Monday, July 5, 2010

A Green Defense of Oil Subsidies: thoughts on the Bharat Bandh

There are few things more complicated than fuel price policy, which is mostly why I've avoided writing about it up until now. But few things are as important in the day-to-day lives of most people.  Fuel helps move us and the goods we need.  It powers the stoves that cook our food.  Farmers need fuel for their tractors, and much of  the fertilizers and pesticides used in modern agriculture are made through energy-intensive processes--processes that require fuel.   It is all very well and good to say we should move toward methods of agriculture that require less fossil fuel.  We should do that, but that shift will take time and a political commitment that doesn't seem to exist at the moment.  In the meantime, it is easy to see that fuel price hikes affect the entire economy from food prices to auto fares.

I wish I could say I've got the answers to the problem of rising fuel prices all figured out and ready to serve up in an easily digestible form.  I don't, but the Bharat Bandh, which aimed to shut down as much of the country as possible in protest of fuel price hikes and the decontrol of petrol prices, left me feeling compelled to take a stand: I support the stated goals of the bandh as far as they go--but I don't think they go nearly far enough.

As much as I hate to say this, in order to understand this issue, you have to understand a few simple things about how fuel prices work in India. I'll promise to make this as painless as possible, if you promise not to click the back button. 

First, about 70% of our oil is imported, so that oil is purchased at prices set by the international market.  Then, various government bodies levy a variety of taxes, which all add up to a large share of the final price charged for fuel in the domestic market.     However, the government has always sought to cushion the economy from the ups and downs of the international market by controlling domestic oil prices and by partly subsidising state oil firms for the losses they incur when international market prices are higher than the government-mandated domestic prices.  So the government gains by taxing oil; but it also loses to the extent that it has to subsidize the losses of state run oil companies for the money they lose due to domestic price controls.

The government has decontrolled the price of petrol because it no longer wants to pay these subsidies--and it's only a matter of time before it tries to decontrol the price of diesel as well. I think these moves, on the whole, are a bad idea. 

Now many of you may ask, why should we subsidize oil, of all things?  Haven't you always said that we should make people pay the full cost of the products they consume? Doesn't subsidized oil lead to more unsustainable use of cars and other problems?

Let me be clear; I think that, as a rule, public subsidies should be designed to help move us toward a move sustainable future--or to help insure access to basic rights, such as food or education. While it is true that cuts in oil subsidies may solve some problems, in the long run, unless they are accompanied by a comprehensive, justice-based program of sustainable development, these cuts will simply result in a massive transfer of wealth upward. That's because a good bit of those subsidies benefit poor people in this country, either directly or indirectly.  Given that fuel is already heavily taxed, I don't think price controls designed to help keep food and cooking costs low are unreasonable--in fact, in the current context, I think they are necessary. In a country where more than 800 million people live on less than Rs. 20 per day, policies that lead to food inflation are not just mean spirited, they are murderous.

Let's put this subsidy issue in proper context.  The current budget offers direct cuts in income tax for the upper middle class and rich, while it's spending on poverty reduction, social services and educaton remains largely stagnant.   And of course, as P. Sainath pointed out in his speech at IIC last week, the government continues to grant massive giveaways to the wealthy in this country through tax write offs and other subsidies. (If you missed the speech, you can read this or this as consolation.)  

Given that the government is drastically increasing the support it gives to the richest in this country, it seems hard to believe that the removal of oil subsidies is motivated solely by a desire to lower the fiscal deficit; rather it is motivated by a desire to cut subsidies to poor people in order to pay for subsidies already promised to rich people. The market is just a useful smokescreen. My, that sounds a bit extreme, doesn't it?  Sorry, but extreme policies tend to sound... extreme, when demystified.

Having said that, there is a lot that is very, very wrong with our current energy policy, and these things need to be fixed.  

Most obviously, a good deal of the current fuel subsidies do not do what they should be doing. Diesel fuel is taxed at a much lower rate than petrol, because it is used extensively in transportation and agriculture; lower diesel prices, we are told, are necessary to keep down food inflation.  Fair enough.  But in reality, a good deal of diesel goes into private cars. In fact, according to the CSE, the government's own Kirit Parikh panel conceded that "cars use up 15 per cent of the total diesel in the country – compared to 12 per cent by buses and agriculture, 10 per cent by industry, and 6 per cent by the railways."  The explosion of private diesel cars in Delhi and elsewhere has been driven by the low price of diesel fuel. This has nothing to do with food; but it has a great deal to do with the rise in pollution we are seeing.

A comprehensive fuel policy needs to figure a way around this.  In an ideal world, we would have a tax and subsidy structure that supported sustainable uses of fuel over unsustainable ones. Public transportation would be expanded and ticket prices kept low for all.  Fuel for shared taxis and three wheelers would be kept low, especially in areas where buses and trains are not available or adequate. 

