The Folly Of Fuel (And Other) Subsidies

Huge protests erupted in Nigeria when President President Goodluck Jonathan removed fuel subsidies. The idea of subsidies are intuitively appealing to most people, after all, who does not want to increase the consumption of vital goods and services to the poor and other segments of society? But, a brief economic analysis shows that the hazards of subsidies, especially for fuel, greatly outweigh their benefits.

Let's start off with opportunity costs: In the case of Nigeria, fuel subsidies cost $8 billion a year and consume 25% of the federal budget. No credible arguments can be made that investing these funds in public health, education and infrastructure would better serve the poor.

Studies show that fuel subsidies are highly regressive in nature, that is, their benefits are disproportionately enjoyed by the wealthy. The per capita use of fuel is higher among wealthy individuals who are more apt to drive their own vehicles, rather than utilize public transportation.

To make matters worse, subsidy regimens fuel corruption (all puns intended). For example, the Nigerian government was officially subsidizing the purchase of 59 million liters of petrol a day, when the nation only consumes 35 million liters a day. Hence, at least $4 billion amounted to politically connected individuals massively defrauding the public. Another unintended, but highly predictable consequence of this policy is smuggling: criminal syndicates have made a fortune purchasing fuel at below market value and selling it in neighboring countries at the market rate.

Subsidies almost always lead to economic inefficiency, specifically artificially cheap fuel destroys incentives to pursue greater fuel efficiency and environmentally friendly transportation. In the case of Nigeria, this has led to the unintended consequence of increased air pollution.

One of the most damaging elements of subsidies is their addictive quality; once they are instituted it is politically impossible to wean the public from them. The short term pain that their elimination would cause blinds much of the indirect damage that they cause to economic and environmental health.

Granted, not all subsidies are this poorly administered, but this example does highlight fundamental hazards of undue government interference in markets. And we see that from Africa to America, the shortsightedness of politicians is endemic, because the longer the state distorts a market, the more painful its inevitable correction will be.