Fuel Subsidies Fan the Flames in Latin America

(Bloomberg Opinion) -- As turmoil rumbles across Latin America, energy prices have emerged as a potent flashpoint. Ask Ecuador’s President Lenin Moreno, whose government was almost toppled this month by protests against increases in the cost of gasoline and diesel fuel.

By now, this script is both tragic and familiar. In recent years, similar stories have played out in Argentina, Mexico and, most visibly, Brazil, where a trucker strike over higher diesel prices in May 2018 gridlocked the economy and forced the government to cave to protesters’ demands.

The culprit in all these cases was the same: fossil-fuel subsidies, which are widely regarded as wasteful, environmentally harmful and almost entirely ineffective. All too often, efforts to end them have ignored hard-earned experience, leading to avoidable economic disruption and civic unrest.

Ecuador offers a case in point. Since the 1970s, it had been subsidizing the price of gasoline, diesel and liquefied petroleum by up to 85%. Over the past decade, these handouts averaged more than $2 billion a year, equivalent to about 7% of public spending and two-thirds of the country’s fiscal deficit.

Yet fuel subsidies aren’t just expensive. They also distort industrial development, crowd out spending on benefits such as health care and education, and encourage corruption — in Ecuador’s case, the illegal diversion of fuel to Colombia, Peru and offshore fishing vessels. By some estimates, the local costs of artificially cheap energy — thanks to global warming, pollution, accidents and road damage — exceed the fiscal burden of the subsidies themselves.

Conceivably, such drawbacks might be worth it if these policies were a big help to the poor. But there’s little reason to think they are. Most of the benefit, in fact, goes to the better-off. Researchers at the Inter-American Development Bank concluded that it takes nearly $14 in gasoline or diesel subsidies to provide $1 in benefit to the poorest fifth of the population. Compare that with the 2:1 cost-benefit ratio of a simple cash-transfer program. Moreover, countries that get rid of gas and diesel subsidies would need to devote only one-fifth of the resulting savings to compensate the bottom two-fifths of households for higher fuel prices.

You can’t blame Moreno for trying to end this lose-lose proposition, especially because he was doing so to unlock a badly needed $4.2 billion aid package from the International Monetary Fund. But he moved too quickly, failed to adequately consult indigenous groups that are heavily reliant on rural transport, and neglected to put effective cash-transfer programs in place to cushion the blow on the poorest.

That should be a lesson for other Latin American countries struggling with the same dilemma. Unfortunately, even with much lower oil prices since 2014, only a handful of them have made meaningful progress in reducing energy subsidies. There’s no doubt that they should be phased out. The key is to ensure that the public understands the benefits first, then to proceed gradually and prudently. One model to consider is Iran’s 2010 fuel-subsidy reforms, which were preceded by extensive legislative debate, a big public-awareness campaign, and direct cash deposits that were released before the subsidies were slashed. As a result, the reforms took effect with minimal discontent and fuel consumption soon fell sharply.

Of course, a smart phaseout of subsidies won’t solve the wide range of challenges besetting Latin America. But it might avoid adding fuel to the fire in nations already simmering with discontent.

Editorials are written by the Bloomberg Opinion editorial board.

©2019 Bloomberg L.P.