Fuel Subsidies Should Go!

Postscript By WaziriAdio                      waziri.adio@thisdaylive.com

About two weeks ago, President Muhammadu Buhari gave the clearest indication so far that he is not persuaded by the growing clamour for the removal of subsidies on kerosene and petrol. “I have received a lot of literature on the need to remove subsidies,” he said. “But much of it has no depth.” According to a press release from the presidency, he made this categorical statement after receiving briefings from senior officials of the Ministry of Petroleum Resources, the Nigerian National Petroleum Corporation (NNPC) and other agencies in the oil and gas sector.

This statement came as a major shock to those who had thought the removal of fuel subsidies was just a matter of when and not if, and who had indeed expected the president to swiftly dispense with the subsidies within days or weeks of coming to office. However, the statement was sweet music to those in favour of subsidy retention. I belong to the gutted camp. Though the president’s statement had a ring of finality to it, my sense is that President Buhari has not closed the book on this very important matter. In case he has, I will urge him to reconsider.

In the following paragraphs, I intend to examine the arguments for and against fuel subsidies, both in theory and actuality. I will conclude by addressing what I think are the stated and unstated concerns of the president and show that the current fuel subsidies are inefficient, badly targeted, anti-poor, open to elite capture, garnished with perverse incentives, riddled with corruption, unaffordable and unsustainable. I may or may not be able to demonstrate acceptable depth to the president. But I do hope I can re-open the debate on optimal use of scarce public resources especially at a time when government revenues are not just dwindling but are also expected to plummet further.

First let’s look at the economic arguments for and against subsidies in general. A basic principle in economics is that the best way to allocate scarce resources is through the market forces. The dismal science instructs that tampering with the interaction of the forces of supply and demand is likely to lead to distortion, allocative inefficiency and overall loss to the society, called dead weight loss. Subsidy is an interference with the invisible hands of the market because, basically, it entails selling a good below the price buyers and sellers believe is optimal or making the good cheaper to produce. The government has to pay the balance between the equilibrium price and the subsidy price to guarantee supply because at the subsidy price, producers would supply less and consumers would demand more, leading to shortage of the good. The sum of this is that with subsidies, the society takes a hit in two ways: putting factors of production to less efficient use and diverting additional scarce resources from other competing needs. This is not good economics.

However, this does not mean that subsidies cannot be justified. Even classical economics recognises that market forces do not always produce optimal outcomes. Economists accept that the market can fail for a number of reasons, ranging from lack of enough information (information asymmetry), the existence of market power (monopoly), lack of effective demand (public goods), existence of benefits or losses to third parties not involved in a transaction (externalities) etc. When markets fail, government can intervene to correct the failure. It is also accepted, even if grudgingly, that government can intervene in the market to pursue strategic objectives such as keeping prices low, encouraging consumption of some desirable goods (merit goods), propping up local industries, reducing inequalities, etc.

In line with the above, justifications for introducing and keeping fuel subsidies would include making fuel affordable, especially to the poor, reducing the inequality and further impoverishment that could be fostered if fuel is priced out of the reach of the poor, reducing cost of production, improving competitiveness, keeping prices stable and ensuring widespread benefits from national resources etc. There is also the political part. Attempts at removing subsidies are usually met with stiff resistance and could lead to electoral loss, political upheaval and even violent overthrow of government. So apart from structural and strategic economic considerations, keeping combustible subsidies could be the small price for regime security or political stability. However, it is always important to keep assessing subsidy programmes to be sure it is meeting its desired objectives and that the benefits outweigh the embedded losses.

Okay, enough of theory. Let’s now turn how fuel subsidies have played out in our country. The first thing we need to establish is that there is subsidy on kerosene and petrol in Nigeria today because there are some who do not believe a subsidy exists. According to information sourced from the NNPC, we consume between 35 million and 40 million litres of petrol per day. If our four refineries work at 100% capacity, which is impossible, the total refining capacity as revealed by NNPC is 19.5 million litres per day, meaning we still need to import at least half of our petrol needs.  According to the Petroleum Products Pricing Regulatory Agency (PPPRA), the current landing cost of petrol (as of 22 July 2015) is N116.7 per litre and the expected open market price (when distribution margins are added) is N132.2. Petrol is officially sold for N87 per litre. Similarly, the expected open market price of kerosene is N117.52 while its official price is N50/litre. This means that at the moment there is a subsidy of N45.2 on each litre of petrol and N67.52 on each litre of kerosene.

If we use the lower figure from NNPC on daily consumption (35m litres per day), that is N1.58 billion spent on petrol subsidy alone per day, or N47.4 billion per month or N569.5bn per annum. This estimated subsidy is of course much less than the N1.5 trillion we burned on fuel subsidies in 2011 (more than 30% of that year’s budget), but 2015 is not 2011. This estimated figure represents at least 13% of our N4.5 trillion budget for this year. But it is worse than that: it is about 300% higher than the N145.2bn allocated for subsidy in the 2015 budget and 64% of the entire domestic and external borrowing of N882bn in the same budget. Maybe at the best of times we can afford such a huge expense on just one item. But not this time. In fact, we are in a deep fiscal hole at the moment, and the least we can do is to stop digging. The president himself said he inherited a near-empty treasury. So how does he expect to pay for the fuel subsidies? Borrow more? If it is acceptable to borrow to pay salaries, it is surely not to borrow to pay for a badly-targeted subsidy programme.

