1,591,071 439,5104 286 29,600,000 1,450,082 2,359,649 909,5675 312 34,200,000 1,754,373 3,263,522 1,509,1496 340 36,900,000 1,988,510 4,092,542 2,104,0327 377 42,600,000 2,418,612 5,392,826 2,974,2148 426 48,200,000 2,886,144 6,852,862 3,966,7189 517 57,100,000 3,641,021 9,010,123 5,369,102

10 Max 80,000,000 6,230,652 13,900,000 7,669,348Total   394,000,000 23,100,000 48,100,000 25,000,000

SIMULATION OF TARIFFS RESTRUCTURING

New structure

Current structure

0.0

5.1

.15

.2ta

riff (

fils

/kW

h)

0 500 1000 1500kWh

CONSUMER’S SURPLUS AND DEADWEIGHT LOSS

JORDAN FEBRUARY 2012 REFORM

From 6 to 12 blocks

Increase in tariffs for high consumers

Consumers who use 600kWh or less of electricity per month (89 per cent of households) continued to pay the same tariffs

Consumers above 600 kWh pay gradual increases up to 0.548 JD/kWh (>3,000 kWh/month).

CONCLUSIONS

Motivation Budget crisis: Governments reform

subsidies when they have no other choice

Key ingredients: Restructuring of tariffs Quickly implemented Implicit mean price increase Increase in tariffs only for top consumers