Oil subsidies fueling the rich, not poor

Maxensius Tri Sambodo ,  Jakarta   |  Thu, 04/17/2008 11:17 AM  |  Opinion

The government and the House of Representatives recently agreed on amendments to the 2008 state budget with new macroeconomic assumptions. The government acknowledged, though, that the budget estimates could still change if the global economic condition worsen, the international oil prices persistently hover above US$100/barrel, average Indonesian oil output falls below the target and food prices continue to rise.

Basically, these external factors have negative impacts on the stability of commodity, financial and labor markets in Indonesia, through the supply and demand side mechanism.

By dividing the sources of destabilizing, it is clear that most of the external factors are uncontrolled variables. This notwithstanding, the government fixed the prices (price rigidity) for many strategic commodities such as rice, oil for the transportation sector, gas and electricity with the consequences that the government has to put up subsidies to defend the the rigidity of the prices.

Basically, subsidies will not make the market work properly, because commodity prices do not reflect the real cost or the scarcity of the products. As a result fiscal capacity will determine how far the subsidies will go. Based on the latest budget, the fiscal deficit will rise to as high as 2.1 percent of gross domestic product.

At the same time, there are no clear and good exit strategies for reducing subsidies. In fact, the current energy policy is anti-poor. For example, in terms of reducing oil subsidies, the government will implement "smart cards" for subsidized gasoline users and accelerate the energy conversion program from kerosene to gas. However, it seems the costs of implementation of those policies are higher than the benefits because subsidies are not allocated for the target group.

For instance, in many places where the kerosene conversion program was implemented, many people lined up for kerosene. Poor people have a different ability to adapt to policy changes, depending on their background, education, experiences and occupation.

Urban poor people usually buy kerosene daily because of income uncertainty and competing demands with other expenditures. This kind of consumption pattern is not accommodated into the conversion program. Further, the lack of supporting policies such as cash transfer for the poor or food subsidies causes difficult transitions for the poor. High inflation together with low institutional capacity to implement the program cause poor people to become marginalized.

One can conclude from the oil subsidy policy that Indonesia is a heaven for rich people, because both rich and poor people can buy petroleum at the same price. This anomaly is very obvious when we look at how more rich people prefer to buy petroleum in Pertamina petrol stations, which sell subsidized and non-subsidized gasoline, rather than Petronas or Shell stations that sell only the non-subsidized.

Moreover, many rich people can enjoy luxurious facilities in their own car. The others have to stand in buses without air conditioning. This kind of policy paradox occurs because the government tends to use commodity price subsidies instead of target group subsidies. Basically, good policy needs to shift from commodities to target group subsidies for reasons of equity.

Solving the problem of subsidies is a chicken or the egg dilemma. If government cuts fuel subsidies, inflation will skyrocket with serious implications on the living costs of the people, notably the poor.

However, there are many other ways to reduce subsidies through either a big bang or a gradual approach, each with its costs and benefits. A gradual approach would have a low impact on economic destabilization compared to the big bang.

What are the costs of implementing current fuel subsidies?

First, it is clear the government loses an opportunity to convince people to use limited resources effectively and efficiently.

Second, there is a policy bias to the rich because the government has limited capacity to increase the capability of the poor. This causes such problems as social jealousy. Third, in the long run it depresses fiscal capability.

It is true the government can finance subsidies by issuing debts on both the domestic and international markets. But this borrowing spree will sharply increase the government's future debt obligations.

But there is room for the government to reduce the budget deficit and improve economic prospects in the future if it tries to shift commodity subsidies to the target group and uses savings from reduced subsidies to increase the capacity of the poor and build more public utilities.

The government's statement that it will "not to increase oil price until 2009" clearly indicates it underestimates the change in global economic conditions and overestimates the domestic economic resilience.

The writer is an economist at Economic Research Center of the Indonesian Institute of Sciences and can be reached at mtsambodo@yahoo.com.

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