The folly of fuel subsidies

Philippine fuel companies, including the one shown above in this November 2009 file photo, have been prompted to hike pump prices, no thanks to higher costs in the world market. From January to April this year, a total of eleven oil price increases have been reported. Photo by Nonie Reyes

[Blogger’s note: This is another contribution from Arnold S. Tenorio, the Manila Times’ business section editor, who wrote this as an editorial for his paper that came out on March 14, 2011. He holds an MBA degree from the University of the Philippines and the distinction of being the only contributor for this website. His first contribution was an assessment of President Benigno Aquino III’s Daang Matuwid (Straight Path). See: Manila Times, Arnold Tenorio]

As oil revisits the record-high of 2008, it has become fashionable to debate over whether or not to impose price controls, and whether or not to extend subsidies to the poor.

The debate becomes more querulous since more expensive crude cascades into higher prices of other commodities, including food.

The government, the business community, and orthodox economists are one in dismissing price controls as counterproductive, supposedly worse than the problem they are aimed at solving.

To rehearse the argument, price controls create artificial shortages, since other things being equal, producers would rather not sell at a loss, especially if demand is strong. The shortage encourages a black market to emerge for the commodity whose price is controlled. As a black market, the price is set erratically, sometimes at rocket-high levels to reflect the pent-up demand for the controlled commodity.

In any event, the non-poor are the heaviest users of oil, thus only this group stands to benefit from any price control. So far, so good.

But in the same breath, those who argue against price controls also push for fuel subsidies for the poor – and herein lay the problem.

The argument for subsidizing the poor’s fuel consumption rests on the assumption that more expensive oil would leave them with little to spend on more essential items such as food, health care, education, among others.

The trouble with this line of thinking is that the poor, having been spared from the burden of costlier fuel, have no incentive to economize on this commodity.

Witness here the hordes of public utility vehicles (PUVs) — jeeps, buses, and tricycles — that have apportioned for themselves lanes upon lanes of otherwise public roads while waiting for commuters to emerge from their places of work or school, or to alight from the overhead trains.

As if the public nature of these infrastructures gave PUVs the license to transform these roads into terminals and parking lots!

In appropriating the roads, PUV drivers not only clog up byways and constrain access by other motorists. Worse, PUV drivers leave their engines idle, wasting so many liters of fuel and in the process generating pollution. Imagine the health costs not only on the drivers, but also on commuters, who include children.

Especially in the case of a commodity like oil, a free market characterized by rising prices naturally bring down demand, thus helping reduce the aforementioned externalities.

Besides pollution and its consequences on the health of people and the environment, irresponsible consumption of oil leads to the waste of this fossil fuel, as well as of scarce foreign exchange that could have been used for other more productive activities.

And all because the government and oil companies grant the “poor” PUV drivers — and by extension, their operators — fuel subsidies.

Another problem with subsidizing only the poor’s fuel use is that this policy is blind to the differential impact of rising oil prices on members of the so-called non-poor.

The non-poor is not solely the rich.

Counting among the non-poor — and comprising the bulk of them — is the middle class, whose numbers increased throughout the country’s recent growth spurt alongside the boom in the overseas Filipino worker (OFW) diaspora.

By lumping them with the rich, the middle class suffers from rising fuel prices in more ways than one. As members of the non-poor, the middle class help pay for the fuel consumption of the poor under the oil companies’ cross-subsidy pricing scheme.

Many members of the middle-class are also subject to the withholding tax system, thus, unlike the rich, see their incomes reduced every month automatically. For like the poor, many in the middle class don’t have price escalation clauses in their work contracts, leaving the latter equally vulnerable to inflation.

Now a portion of the taxes withheld from the middle class find their way into financing the government’s outright subsidies for the poor. The irony of it all is that, with the government faced with a budget deficit, public services availed of by the middle class not only enjoy no subsidy, but are usually subject to rate increases to plug the fiscal gap.

So it’s not the poor who end up with the short end of the stick during rising oil prices. At least they have subsidies. Not so for the middle class.