Economics Politics & government

[2751] When should we cut fuel subsidy?

Ten months into 2014, I have now resigned to the fact that my projection for the annual inflation rate in Malaysia is too high, with the actual rate being relatively benign. The reason I had put it so high — it was in the region of 3.5%-4.0% compared to what it would likely be, which is 3.0%-3.5% — was that I had expected a drastic subsidy cut early on. It did not happen until yesterday. Even yesterday’s cut is not enough to salvage my projection. I have of heard drastic, crazily complicated plans to revamp the subsidy system that would definitely help me be right, but that has either been postponed, or canceled. While I like to be right, I hope the convoluted system will be canceled. I hope the government would just stick with subsidy cut-cash transfer policy.

Politically, subsidy cuts are always a hot potato. It attracts criticisms from a whole lot of people.

Me? While I have criticized certain cuts from time to time, I am generally supportive of it for various reasons. I have been a long-time supporter of transforming subsidies into cash transfer. This time around, I do not have much reason to oppose the cut. Government influence, at least from the GDP perspective, is coming down, suggesting less government spending with the wider economy in mind.

So, I think I would like to engage on two criticisms directed at the recent cut. One questions the cut on the basis that crude oil prices are coming down. Another goes, subsidy cannot be cut until there is a viable public transportation system in place first.

On oil falling prices, I have said it in the past and one person has brought it up on Twitter (where I spend most of my time these days neglecting this blog, my column, my book project … and work… maybe by just a bit), that the best time to eliminate fuel subsidies is when prices are low, like right now. Acting when prices are low is acting from a position of strength and not out of desperation. If the argument that says we should not cut subsidy when prices are falling down is a good one, then when exactly should we cut it?

Is it never?

If the answer is not never, consider the counterfactual. If prices are higher, would that be the best time to cut subsidy then? Under the scenario of the rising prices, the effect of subsidy cuts on consumers and the economy at large would likely be greater than when cutting it when prices are low, because at that time, the situation would have been more desperate and would probably demand steeper cuts. There would likely result more shocks to the consumers that make the pain of higher cost more acute than it should be. As I have written on Twitter in a snappier way, “[you] criticize the cuts because oil prices are coming down. If prices were going up, would you be happy with bigger, more desperate cuts?”

From government finance perspective, I think cutting it earlier makes more sense. It means more saving for the government to finance other stuff earlier. If we are to wait for the government to cut subsidy only when prices are rising some time in the future, then the saving would probably be lower. The saving can finance the cash transfer program, among others.

Besides, a responsible policymaker wants a countercyclical policy. You do stuff that are painful but necessary during the good times, not during when times are bad. Look at the effect of austerity. The criticism of European austerity is exactly because of the poor timing of its austerity program.

On the point that we should wait until the public transportation system is good, I think this is a costly wait-and-see game. It is also partly a chicken-and-egg issue.

I label it as a wait-and-see game because the last MRT line is scheduled to only be completed by 2020. Keep in mind that construction on the two other lines has not started yet. Even then, I am unsure the public transport system would be reliable with comprehensive coverage. Do we want to keep the subsidy regime running until we are completely sure the transportation system is completely up and running in donkey-years’ time? That is a lot of money, never mind who knows what will happen with crude oil prices until then.

I also box this particular criticism against the cut as a chicken-and-egg problem. I would even argue it is a case of Catch-22. We need the money to invest in public transportation, but we do not have the money to do so if we keep up with the subsidy regime. We need to break the loop and not engage in such mind-numbing logic. At the very least, the cut in the subsidy bill and in the deficit ratio could help bring yields on government debt down, allowing the government or the relevant government-linked bodies to borrow at a cheaper rate to fund infrastructure project.

“But,” you say, “we are going to have the GST!” Yes, but I think every saving helps. “But,” you go on, “what about corruption-wastage-leakage in government spending? Sure, I share your concerns there but I think that requires some political changes but that requires some effort. In the meantime, until that happens, it should not prevent us from doing other stuff. It is not a mutually exclusive problem and it is not a sequencing problem either.

