How to Tackle Subsidies in the GCC?

This Article was Published in Arab Times, Gulf News, Akhbar Al Khaleej, Al Qabas, Zawya

Subsidies are easy to roll in but difficult to roll back. The vexed issue of tackling subsidies comes to the fore in difficult times and hence this topic assumes importance in a low oil price situation. According to IMF estimates, GCC countries will spend roughly USD 60 billion on energy subsidies in 2015. While subsidies are offered under various categories, the major one is always energy subsidies. Very high amounts of energy subsidies in the GCC have led to wasteful consumption, which is reflected in the high per capita burden of these subsidies.

This issue is a topic of importance not only to the GCC, but also to the wider MENA region. Arab countries spend nearly 7.2% of their GDP on energy subsidies (pre-tax), while the comparative figure for advanced economies is just 0.03% and about 0.9% for emerging markets. Hence, the scale of subsidies is relatively too large to ignore. Also, given the high subsidy rate in the GCC (averaging nearly 70 to 80% of the cost), it often promotes wasteful consumption and encourages energy intensive industries rather than labor intensive industries.

Before we tread the subject of how to reduce the impact of subsidies, it is important to understand the context of subsidies in the GCC vis-a-vis other Arab countries. In the GCC, subsidy is a form of “wealth distribution,” while in other Arab countries it is more a form of support to poor people as a poverty alleviation tool. Therefore in the context of the GCC, where subsidy is more of a wealth distribution mechanism, the factor of demography plays an important role. In economies like the UAE, where expats are super dominant as a share of total population, the role of “wealth distribution” takes a back seat while that may not be the case in other GCC economies where the share of expats is more or less balanced.

Hence, it is no wonder that UAE recently launched the bold initiative of ending the energy subsidies. In July 2015, the UAE announced linking gasoline and diesel prices to global oil markets staring August 2015. It became the first country in the GCC to remove transport fuel subsidies. The move is expected to result in a savings of about $7 billion for the UAE. Given the large expat population (of over 90%), the burden of such roll back on nationals can be minimal. Hence, we must not assume that all other GCC countries will also follow a similar path.

While the intention behind energy subsidies is to relieve the burden on the poor, such an argument may not be valid for the GCC given the high per capita income and the classification of the GCC as rich rather than poor. It is important to note that in the context of other Arab countries, though subsidies are directed to help the poor, it is often the rich that benefits from them.

What steps should the GCC take now?

It is not a question of “If”, but rather a question of “how” to reduce subsidies and gradually lessen its impact on the fiscal situation. The following can be proposed as ways to tackle this  this vexing situation.

     1. Find alternative methods to distribute wealth: Since in the context of the GCC, subsidies are more of a “wealth distribution” mechanism than a “poverty alleviation” mechanism, it may be a good idea to come up with alternative methods of wealth distribution and replace such methods gradually over time to reduce the burden of subsidies. Direct cash transfer is being proposed by some scholars as an example of this route. The main advantage of such an idea is that it shifts the burden of rational decision making from the State to  individuals and families directly.

     2. Introduce innovative strategies: GCC states can think of introducing various concepts surrounding the subsidies rather than a strait jacket approach of providing the service almost free of cost. The concept of “Tiered subsidies” linked to consumption (low price up to a certain point and high price thereafter) can reduce wasteful consumption. “Smart subsidies” can link subsidies to certain KPIs like national employment or training new graduates. The idea of “Targeted subsidies” can also be tried when promoting certain sectors (say SMEs) becomes more important and therefore can be linked to subsidies provided. Innovation in subsidies can produce better results.

     3.  Aim for efficiency in production: The subsidy burden is simply the difference between price and cost of production. While the suggestions in introducing innovative strategies can work on the price side, it may also be a good idea to focus on how to reduce the cost of production by improving the efficiency of the production of energy. Development of alternative sources of energy fits nicely into such a scheme of thing.

      4.  Launch effective communication: The factor of high subsidies in the present time can disproportionally increase the burden onto future generations. An effective communications strategy that explains the long-term burden of high subsidies and how it crowds out investment in infrastructure can go a long way in gaining support forthe idea that subsidies should be reduced over the long term.