The political economy of energy subsidy reform

Type Book
Title The political economy of energy subsidy reform
Publication (Day/Month/Year) 2017
Publisher Washington, DC: World Bank
Every year governments spend vast sums of resources subsidizing the consumption
of energy products, with many perverse effects. The resources spent on
subsidies divert public budgets from other purposes such as investments in
education and infrastructure. Energy consumption subsidies, although often
intended to benefit the poor, are typically regressive as the bulk of the benefits
accrue to those with the highest levels of consumption—those at the top of
the income distribution. Subsidy programs also distort energy markets by
encouraging excessive consumption overall while shifting demand toward subsidized
products and away from those products whose pricing better reflects
real market conditions.
These problems are widely known, yet the total level of subsidy remains high.
Consumer and producer subsidies were estimated at 0.7 percent of global gross
domestic product (GDP) in 2013 (Coady et al. 2015). That’s because subsidies,
for all their distortions to the function of government and energy markets, are
often extremely popular politically. Consumer-facing subsidies usually begin as a
price stabilization policy, typically in the form of price controls, and organized
consumer groups around the world have credibly demonstrated they will
mobilize—even to the point of riot—when the price of essential products rises
to unacceptable levels.
Subsidies that begin small with noble, well-focused purposes to ensure price
stability can become entrenched. The presence of a subsidy attracts supportive
interest groups that mobilize politically to press for larger, more permanent
subsidies. As a result, removal or redirection of the subsidy becomes harder.
Indeed, the problem of energy subsidies isn’t one of expert knowledge about
their perverse effects. It is, rather, a problem of political economy.
This study explores the political economy of energy subsidy reform. For years,
especially in the 2000s when energy prices have been high, this topic has been
central to many political agendas. In 2009, the Group of 20 (G-20) advanced and
emerging market economies called for a phaseout of inefficient fossil fuel subsidies
in all countries, and the G-20 reaffirmed this in 2012 (IMF 2013b).
2 Introduction
The Political Economy of Energy Subsidy Reform •
The experience with reform is highly varied. Currently as many as 27 countries
are already reforming fossil fuel subsidies. In addition to subsidy reform,
40 countries and over 20 subnational jurisdictions now apply or have scheduled
the introduction of a carbon price, and another 26 are actively considering one
(Klevnäs, Stern, and Frejova 2015). Despite many failures at reform, there have
also been striking successes. All told, subsidies today are US$117 billion per year
lower than they would have been without recent reforms (IEA 2015).
Indeed, a study on the political economy of energy subsidy reform is particularly
relevant today because the steep decline in most energy commodity
prices over the past two years has created an opportunity for reformers (CFR
2015; Klevnäs, Stern, and Frejova 2015). Lower prices for crude oil and products
have meant that the subsidy needed to sustain retail price controls is much
smaller. Indeed, in some countries, the continuation of price controls set in the
era of high global prices means that, in effect, schemes that used to create
subsidies are now raising the local cost of energy products relative to global
markets.1 For commodity exporting countries in particular, low prices have
created massive fiscal pressure on governments, which in turn has created
urgent needs for reform.
In short, many political leaders have seized these reform opportunities. What
should be learned from their experiences? And how can reformers remove and
reframe subsidies in ways that are politically durable—so that the problem of
subsidies does not reappear when world market prices rise again?
Relatively few World Bank reports provide a political economy perspective
on energy subsidy reform. Most of the work by Bank teams on subsidies has
focused on the sectoral efficiency, fiscal sustainability, optimal policy design,
or distributional impacts of subsidies. For example, a recent internal stocktaking
of analytical reports on energy subsidies by Bank teams over the past
10 years found that only a quarter of them undertake some analysis of the
political economy of reforms. It is widely known that political economy is
central to energy subsidy reform—a point made in an array of diverse studies
(Beaton et al. 2013; Victor 2009). Yet, to date, most of the literature on energy
subsidies has not engaged with political economy needs in a structured,
detailed manner.

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