Ultimately, I see the argument on public transportation as one that prefers to do nothing.


[2714] Look at those prices!

The government cut subsidy off gasoline and diesel back in September by 20 sen per liter, resulting in a cool chart:


I am just showing this because it is an awesome chart. Price index can be boring because nothing really happens. In September, well, it jumped. Inflation on yearly basis had been creeping up slowing to 2% for the past few months. In August, it was 1.9% YoY. In September, it was up 7 percentage points to 2.6% YoY. You can see the cause of the jump from the chart above.

It should jump again in October because of the abolition of sugar prices. I am expecting inflation to go well above 3% YoY in 2014. The government however expects inflation in 2014 to be 2.5%-3.0% YoY. I just think the government projection is just too low given those subsidy cuts, further expected subsidy cuts in 2014 and simply, a growing economy (unless, disaster is up ahead somewhere).

Anyway, you can also see the drastic increase in inflation for the alcohol and tobacco category. Smokers would know why (cough, 50 sen, cough).


[2154] Of introduce targeted cash transfer instead of targeted subsidy

In spite of opposition that saw the streets of Kuala Lumpur filled with pro-fuel subsidy groups during the Abdullah administration, efforts to liberalize the fuel subsidy regime have gone a long way. Several arguments, including one that criticizes the untargeted and blanket nature of the policy have gained tremendous traction. The fact that it benefits those who do not need or deserve the subsidy is clearly one of the main motivators — the bigger drivers are probably cost and waste — behind the reformation of the policy.

The Najib administration is addressing this particular criticism. That has resulted in multiple novel moves and proposals from the federal government. Among the proposals reported in the mainstream media are different prices for different groups, a cap on subsidized fuel consumption and access to subsidy based on engine size. All of it tries to discriminate consumers at the pump. While the moves and proposals may reduce the size of fuel subsidy either in value or in quantity, the proposals under explicit fuel subsidy regime are too convoluted. The more convoluted the methods are, the more complex the implementation will be. That is a recipe for a disaster, policy wise.

I appreciate the government’s effort at making the policy more targeted and hence, making it less wasteful in terms of opportunity cost. Yet, these novel ways are unnecessary given the existence of at least one simpler alternative.

Just observe the recent attempt to limit the sale of subsidized fuel to foreigners at the border. So complicated was it that everybody was confused and in the end, it did not work. Consumers found ways around the restriction.

There is a better and much simpler way to do to this.

Before we proceed to that better and simpler policy, it is crucial for us to recall the purpose of the fuel subsidy. Its goal is ultimately to reduce the cost of living of the less well-to-do Malaysians. On top of that, fuel subsidy is not the only way to achieve that goal.

With that in mind, the better alternative to targeted fuel subsidy is a simple targeted cash transfer from the government to those who deserve it.

Why targeted cash transfer?

The first reason is that it paves the way for total elimination of fuel subsidy to free up the market. Since free prices signal scarcity, individuals and entities will make decisions that are more reflective of the reality of the energy market. On top of that, it creates real competition among pump owners. The same system of free prices already exists in the United States and Australia. Its effectiveness is proven.

Not only that, elimination of subsidy at the pump reduces consumption, all else being constant. That means lower carbon emissions. In times when carbon emissions are a worldwide concern and in light of the Najib administration’s promise to announce a carbon cut roadmap in the near future, this is an opportunity to integrate transportation and energy policies together environmental policy. Such integration is important given that, according to the International Energy Agency in 2007, the transportation sector was the source of 30 per cent of Malaysia’s carbon dioxide emissions in 2005.

Thirdly, cash can be used for a variety of things and not just fuel. Maybe a beneficiary of such a cash transfer appreciates books or food more than fuel. This has the potential of increasing the beneficiary’s welfare higher than what a fuel subsidy policy can bring. If the beneficiary does appreciate fuel more than anything else, then he or she can simply buy the same amount of fuel he or she would have otherwise bought under the fuel subsidy policy. In other words, there are more choices. The economics behind cash transfer is clearly more welfare enhancing than a simple fuel subsidy.

