Fossil-Fuel Subsidies Help Asia Roar

Governments have long provided subsidies, direct and indirect, on fuels for both consumers and producers. Providing subsidies on fossil fuels is costly in terms of public health and climate change. In 2009, G20 leaders agreed that subsidies should be curtailed, but Asian countries continue to fund them to support economic growth. Subsidies for consumers lead to waste, traffic and pollution. Less scrutinized, according to Will Hickey of SolBridge University, are the many subsidies for fossil-fuel producers not available to producers of alternative fuels: preferential land-acquisition policies, support for infrastructure like ports or highways, special financing for exploration, quick approval for destruction of habitat and eminent domain, resistance to pollution regulations or low penalties for violations, and even government guarantees of profits. The subsidies distort market pricing, contributing to inefficiencies and waste. For Asia's emerging economies, the subsidies are unsustainable as fuel prices rise, their exports decline, and the environmental and health costs rise. – YaleGlobal

Fossil-Fuel Subsidies Help Asia Roar

Ending subsidies for fossil fuels could slow climate change
Will Hickey
Friday, March 15, 2013

Subsidizing pollution: Traffic snarl in Jakarta (top); China’s state-owned oil refinery

DAEJEON: One reason behind greater pollution leading to global warming has been artificially lowered gas prices brought by subsidies. Governments have carried on this shortsighted policy to foster growth and satisfy consumers. But as world fuel prices begin rising again, the costs of subsidy – both budgetary and environmental – will come to the fore. While the much-talked-about carbon tax remains unpopular with consumers, curbing producer subsidies that encourage fossil fuel consumption could be a more effective way to fight environmental challenges.

In 2009, G20 leaders acknowledged world subsidy problems and sought to “phase out and rationalize over…inefficient fossil fuel subsidies.”Yet one only needs to visit bustling Shanghai or Jakarta today to see that Asian economies have taken the opposite approach during the past four years and are more reliant on fossil fuels than ever before to support economic growth.

Nominally, fuel subsidies can and do exacerbate huge traffic jams from Tianjin to Mumbai. This has two major outcomes: wasted time and money. Recently a study by economists at Texas A&M University found that Americans waste more than $181 billion a year in lost productivity and fuel consumption just sitting in traffic. Imagine the aggregate costs to the world economy when Asia is factored in – $1 trillion would perhaps be a conservative estimate. Nonetheless, reversing policy on promised consumer subsidies is a challenge. Last year, attempted political reform of consumer subsidies, in other words, raising prices to reflect market economics, in Nigeria and Indonesia led to riots.

The consumer fuel subsidy has become a right of entitlement fixed in many minds, especially in countries rich with natural resources, while demands from foreign institutions and economic experts in London or Vienna ring hollow with the average person slugging it out on the streets of Colombo, Hyderabad or Chicago. Economic theory is disconnected from reality.

Fossil Fuel Consumption Subsidy Rates.Enlarge Image

However, consumer subsidies, while visible, are the tip of the iceberg. Most of Asia’s fast-paced growth is being driven by hidden upstream producer fuel subsidies that abet the Asian export model. These subsidies strain state budgets and create a false economy. If fuel prices were aggregated for true costs – or the baseline called “zero-price gap subsidy” by OECD for transport, storage, production, taxes, health/environmental liabilities – Asian economic activity would be considerably dampened, as it is currently in the EU and US post–economic crisis.

Producer subsidies, especially in China, can be found at the state, provincial, local and corporate levels under the guise of state-owned enterprises, or SOEs. Precise data are hard to extract.

Consider a few examples of what producer subsidies have done to distort usage in Asia: In China, to attract investors, unregulated coal-fired power plants spring up in provinces, spewing pollution that violates Beijing’s national policies. In Malaysia, production-sharing contracts ensure that oil investors are backstopped. New tollways in Thailand and megalith airports in Indonesia are indirectly subsidized via preferential land-acquisition policies, below-market rate capital and tacitly approved destruction of rainforests and grasslands. Even in the US, rights of way are given to pipelines under eminent domain clauses. Such incentive subsidies are not widely available to other investors or businesses.

