Sustaining Fuel Subsidy Reform

Overview

Fuel consumption subsidies threaten the fiscal and economic health of countries around the world. Economists widely agree that the subsidies, which reduce consumer prices for petroleum and natural gas below free-market prices, often strain government budgets, fail to target poverty efficiently, and distribute benefits unfairly. Yet, political barriers often obstruct practical policy changes; for example, the prospect of street protest discourages sensible subsidy reform. Still, over the last two years, governments around the world have taken advantage of the plunge in oil prices and reduced or eliminated subsidies. Recognizing that low oil prices can mitigate the increase in consumer bills caused by subsidy reform, ten countries have, since 2014, completely eliminated subsidies on at least one type of fuel, and a further twelve countries have reduced subsidies. This advances U.S. economic, geopolitical, and environmental goals because subsidy reform can reduce world oil prices, instability in strategically important countries, and wasteful use of fossil fuels, which contributes to climate change. In particular, recent reforms in India, Indonesia, Ukraine, Egypt, Saudi Arabia, and Nigeria all bring strategic benefits to the United States.

Varun Sivaram

Philip D. Reed Fellow for Science and Technology

Jennifer M. Harris

Nonresident Senior Fellow, Brookings Institution

Recent reforms may not be permanent, however. Past fuel subsidy reforms have often come undone when prices rose or when reform-minded leaders fell. Varun Sivaram and Jennifer M. Harris, reviewing the historical record, reveal three ways governments have reinforced reforms against backsliding: by depoliticizing fuel prices and transferring control over prices to independent regulators, who enforce the link between domestic and international prices; by preempting popular discontent and rapidly demonstrating tangible economic benefits from reform; and by locking in partial subsidy reforms with subsequent reforms as they pursued long-term strategies to eliminate all fuel subsidies and liberalize their energy sectors. The United States can help countries reinforce their reforms, and the authors make recommendations for how U.S. policymakers should do so. Where it has strong relationships, the United States should prioritize reform durability at the highest political levels. In addition, the United States, acting through institutions such as the World Bank, should provide financial support for a limited period of time that creates a path for countries to consolidate their reforms. Finally, the United States and international partners should create aid packages that reward long-term reform over decades; they should also drive private investment into the energy sectors of countries that have reformed fuel subsidies to support broader energy sector liberalization. 

Selected Figures From This Report