Fuel for tractors, trucks and freight trains would be inexpensive, but animal powered farming and transportation would also be encouraged where practical. And we'd encourage local food production whenever possible: why subsidize the transportation of Punjabi rice to Kerala, if the same money could encourage southern farmers to plant more rice? All private cars would pay full price at the petrol pump since they pollute the most and take up the most room on our roads, per person. And diesel for private cars would be more, not less, expensive, since it causes more pollution. 

The problem is that we don't live in an ideal world, and so efforts to price the same fuels differently depending on how they are used invite fraud and corruption.  For example, if these policies were implemented, farmers all over the country would be tempted to resell their subsidized diesel to corrupt middlemen who would resell it for use in private cars. 

So what kind of fuel policies might a practical government implement if it wanted to be both environmentally friendly and fair?  After a lot of thought, two general approaches suggest themselves:

Approach I: Maintain fuel subsidies, but...
First, there are a host of things the government could do to encourage a more sustainable economy within a framework of fuel subsidies. We could start by encouraging good things directly. For example, public transportation could be further expanded and subsidized. Delhi buses are too crowded, and most Indian cities lack any viable system of public transportation at all.  There's a lot of room for growth in this sector! 

We could also do things to discourage unsustainable behavior. If we can't figure out how to tax private cars adequately at the pump (especially those that use super-polluting diesel fuel), then we could do other things to make them more expensive--increased fees at the point of purchase, parking taxes, etc. I'm not an expert here, but you can read this piece from CSE for a taste of how this might work in one context.

And there is a lot of good we could do simply by not investing public money in stupid places. As P. Sainath rightly said last week, it is pointless to subsidize "sunset industries" like automobiles. I'd add "World Class" airports to that list, by the way.  Mark my words, within a decade, rising oil prices--subsidized or not--are going to make the public money we've spent on encouraging the manufacture and use of cars and airplanes look silly, if not criminal!

 Approach II: Cut fuel subsidies, but...
There is another road, of course.  The government could cut fuel subsidies, while at the same time vastly expanding the support it gives to the people who actually need it. I'm not going to go into a lot of details here, because the list is long;  a few examples will have to do.  Instead of trying to keep food inflation down by subsidizing oil prices, the government could do things that would reduce hunger directly.  A universal public food distribution system would not be nearly as expensive as many people assume and it's favoured by some very bright people.  In transportation, many of the measures mentioned above, would work, with or without subsidies.  Expanding access to work under the NREGA--and increasing the wages offered under that scheme--would help, as would increasing the access of small farmers to credit at reasonable rates.

Those who complain that subsidies distort markets and should be done away with either fail to see--or fail to admit--that all economies and societies rely on some kind of subsidies.  India is no exception.  The only question is, who subsidizes who?  The problem with the current cuts in fuel subsidies is simple: at root, they are all about getting poor people to pay for subsidies to wealthy people and wealthy companies.  From where I sit, that just doesn't add up!


  1. There's another link here which people overlook. Increase in fuel prices can actually bring down inflation! It's quite simple. Here's how.

    Extra money spent on fuel means that it can't be spent on other items. Therefore logically the demand for those "other" items will go down which will decrease prices. Based on my understanding of economics, the whole "oil prices will fuel inflation" is overblown. It will certainly have an impact, but will balance out overall.

    As far as the fiscal deficit goes, we're in a precarious situation. If we don't do something drastic, we will go bankrupt by 2013.

    My feeling is that the government simply has no choice. After all, which government wants to lose popularity? This whole "bharat band" is terrible branding for the UPA. I don't think they would ever have done something like this if there was any other way out. The government is so sensitive to other things like religion etc, it's impossible that it would do something like this that risks eroding their base.

    From where I'm sitting, this looks like a courageous decision. Something that I didn't really think the government had the guts for...

  2. @Bhagwad,
    I hope you understand that I am extremely ambivalent about oil subsidies in any form at all. That's why I think this discussion is problematic when it is waged in sound bytes as it has been, though I understand why that's happened.

    And I doubt I would really agree with either wing of the opposition in terms of overall energy policy; just as they don't seem to agree with each other. (And I'm not going to pretend I've got it all figured out, either!)

    But here's what worries me. Though you may be right about the tenuousness nature of the fuel-inflation connection generally, I think there is a difference when it comes to people who are spending much of their expendable income on food already; they can't buy less without going hungry. That's why they say the demand for things like food is relatively inflexible. While those of us with resources may just cut back on the frills, for many, many people there are no frills to cut. I think if we look back at the round of inflation the preceded the round caused by the bad monsoon last year, we'd find more evidence of that connection, but I don't have time to hyperlink it.

    Whatever the government does about oil subsidies, it needs to address food security and hunger.

    As for the budget, P. Sainath was convincing on this; there are many, many ways in which the government is choosing to pass up legitimate income in order to subsidize unsustainable development--and the big fish, generally. Tax breaks for car manufacturers come to mind, but the list is long. I wish I'd take better notes, but he's written most of it down already.

    In the long run, of course, there is no way around it: oil prices will rise, whatever the government does. In that sense, one could argue that some of the current debate distracts from that long term reality.

    I loved the video, by the way!


What do you think?