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Do subsidies work?


Petrol prices are going up in Malaysia
ON 4 June 2008, the Barisan Nasional (BN) federal government announced a 40.6% petrol price increase effective at midnight. Pump price went from RM1.92 to RM2.70 per litre. Barely a week later, the Pakatan Rakyat (PR) federal opposition launched its Protes campaign. Then PAS vice-president Datuk Husam Musa promised that if the PR managed to wrestle federal power, it could and would lower fuel prices despite a global increase in petroleum prices. Husam said the obvious solution was to increase the use of gas, as opposed to petroleum products, for domestic consumption, including for transportation.

The BN government’s decision to decrease petrol subsidies was understandable. In 2007 alone, subsidies for petroleum products amounted to RM16.1 billion — or 37% — out of a total of RM43.4 billion in subsidies allocated to the rakyat. But was Husam’s suggestion any more practical than the government’s to cut petroleum subsidies? After all, in 2007, the Economic Planning Unit estimated Petronas’s gas subsidies to be RM18 billion — or 41% — of the total amount of subsidies. And unlike petroleum subsidies, which are borne by the government and subjected to profit sharing agreements with other oil giants, gas subsidies come directly out of Petronas’s pocket. In fact, Petronas says it has borne RM97 billion in gas subsidies alone since 1997.

So many questions arise just from a quick perusal of these figures. Was the PR misleading the rakyat with its call to lower fuel prices? At the same time, was the BN government justified in increasing fuel prices so drastically? Do subsidies harm or benefit the rakyat? What is a subsidy anyway?

Subsidies 101


Universiti Malaya’s Prof Dr Edmund Terence Gomez tells The Nut Graph that there are different kinds of subsidies. “We must make a distinction between government subsidies for the poor, and subsidies that are meant to promote and develop domestic enterprises,” he says in a telephone interview.

An example of a trade protectionist subsidy is how the US government protects its agricultural sector. Gomez feels that subsidies are necessary for both helping the poor and to nurture certain domestic sectors. “Otherwise, we will be too dependent on multi-national companies which might not operate in the rakyat’s best interest,” he says.

In the case of gas, it appears as though Petronas’s subsidies are meant to be cross-cutting. Subsidies do not only go to natural gas for vehicles such as taxis, and the fishing sector, they also go to the power sector and other large consumers.


(pic courtesy of Piarapakaran Subramaniam)

Water and Energy Consumer Association of Malaysia secretary-general Piarapakaran Subramaniam says: “Cross-cutting subsidies intentionally creates a market that is not real, because the prices are then fake.”

In a telephone interview with The Nut Graph, he says this creates a host of other problems. One, it means that in a subsidised environment, people cannot factor in true market prices when they make daily lifestyle decisions. For example, people continue to buy big cars and do not try to reduce fuel consumption. Two, when subsidies are cross-cutting, they tend to benefit larger companies rather than the deserving poor. Three, this could lead to irregularities in how subsidies are disbursed if there is a lack of transparency.

“For example at the moment, gas subsidies going to industry are higher than diesel subsidies going to fisher[folk],” he says.

In figures made available to The Nut Graph, the current subsidised price for diesel for the fisheries and transportation sector amounted to RM38.65 per million British thermal units (MMBTU). However, the subsidised price of gas supplied to the power sector was RM10.70 per MMBTU.

The October 2008 market price for gas going to the power sector, however, was RM38.87 per MMBTU, while the market price for diesel going to fisheries and transportation was RM54.26 per MMBTU. In effect, this means the subsidy for gas to the power sector amounted to RM28.17 per MMBTU, compared to only RM15.61 per MMBTU for fisheries and transportation. So Piarapakaran is right — the per unit amount subsidy given to the power sector is nearly twice the amount given to fisherfolk.

