x Abu Dhabi, UAEMonday 24 July 2017

Subsidy removal will undermine region’s economies

Removing subsidies can cause even worse problems if it damages local economies or increases the rate of youth unemployment.

When it was first mooted that energy subsidies might end in Egypt, Yemen and Tunisia – three countries where household income is low and poverty high – it was clear a crisis would occur if such a policy was implemented any time soon. All three nations are economically fragile, in states of delicate transition and prone to instability.

There is, in fact, an outright and dangerous disconnect between the reality of those who live day to day in these countries and those who seek to remove the subsidies and float energy prices to levels approaching those in the western world.

This is because talk about energy subsidy reform for Arab countries is not, in any sense, a debate. Rather, it is a monologue conducted by international lending agencies – and there are always dangers in listening to only one side of a story.

It is true, of course, that universal subsidies are a vast waste of resources.

When a government imposes a subsidy, four things generally happen. Firstly, a subsidised product is sold below the actual cost of its production. Secondly, people tend to consume more of that particular product. Thirdly, other public spending priorities get sidelined and lose funding. And finally, government deficits tend to grow as subsidies take hold.

It is also true that the logic behind subsidy reform is sound: imposing controls on spending and conserving resources are responsible and appropriate policies.

By some estimates, energy subsidies in the Mena region claim 8.5 per cent of GDP, which is not sustainable in the long-term. But, as far as those Arab countries are concerned – and Tunisia has already begun a subsidy elimination programme – various complexities will manifest themselves if subsidies are removed too quickly.

Since energy use permeates every industry and every home, a universal subsidy is, by definition, spread across the economy. For instance, energy subsidies lower domestic food prices by reducing local input costs, such as transportation, storage and processing.

If energy prices rose dramatically, producers and employers would either try to cut overheads, or pass increases onto consumers, or both. Imagine if this were to happen in countries struggling with explosive levels of youth unemployment.

Arab countries in post-revolution transitions also have more investment and production constraints than they did three years ago. They have worse internal security, higher insurance costs, weaker currencies, costlier inputs and less liquidity.

Subsidised energy is one of the few mitigating factors that has continued to breathe some life into these countries’ private sectors that have been hit hard by the revolutions and their aftermath.

Energy subsidies also partially buffer domestic markets from higher global food prices.

If they were removed, some local farmers and small producers would be driven to the wall by higher costs.

External competition would further compound local market challenges, particularly from European and US agricultural exporters, who are – and the irony is rich here – heavily subsidised.

The consequences would be felt most severely in the rural areas of these countries because of the absence of adequate employment opportunities outside the agriculture sector and significant rural poverty.

In Tunisia, Yemen and Egypt, agriculture generates between 9 and 15 per cent of GDP, and in Tunisia and Egypt accounts for 17 and 28 per cent of employment respectively. Any removal of subsidies would ripple through the economy by accelerating the cost of living.

The most crucial issue to target, therefore, should be how to raise productivity so people can enjoy a better standard of living through higher incomes.

All of this is a matter of sequencing reforms properly. It shouldn’t be about simply removing an item from a budget. If the universal energy subsidy is eliminated too quickly in these Arab countries, particularly at this fragile stage of their effort to rise and recover from extended economic trouble and political instability, the consequences could derail their economies even further.

Amal Kandeel runs Pioneers International, a US-based company specialising in business and development advice for the Middle East and North Africa region