Category Archives: Development Economics

Why fossil-fuel subsidies should be phased out

In recent weeks I have come across seminal literature on how the elimination of fossil-fuel subsidies are a relatively low-tech free-market solution to tackle global warming. The elimination of fuel subsidies is projected to curb fuel use and lead to the emissions cut necessary to avert a 2 Celsius rise in global temperature.

Source: International Energy Agency / Click the map for the larger version.

However there is another silver lining in phasing out these subsidies. The fossil-fuel subsidies tend to be incredibly regressive- considering that most of these subsidy programs are intended as poverty reducing measures. According to IMF estimates of 2010, 65% of total fuel subsidies benefit the richest 40% of households in developing countries. Only 8% of subsidies went to the poorest 20% of the population.  These statistics clearly indicate an inequitable distribution of subsidy benefits. Fossil-fuel subsidies are also a tremendous strain on public budgets. For instance, in countries like Pakistan and India, large proportion of these subsidies are actually debt-financed. Further, the periodic upward revisions of the international fuel prices forces these governments to plow even more money into subsidies to keep pace with the global oil market. In a report last year, International Energy Agency (IEA) found that the rise fuel subsidies closely tracked the rise in international fuel prices. So a gradual drawdown of these unsustainable fuel subsidy programs would not only avoid unintended distributional consequences but relieve budget pressures.

A proportion of the budgetary savings could then be used to make compensatory payments to lower-income households. The qualified households could use these payments to purchase fuel or petroleum products. Similar payments or tax credits would also need to be offered to relevant businesses to ameliorate the possible food price inflation that might result as a consequence of the rise in transportation and shipping costs.