Alternatives and solutions

But does this justify the BN government’s removal of subsidies — first of petroleum in 2008 and now of sugar, although there have been conflicting reports about the sugar subsidy? Asst Prof Dr Paul Barter of the National University of Singapore tells The Nut Graph he is not against subsidies in general, but that subsidies must be given more sensibly.

“As it is, with fuel subsidies, the people who benefit the most are the people who use the most fuel, and these are usually high income groups who drive big cars and so on,” says Barter, who specialises in urban transport and public policy issues. Therefore, when fuel prices skyrocketed in June 2008, the rich were ultimately able to absorb the shock.

“The Malaysian government subsidises fuel, but in the 1980s and 1990s, they did not subsidise the growing public transport sector. With huge capital costs and potentially good long-term effects, public transport was actually the sector that needed subsidies,” he says in a telephone interview.


(pic courtesy of Paul Barter | nus.edu.sg)

Barter also says that income for taxpayers could be used to subsidise healthcare for the poor, if the government’s justification for subsidies is to help the underprivileged. “There are positive side-effects to keep people with lower income healthy. But why use taxpayers’ money to subsidise people driving around in big cars?” he says.

Piarapakaran believes that a balance can be struck between lifting subsidies and helping the poor. He says subsidies could be more targeted at the poor by using per capita income as the main eligibility criteria.

“And if we want to subsidise certain business sectors, we can structure incentives such that they are given only to businesses that perform,” he says. For example, he says promising start-ups can be given tax breaks for their first five years. “But we cannot keep giving incentives forever and ever,” he says.

Ultimately, Piarapakaran says that with any economic policy geared towards helping the rakyat, the plan must be to make them independent and empowered. “This is so that when the government finally removes subsidies, they don’t hold the rakyat by the neck,” he says. favicon

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5 Responses to “Do subsidies work?”

  1. Sean says:

    “Targeted at the poor by using per capita income as the main eligibility criteria [sic - should be criterion]”

    I don’t see why it’s necessary to even identify ‘the poor’ for subsidy. Besides negatively labelling them, introducing a criterion creates a system that can be ‘gamed’ and increases bureaucracy.

    Subsidising people by paying a flat ‘cost of living allowance’ as a tax credit would allow people to individually choose what to subsidise, avoids labelling anyone, cannot be gamed – as everyone gets the same amount, encourages independence by having no strings attached, utilises existing financial channels, and encourages those people who might otherwise remain ‘outside the economic system’ to interact with banks and tax offices.

    As long as subsidies are decided for the rakyat by someone who doesn’t need them, or their availability is restricted by arbitrary rules, the rakyat will continue to be held by the neck. The only way for a government to really set its people free is to give them all a little bit of cash.

    How many adults in Malaysia in 2007? 16 billion Ringgit / 16 million adults is RM1K each. In a house with 1 wage earner, 1 ‘domestic engineer’ and 2 elderly dependants, that’s RM4K or RM80 per week. That ought to amply subsidise the wage-earner’s Kancil to the factory and local shops.

  2. Vikraman says:

    I’m very suprised that TNG (which normally gets very good opinions from real experts) did not get an opinion from a proper economist for a question that’s so intrinsically economic in nature such as subsidies. Let me lend a helping hand to fill in the gap that TNG has left out.

    http://www.nytimes.com/2008/08/17/business/economy/17view.html

    A very simplistic view of the situation but an economically sound one. Price is not just a random number thought up by a few hacks in a small office, it’s a complex system of controls created by the demands and supplies available. Once you start messing with the price through artificial interventions, you send the entire equilibrium of supply and demands to hell. Depressed prices through government subsidies increases demand tremendously but the supply remains unchanged hence the price of the good will necessarily increase!

  3. MyMalaya says:

    I am in for the removal of fuel subsidies. Just use the money from the subsidy to improve the public transport and healthcare. The lower income group will be the ones who benefit the most if the subsidy is removed and allocated to other areas.