There are two related arguments usually made in support of fuel subsidy in Nigeria, which the president also mentioned in the meeting mentioned above: fuel subsidies benefit the poor and their removal will disproportionately affect the poor. “When you touch the price of petroleum products,” President Buhari said, “that has effect on triggering price rises on transportation, food and rent… that’s those who earn salaries but there are many who are jobless and will be affected by it.” This pro-poor argument cannot stand proper scrutiny. To start with, the subsidy is open to all, not narrowly targeted at the poor. Members of the middle and the upper classes benefit more in terms of the volume of fuel consumed and access to supply.

This is a wasteful use of scarce resources because we end up giving subsidy to those who don’t need it. For example, anytime Alhaji Aliko Dangote buys petrol, the richest man in Africa receives subsidy too!
Besides, it is only those who live in urban areas who enjoy the subsidy at the moment. Outside of Lagos, Abuja, Port Harcourt and a few other Nigerian cities, petrol is sold between N100 and N200 per litre in most parts of Nigeria, even when sold directly from the pump. And whenever there is scarcity, which is becoming incessant these days and will continue as long as there is dispute over subsidy payment, the price of petrol goes up as high as N300 or more. That is more than double the real (non-subsidised) market price of N132.2 from the PPPRA template. And that is without taking account of the unnecessary hardship and risks people are exposed to and time lost and financial losses incurred while looking for fuel. The case of kerosene, the product mostly consumed by the poor, is even worse. On the average, most poor Nigerians buy kerosene for N150 per litre, well above the market price of N117.52 from the PPPRA template and three times the subsidised price of N50.

The point here is that our fuel subsidy has become a failed policy. It is not affordable and non-sustainable. It is not benefiting the intended beneficiaries, the poor, and it additionally crowds out public investments in education, health and other areas critical to empowering the poor and lifting people out of poverty. Besides, it has been captured by people who can afford to do without subsidy and worse it is available to people who don’t need the subsidy at all. This is the very definition of inefficiency, waste and ineffectiveness. Most Nigerians, especially the poor, are paying the deregulated price already because that’s the price it is available to them.

Yes, the poor will be disproportionately affected if fuel subsidy is removed because they, unlike the rich, spend a high percentage of their incomes on food and transportation, which will be immediately impacted by increase in fuel prices. While this is a legitimate concern, this might be exaggerated. A transporter that regularly buys petrol at N150 per litre in Mopa, Kogi State would have passed at least some if not all of the increase to passengers and a farmer or trader who pays higher transport fares for her goods in Daura, Katsina State would have done the same to consumers. So it is not only that Nigerians are buying fuel at deregulated prices, they are absorbing the inflationary impact and multiplier effects already.

The president also alluded to another major ill of the subsidy programme when he said “we have to go back to the old days of transparency and accountability.” Yes, corruption is a big issue here. In fact, the most compelling argument for the removal of subsidy today is that it is a big scam that enriches some briefcase billionaires and their sponsors in government at the expense of the entire country, especially the poor. I am inclined to think the president thinks he can fix the problem by fixing the corruption in the administration of fuel subsidies. He shouldn’t bother. Or he should save his energy for other areas. It is the subsidy itself that has created the perverse incentives for corruption and abuse. Remove the subsidy and the corruption in its administration will magically disappear. Except the programme is redesigned, the incentive for collusion by officials and operators is too high and the cost of monitoring or enforcing compliance across the board is so huge and the opportunity cost to society so heavy that it is not worth the likely benefits.

It is highly conceivable that a major yet unstated worry for the president is the resistance and the backlash likely to follow fuel subsidy removal. This is a reasonable concern when we take into consideration how Nigerians have responded to partial removal of fuel subsidies since April 1992 under General Ibrahim Babangida and especially the massive protests of 2012, which the President Goodluck Jonathan administration didn’t manage to recover from. But this is another exaggerated concern. The year 2015 is not 2012 or even 1992. If nothing else, the last three years have exposed the lie in the subsidy programme and ripened the issue for reform. Today, most of the people who led the Occupy Nigeria Movement are the ones advocating subsidy removal. This is not to say there won’t be resistance.

The task is to know that subsidy removal is more of politics than economics and to devise strategies to build a robust constituency of support and overcome expected resistance. Besides, the people who elected President Buhari expect him to take tough decisions that will come with some pains but put our country on the path of sanity and sustainability. If the president is really keen on protecting the poor and the vulnerable, he should either evolve a way of giving them the subsidies directly or invest subsidy savings on public transportation, food, education, health and other areas that can both insulate the poor from attendant price hikes and improve their productive capacities. The fuel subsidies in the present form need to go, and there can be a better time than now.