The Arab world’s subsidy nightmare

Energy subsidies, a mainstay of social protection in the Arab region, are being targeted for phaseout by the IMF.

by Hassan Sherry

For decades, policies maintaining tight control of domestic energy prices have shaped the political and economic environment in most Arab countries. According to the International Monetary Fund (IMF), expenditures on energy subsidies by governments of the region have accounted for about half of global energy subsidies, amounting to almost $240 billion in 2011, nearly 8.5% of the region’s GDP. This is explained by the fact that redistributive commitments of Arab countries, largely through the reallocation of rents, have shaped the social contract since the independence years following World War II.

Many in the Arab world perceive energy subsidies as an important social safety net for the poor in a region where poverty is widespread. According to a 2012 UN Development Programme report, poverty levels range from 11% in Jordan to 30% in Morocco, 40% in Egypt and close to 60% in Yemen. The report argues that subsidies are a form of public benefit which boosts industrial growth. Crucially they also enhance access to energy, an underlying condition for achieving the Millennium Development Goals, in a region where 65 million people had no access to electricity in 2002.

For the past three decades, however, the Arab region has embarked on a series of externally driven and designed structural adjustment programmes prescribed by the IMF, in which the unwinding of general subsidies, in particular energy subsidies, has been a core ingredient.

Although these programmes have failed to prevent rising poverty and unemployment in the region, and induced further wage cuts and a shift from the productive manufacturing sector to the service sector, the reform of energy subsidies remains among the core components of IMF policy advice to Arab countries. Civil society has argued that such reforms, which at no point were part of a comprehensive economic and social development plan, required fiscal retrenchment that betrayed the social contract, thereby triggering the recent uprisings and sociopolitical transformations.

The IMF has treated energy subsidies as a policy tool that is expensive, inefficient and regressive over the long run, which reduces incentives for investment in renewable energy and diverts public spending away from key social programmes, such as health and education. While subsidies create budget pressure, the IMF has overlooked the political context and social implications associated with its approach. It has proposed mitigating measures to accompany the reform process, including expansion of social safety nets; targeted energy subsidies and/or cash transfers; and universal programmes, which involve the elimination of energy subsidies in favour of a system of universal and untargeted cash transfers intended to benefit a wide spectrum of society.

The measures may sound practical, but face major constraints when considering underdeveloped social protection schemes in Arab countries, corruption and  the  absence  of transparency mechanisms. Moreover, in a region where administrative capacities are inadequate and informal economies are large, targeted subsidies are infeasible. Evidence from Egypt suggests that safety nets are ineffective in  cushioning the poor against price fluctuations and that the cash transfers measure implemented in 2012 has been inadequate and underfunded. Iran’s 2010 subsidy reform and the adoption of universal cash programmes was applauded by the IMF, but resulted in a slowdown in economic activity, raised the inflation rate and undermined political support for such a strategy.

Deep-rooted injustices

While subsidy reform in the Arab region may be seen as a step with macroeconomic benefits, the determinants of the weak economic performance of Arab countries are rooted in their political economy as much as the productive structures and go beyond the reach of the IMF’s traditional austerity proposals. By calling for short- to medium-term phasing out of energy subsidies, the IMF is targeting the symptoms rather than the causes of the deep-rooted social and economic injustices that sparked the region’s uprisings.

Reversing the underperformance of Arab countries will not be achieved without profound changes in the productive structures of their economies – by moving towards developmental states and building effective institutions that make economic and social development a priority objective.

Arab authorities must rethink their policy choices towards promoting manufacturing and the acquisition of industrial capabilities. This would generate decent employment, stimulate productivity and create linkages with other sectors, thereby easing the need for subsidies in a region highly dependent on them. Still, any choice of reform strategy, which should be a medium- to long-term endeavour, must be accompanied by an inclusive rights-based protection framework. It must also depend on the specific country context, taking into consideration the existing levels of poverty within the reforming country, the status of social and economic development of the country, and its administrative capacity to implement social protection measures.

Taking these factors into consideration, appropriate reforms to energy subsidies should be developed, in consultation with stakeholders including civil society organizations, which are more gradual and legitimate. As a result, a more efficient and progressive fiscal framework, protecting vulnerable poorer people, can emerge.                             

Hassan Sherry is with the Arab NGO Network for Development in Lebanon. This article is reproduced from the Bretton Woods Observer (Winter 2015) published by the Bretton Woods Project.

Third World Economics, Issue No. 585, 16-31 Jan 2015, pp12-13