  4. Piarapakaran says:

    Dear Sean,

    We are not labelling anyone ‘poor’. Your argument of subsidy is good and fine. Our concern is to assist these people to stand on their own. We log their lives and leave them to rot. I’m sure they deserve a good quality of living standards.

    However, when the minister of KPDNKK said that the sugar subsidy benefits the industries more than the public, no one asked him why. This is because of lack of enforcement. A biscuit manufacturer and a sweetened drinks manufacturer are enjoying this subsidy. Why? Initially it was given to the people, somehow the ‘economists of the country’ do not see how industries utilise the situation for their benefit. We face an artificial ‘sugar shortage’. How do you control them?

    The natural gas subsidy gives stress to natural gas reserves, this should not be the case. There are other fuels available for industry. Any business will choose economical operation costs. At least, that is what I must consider during a plant design.

    As an engineer, I have seen wasteful practises just because they are cheap. If the government policy is to give a subsidised price of electricity for those industries with more than 5% of operational costs from electricity, imagine if they are reach 4% – it’s cheaper to waste. Do you think it is fair for you to pay for their wastage?

    Reality shows that everthing has limitations, we should work to use it with proper planning. The world will not produce more oil and gas, unless we are willing to wait for another 50 million years. Some science needs to be pumped into the economy to ensure reality is in place.

    You are free to comment on this, but this is my view as an engineer who sees economy as a tool to put things back to sustainable consumption.

    Some thing for you to ponder: Logging assists a state to earn from sales. It’s a good revenue, especially for matures logs worth more than RM 50,000 apiece. This takes away the ‘sponge’ effect from our soil. Eventually when floods occur, we spend more. I’m not sure if this can be a sensible economy. Short term gain, long term loss.

  5. Sean says:

    Hello Piarapakaran

    I’m sorry I only referred to the personal and not industrial side of subsidy. I wanted to, but I’m not gifted with brevity and my comment was already long. I have a personal vendetta against “identifying the needy” (the last identity they need), hence my focus on that.

    I’m also at a bit of a loss to suggest alternatives for subsidising industry. While I’m largely in agreement that ‘protectionism’ is not ideal, giving financial incentives to crap industries seems idiotic. Paying subsidies direct into consumers’ pockets does at least shift the blame (for who eventually benefits) from government to consumers, but might also create a wiser ‘critic’, so that better decisions might be made as to which industry gets how much subsidy.

    Your examples of sweetened drinks and biscuits is perhaps locally complicated. While another country might give its ‘identified needy’ a cash handout that they might – from habit – spend on local sweetened drinks and biscuits, the same country might spend public money on campaigns to persuade its citizens NOT to spend money on sweetened drinks and biscuits, and even legislate to complicate the sale of goods with adverse health effects. A varied print and broadcast media might also prominently feature adverse comment on such foods, if the media owners were sufficiently free from complicating ‘interests’.

    Can we easily suggest a local solution for industrial / commercial subsidies? Things are complicated by prohibitions on access to information, and absent or subverted regulation of trade and industry. Something has to be done – if I had an answer that I thought would work, you can be sure I would post it in an over-long comment!

    I agree with your final statement in the article – start-ups are probably the least controversial prospect for subsidy. I wouldn’t personally advocate ANY corporate body for subsidy in Malaysia until many, many substantial changes are made to regulation and freedom of information, however. There is far too much ‘gaming’ going on and not nearly enough decent industry.

    As for the last part of your last comment – I think Malaysia should be a world-famous timber exporter – why not? But natural resources should not be mined liked mineral ones (and even some mineral ones – like karst – should be protected). I’d like to see the logging done sustainably, in partnership with the forest-dwelling peoples. That does mean that forest timber could only be extracted from an area with several-decade-long intervals, and would put up costs. On the plus side – as you point out, less flooding, more even water supply, better air, and you when you tell people you’re from Malaysia they wouldn’t be able to ask you why you destroyed the rainforest.


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