The next question is, naturally, how to do it.

If the sale of subsidized fuel is to be limited, then the government will have a good idea about the maximum amount of money it needs to spend on fuel subsidy. Furthermore, the lower the cap, the higher the likelihood a beneficiary of the subsidy will exhaust his or her quota. From there on, certain statistical manipulations can give us the size of money transfer per capita required to make the cash transfer method the equivalent of the fuel subsidy policy in terms of value.

The cash transfer itself can be delivered to the deserving via the existing tax system. Here is another beauty of cash transfer. It pays only to those who have filed their taxes. Thus, this is yet another incentive for those who have yet to file their tax to finally do so.

For those who just want to fill up their vehicles, here is another reason to support a simple cash transfer instead of an explicit targeted fuel subsidy policy: no weird rule at the pump. With cash transfer, any discriminative method used to ensure that the policy is targeted is done not at the pump but during the transfer of cash. This makes its implementation simpler.

So, what about it that is not to like?

Mohd Hafiz Noor Shams. Some rights reserved Mohd Hafiz Noor Shams. Some rights reserved Mohd Hafiz Noor Shams. Some rights reserved

A version of this article was first published in The Malaysian Insider on January 19 2010. Unlike the TMI edition, I added several sentences and phrases here to emphasize or rather, to clarify that the cash transfer is targeted in a sense that whatever discriminative method introduced in a subsidy regime can be applied to cash transfer system.


[1858] Of price, liberated

Behind every crisis, there is an opportunity as the cliché goes and the opportunity presented by the period of high energy prices has been satisfyingly utilized. Whatever goals scored by economic liberalism in this country, it is definitely one point up:

PUTRAJAYA, Dec 19 – Fuel prices in the country will be determined by the flotation mechanism.


Consumers, he said, should brace themselves for a managed flotation mechanism for oil prices based on market rates.

Shahrir said that many factors had to be examined before finalising the mechanism which includes generating revenue for the Government and providing stronger purchasing power to consumers. [Shahrir: Fuel prices to be determined by flotation mechanism. The Malaysian Insider. December 19 2008]

It may not be ideal but at least, the direction taken deserves endorsement. Gradual improvement is something I can appreciate.

With fuel subsidy and control over fuel prices have been significantly eroded to incorporate greater liberty and less government intervention, it is time to target other supply and price control mechanism.


[1821] Of Minister Shahrir suggested elimination of fuel subsidy

According to Bernama:

KUALA LUMPUR, Oct 31 (Bernama) — Domestic Trade and Consumer Affairs Minister Datuk Shahrir Abdul Samad today suggested the government removed the 30 sen subsidy on fuel prices if the pump price goes below RM1.92 a litre. [Govt Should Remove 30 Sen Subsidy On Fuel Prices, Says Shahrir. Bernama. October 31 2008]

Four days ago, I suggested a similar move with the similar mechanism, i.e. removal of subsidy when the market prices fall below the current subsidized retail prices. I shamelessly quote myself:

With global crude oil prices having more than halved since it peaked at about USD150 per barrel just months ago, this is definitely one of those rare opportunities to make a permanent structural change to our economy by effectively eliminating the fuel subsidy for once and for all.


With decreasing subsidy quantum, the government could just maintain the current prices until the quantum of subsidy becomes zero. This happens when market prices equalize with the current subsidized prices. In doing so, elimination of subsidy does not require a hike in retail prices. When that happens, the government could immediately float it.

This strategy significantly reduces political opposition to the idea of subsidy removal. I suspect what was protested in the past was prices hike, not subsidy removal per se. [Of the best time to kill off the fuel subsidy. The __earthinc October 27 2008]

I also wrote in the same entry:

Unfortunately, there is little chance for this little maneuvering to see daylight. The government has already hinted for further reduction of RM0.15 by the end of this month. [Of the best time to kill off the fuel subsidy. The __earthinc October 27 2008]

I would like to take that back. There is a chance after all if the dear Minister pursues the matter with tack.