This article was published in Financial Times on December 7, 2015.
Cut fossil-fuel subsidies to benefit both rich and poor
By Ngozi Okonjo-Iweala
Ngozi Okonjo-Iweala is a member of the Global Commission on the Economy and Climate and Minister of Finance for the Federal Republic of Nigeria.
Globally, government support for fossil-fuel subsidies will amount to almost $650bn this year. The cost of these subsidies far outweighs the benefits and burdens the middle classes. Reforming the system can make energy infrastructure more efficient, shore up public finances and allow more targeted spending on public services.
The idea is not a new one. In 2009, the G20 countries and the Asia-Pacific Economic Cooperation forum committed themselves to cutting inefficient subsidies but progress has been limited. But in the context of the decline in oil prices, which benefits consumers, we have a golden opportunity to deliver reform.
About 30 countries, including my own, Nigeria, have already made efforts to phase out fossil-fuel subsidies. In spite of the difficulties, it is well worth the effort.
In 2012 in Nigeria we reformed petrol subsidies. Conscious that the public might be concerned, we ran an information campaign to explain how the savings would be used to help everyone. Political pressure, however, led to the policy being introduced earlier than planned and, as a result, the changes came as a shock to many. This led to protests and the reform had to be partially rolled back.
Despite this, we were right to act. Even phasing out half of the subsidies was a substantial achievement. Some $13bn worth of petrol subsidies, including many fraudulent claims, had burdened the national budget, and we were able to redirect some of those funds. Within a year, our programme to reinvest the savings meant we could finish the renovation of a north-south national railway, as well as introduce improved maternal and childcare services in 500 primary healthcare centres.
Using lessons learnt from Nigeria and other countries we can put together a set of best practices to follow. These include co-ordinated communication, implementation and redistribution efforts. Reform should also create a broad sense of political ownership, especially in fiscally decentralised countries.
One of the most common concerns about removing subsidies is that it will hurt the poor. But in reality the subsidies benefit high-income populations and industry much more than low-income households.
The International Monetary Fund has estimated that more than 40 per cent of fuel price subsidies in developing countries accrue to the richest 20 per cent of households, while 7 per cent of the benefits go to the poorest 20 per cent.
It makes more sense to remove subsidies and redirect cash into investments that go directly to those who need it most. That was the aim of Nigeria’s programme and it is being tried elsewhere. In Germany and Poland, for example, coal subsidy reforms were supported by cash assistance for workers affected by mine closures.
Governments attempting reform should tell the public well in advance of fuel price rises, and clearly explain measures that will be taken to support those affected. Ghana, for example, successfully used radio broadcasts to publicise an independent poverty and social impact analysis of subsidies.
Most of the best reform attempts have been staggered over time, rather than applied at once. Angola, India and Peru, for example, are first reducing subsidies for petrol, used mainly by wealthier people, before reducing those for diesel and kerosene, which are used by lower-income groups.
The benefits extend beyond the economic. Done correctly, phasing out subsidies will have the added bonus of lowering greenhouse gas emissions and reducing air pollution. In the context of the current effort to secure a global agreement of measures to combat climate change, that is great opportunity. Governments should seize it.