Gasoline and diesel subsidies steer drivers towards overconsumption.
This figure plots gasoline prices for 44 countries. These are domestic consumer prices including all relevant taxes and come from a survey administered November 2012. I have excluded countries with fewer than 25 million people, but if you would like to see the complete list it is available from the World Bank (here).
What I find striking about this is the enormous variation. The average price is $4.71 per gallon, but with a range from $.09 per gallon in Venezuela to $9.50 per gallon in Turkey.
This wide variation in prices is surprising because there is a global market for crude oil. And if your country lacks refining infrastructure — no problem! — gasoline and other refined petroleum products are also widely traded internationally, so you can import gasoline. Although there are differences in transportation, refining, and distribution costs, they can explain only a small part of the variation in prices.
Instead, what explains this variation is taxes and subsidies. Among OECD countries, gasoline taxes per gallon range from $0.49 in the United States, to above $4.00 in Germany and the Netherlands (Knittel, 2012). Outside the OECD the range is even larger, including many countries that subsidize gasoline, selling it for below its price in international markets.
Many of the most generous subsidies are in major oil-producing countries. From an economic perspective, there is little reason why fuel subsidies would be correlated with oil production. Transportation costs are small compared to the market price of refined products, so the opportunity cost of selling a gallon of gasoline is very similar whether or not it came from domestically-produced oil.
An interesting example is Venezuela, which I blogged about last month (here). Venezuela lacks the refining capacity to meet domestic demand for gasoline so it exports crude oil and then imports gasoline. In November 2012 the spot price of conventional gasoline was $2.82 so Venezuela paid this price, plus transportation and distribution costs, only to turn around and sell gasoline for $.09 per gallon.
In Venezuela and in many oil-producing countries, subsidies have long been part of “sharing the resource wealth” with a nation’s citizens. But there are alternative approaches for resource sharing. Residents of Alaska, for example, receive an annual dividend ($878 in 2012) derived from oil and gas revenues, but pay gasoline prices that are above the U.S. national average.
Most economists prefer Alaska’s approach over Venezuela’s. Cheap gasoline causes people to own fuel-inefficient cars and to drive too much. This is inefficient; regardless of how large you think the negative externalities are from driving. In contrast, the Alaska Permanent Fund Dividend is a lump sum payment. It may, on the margin, make people more likely to move to Alaska or to stay there once they arrive. But it doesn’t encourage overconsumption of energy.
The problem is that once gasoline subsidies are in place, it is very hard to remove them. Just look at Indonesia. Energy subsidies in Indonesia will cost the government $32 billion this year — 20% of the total government budget. In May the President announced plans to increase gasoline prices, and tens of thousands of people took to the streets in protest (NYT, 2013). Removing gasoline subsidies is extremely difficult politically and it remains to be seen whether Indonesia will have the political will to pull this off.
The plan in Indonesia is to raise gasoline prices, while at the same time increasing funding for a cash transfer program for poor families. This approach to reform makes a great deal of sense and has been used with some success elsewhere (IMF, 2013). The key is government credibility. The people must trust the government to not back out on its promises to fund transfer programs. It won’t be easy for Indonesia, but the subsidies have become too costly to continue. Reform, even if it comes slowly, will help balance the budget, improve economic efficiency, and lead to cleaner air and reduced traffic congestion.
Lucas Davis is the Jeffrey A. Jacobs Distinguished Professor in Business and Technology at the Haas School of Business at the University of California, Berkeley. He is Faculty Director of the Energy Institute at Haas, a coeditor at the American Economic Journal: Economic Policy, and a Faculty Research Fellow at the National Bureau of Economic Research. He received a BA from Amherst College and a PhD in Economics from the University of Wisconsin. Prior to joining Haas in 2009, he was an assistant professor of Economics at the University of Michigan. His research focuses on energy and environmental markets, and in particular, on electricity and natural gas regulation, pricing in competitive and non-competitive markets, and the economic and business impacts of environmental policy.