Fuel and oil are so essential for Nigeria. They produce a large portion of its income. Learn more about the fuel subsidy.
As the technologies keep developing, the new necessities appear every day. Nowadays people need not only food, water and accommodation. Many of them have new devices, gadgets and cars. The cars and many other things demand special fuel. However, sometimes the price for it is quite high, so particular groups of people can’t afford to pay it. That is why in some cases government understands the problems and tries to help. But to understand the ways it helps, you need to know the answer to the question “What does fuel subsidy mean?”
Such term usually refers to the situations when there are several kinds of fuel, some of which are more expensive than the other ones. In such cases, the governments can help groups of people with lower incomes by paying this difference directly to the supplier. Thus, the cost gets lower, which makes fuel more accessible for people from various social groups.
To answer the question “What does fuel subsidy mean?” we need to know about the key pricing dimensions and mechanisms. They include the following:
- pass- through,
as it has been mentioned, it is connected with the amount of help the government is ready to pay to make the fuel more available. This dimension is interested in the degree to which subsidies reduce the end-price. The part of the cost may be also paid by either private or state-owned companies, and even by individual actors.
this issue concerns domestic pricing fluctuations. Its degree need to match the international price changes. Thus, any international pricing changes are “passing through” to the domestic prices.
the system of pricing regulation and control should be open. This dimension is interested in the degree to which it is actually so.
the degree to which fuel pricing actually follows officially adopted energy pricing arrangements is important in this case.
Market-based pricing. Demand and supply usually determine the price, while government does not interfere in this process.
Ad hoc pricing. On an arbitrary basis, the government tries to control the price changes “manually”.
Automatic pricing mechanism. There exist a special formula according to which the prices can automatically change. The government doesn’t intervene.
Automatic pricing mechanism + a price stabilization fund. In this case, the taxes are taken even when the international prices are low. However, the funds dampen domestic prices when they get high.
Ways of fuel subsidies
It is obvious that there exist more than one way to help people to buy. The main ones usually include the following:
Those are, as a rule, below-market. Specially created policy is able to hold them at a certain level. The help of various private or state-owned companies might be applied to cap or fix the prices. In this case, subsidies are paid trough:
- foregone spending,
- government revenues,
- accounts of energy companies.
Tax exemptions. The reduction of taxes may be also of use in this type. The government usually incurs a cost through foregone revenues.
Monetary transfers / credits. The credits might be bundled with fuel purchases. In-kind rations form can be also applied (typical for electricity industry).
The International Monetary Fund (IMF) has divided all fuel subsidies into two main types:
The first group reduces the energy costs to a level below the world price, adjusted for transportation costs. It can be done explicitly or implicitly.
The second group concerns all policies that hold the after-tax energy price below the level consistent with efficient taxation (a system that applies uniform rates of consumer taxes across all goods, which also includes compensatory taxes to reflect externalities of energy use).
According to the IMF report, the list of countries with pre-tax fuel subsidies (petroleum) contains:
As you may see, there are countries with the high rate of subsidies along with those, which do not have them at all. Nigeria takes the intermediate position in the list with one of the lowest rates.
Such subsidies have both good and bad influence on the poor people. The good effects include:
- more affordable fuel,
- direct costs reduction (including lightning and cooking),
- transportation costs reduction (for instance, for food).
According to the IMF research, if the fuel price is increased by 0,25$ per liter, the real purchasing power of poor households may decrease by more than five percent.
However, the poor ones use only a small part of fuel. Whereas the richer ones (who are 20% of the population) get at least six times more benefits from the subsidy. These results are taken from the facts that a very low amount of poor people has vehicles. Thus, the lowered gasoline prices give them little advantage. They can get more from kerosene costs reduction.
Subsidy benefits distribution for various fuel types by different income groups
LPG (Liquefied petroleum gas)
The main bad effect for the poor comes from the fact that money, which is being spent on the subsidies, may have been directed to the more important things. They would lead to the beneficiaries of the poor in more targeted way. In Indonesia and Saudi Arabia, for example, fuel subsidies total almost fourteen percent of the whole government budget. For Yemen, the figures achieve twenty percent, while for Egypt, it’s an alarming thirty percent. This money could be spent on educational, health, or any other programs for vulnerable groups of people.
Even if everything seems quite good for the rich, it isn’t true. Such subsidy policies affect them as well. The list of negative effects includes:
- very high taxes (to cover the budgetary costs rich wealthy people have to pay enormous sums, and this fact creates a net drain on their budgets),
- reduction of life quality (traffic congestion and air pollution are the most striking effects of fuel subsidies, lots of vehicles influence the atmosphere and, as a result, people’s health),
- slower economic growth (the money could be invested into the human capital or infrastructure).
Now when you know everything about the fuel subsidy, you may decide if it really good or bad thing. Although it has several advantages, it’s hard to say that they cover the harmful effects.
There are different types of this phenomenon and the rates differ in each country. However, if the rate is low enough, it anyway affects people’s life. That is why nowadays the majority of states fight to cancel any fuel subsidies all over the world, because they can not only destroy the economy and slow its development, but also make harm to the atmosphere, which will finally lead to the climate changes. And this process might become irreversible.
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