Producer subsidies are not easily understood or transparent. Much focus is on easily quantifiable consumer subsidies. There are two key reasons: First, many producer subsidies do not affect fuel prices in the short term, especially in regards to oil. These are known as “legacy programs,” such as health and environmental costs, long-term issues where future liability will generate economic distortions. Second, many new producer-subsidy programs are not actively drawing funding from a financial ministry or treasury. Such programs encompass new roads, bridges, ports, and more for transporting fuel.

Producer subsidies at the national level consist of preferential tax rates; land rights, including public domain; and credit subsidies for fossil-fuel exploration, production and shipping. An example would be in the production-sharing contract used in developing countries for oil production – or government guarantees to oil investors to insure their capital outlays via full cost recovery. In other words, guaranteed profits.

Provincial or subnational subsidies are especially endemic in China, where provinces compete against one another for investment.  For example, Hebei and Guangdong provinces have created their own “strategic petroleum reserves” outside the national government. Regional petrol-pricing differences and fuel quotas can foster smuggling activity.

Municipal subsidies include public transport such as buses in Delhi and ferries in Bangkok, both burning polluting underpriced diesel fuel, to create subsidized ticket prices. Municipal electric utilities also have access to low-cost capital through guarantees by local government credit ratings.

Even at the corporate level, collusion between government officials and companies can create a perverse subsidy. In Indonesia for coal mining, transport regulations, workers safety and environmental laws are routinely ignored. State-owned utility companies in Asia, supported at the federal, regional and local levels are energy- intensive and garner a significant source of recurring subsidy activity via rights-of-way for pipelines or transmission corridors which reduce operating costs.

In these local cases, producer-subsidized fuel prices are an unquantifiable black hole below consumer subsidies that create false economic activity. Such wasteful activity and subsidization cannot last.

Two immediate challenges flow from fuel subsidies. The first, climate change, is well publicized, held either in respect or contempt by politicians worldwide. The problem with fossil-fuel addiction and global warming is that it’s a “public goods” problem – no one government wants to take ownership. As long as individual countries seek to promote their economic agendas first, the consequences of climate change will be a problem for other governments. Humanity will pay the price from this denial.

The second issue is that most economies in Asia are export economies, which means they pay low manufacturing wages to keep shipping products abroad to the wealthier EU and US. As long as they have more exports than imports, surplus budgets can easily offset the real-market input costs of fuel subsidies. In other words, underpriced labor is underpinning low cost fuel. Yet cracks are already starting to show, as countries like Indonesia and Sri Lanka report larger trade deficits due to slowing exports and rising import costs.

Governments’ response to slowing exports has been the standard playbook: devalue their currency. Nonetheless, fuel prices have a  real market cost, and a devalued currency buys less fuel on the open market, putting pressure on the consumer subsidy and creating budget overhangs. This tends to exacerbate producer subsidies to make up for slowing growth. If left unchecked, both trends pose ugly consequences for all.

While global warming may be a long-term threat, economic shortfalls are more pressing. The fossil-fuel subsidy model – consumer and producer – that emerging Asia is so highly dependent on for economic growth led by exports for political stability is not tenable long term.

Attacking only the consumer subsidy, with its visible contributions to pollution and bottleneck traffic jams, does nothing to alleviate entrenched and opaque producer subsidies. It will only be possible to address concerns about growth and efficiency when leaders make the hard decisions to reduce both. This requires a mindset change about how energy is viewed, as the subsidies precipitate a deeper addiction to fossil fuels. A total systems rethink is more critical than ever before, for the world’s health and economic viability.

Will Hickey is an associate professor and chair of Global Management at SolBridge University.
Copyright © 2013 Yale Center for the Study of Globalization

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