Energy Subsidies Don’t Work, But Don’t Try Telling the Poor

Bear with me. This isn’t really about Nepal. But it is where I must start. You see, my wife recently suggested we buy a generator for the school she’s helping out over there. It now gets all its electricity from a clutch of solar panels. But they provide only enough power for small bulbs that cast feeble glows against the night. A diesel generator would help the children study and do homework in the evening.

All this got me mulling over the price of energy that poor countries like Nepal must pay.

At a minimum, US$400 (Dh1,469) should get the school the generator it needs. Buying it, however, is the easy part, because the school then will have to keep finding money for fuel. A litre of diesel is 103 Nepalese rupees – about $1. While this might not seem outrageous to us, in local terms it can be a severe hardship. To put it into context, the school’s fees are at most about $5 a month.

But that diesel price isn’t even the real cost. Nepal imports all its fuel from India, and if you tag on haulage into the hills, mountains and valleys, insurance and other expenses, it actually comes out to 112 rupees. The difference in selling and import price – for cooking gas as well as diesel – will cost the country $10 million this month alone.

And as winter beds in and river flows drop, hydroelectric plants will produce less power. So the thud-thudding symphony of generators will rise, as will losses for the state.

The dilemma for Nepal and other poor countries, including Egypt and Jordan, is that while the state can’t afford to keep underwriting the cost of fuel, citizens already can’t even afford the subsidised rates.

Professional cogitators in think tanks and newspaper editorial writers – as a class, people who don’t have to take responsibility for putting to work anything they suggest – will tell you that subsidies must go.

Well, duh. (Note: even beauty pageant contestants don’t hope for world peace anymore.)

Yes, people should pay the going rate. But we make the mistake of thinking that all markets are alike, that oil prices are set in the same way as prices for, perhaps, shares.

Yet, there’s a difference between a market for what people want – like stocks in Facebook, Twitter and GE – and a market for what people need – like oil, wheat and rice.

You may want to own shares in Facebook, but you don’t need them. So there is a bias towards keeping prices fair. Otherwise, who would buy them? And just as crucial, what is bought is kept and eventually sold again. So buyers eventually become sellers, which means there is another built-in incentive to keep things fair all around.

In the end-market for oil, however, buyers destroy – burn, that is – everything. They never become resellers. Instead, they must keep coming back to buy more. So sellers always have an edge.

This doesn’t mean that markets for commodities are always disadvantageous to buyers.

Down by the agora in 400BC, they did a decent exchange for olive oil. But an important element of that trade is that the Thales family bought as much or as little as their neighbours.

The market for oil, on the other hand, is dominated by the US, China and Europe. And what mostly sets prices is the expectation over how much America will burn between breakfast and dinner. It would take Nepal nearly three years to use what the US consumes in a day. The result is that small economies don’t matter in setting prices. Tiny Niue’s price for the roughly 20 barrels of fuel it consumes each day is pegged to the fair price for America’s 18-million-barrel appetite for crude.

So maybe it’s a little disingenuous to keep banging on about poor countries and how they need to keep to market rates. They are irrelevant to the pricing system.

Ganging up won’t work either. In fact, rich countries have tried this, but even they failed to influence prices to their benefit. That’s because, ironically, the market does (sort of) work. Except that it’s biased towards accurately gauging demand from big users. (So major buyers’ needs already are all priced in.) But for a commodity that everyone on the planet needs, “sorta works” is kinda not good enough.

Then there’s our distaste for subsidies. And quite right it is too. Our instincts against this were formed out of the post-war economic consensus. Subsidies distort trade, and that’s a bad thing for building prosperity.

But surely there’s a difference between subsidies for steel makers and subsidies to stay alive in the winter, to commute to earn a living and to cook meals?

Of course there is. Only, we’ve managed to jumble it all up.

Beyond the immediate imperative of fixing fiscal deficits and family budgets, subsidies prompt deep and fundamental political worries as well.

For if we don’t fix this, we’ve perpetrated a terrible hoax on the poor. We’ve invited them to cast aside ancient social restrictions and free up horizons for individuals to live their lives. We’ve tempted them along to the political project of modernity with its material benefits. But now we tell them they can’t afford it. After all this, it’s no surprise that protests against subsidy removal in turn have rehabilitated old -isms and political dead-ends of the left.

We must fix this, then. But no one seems to know how. So let’s just say that for now, my wife and I really ought to think about how to fuel that generator in Nepal.