IMF seeks to end to fossil fuel subsidies

May 7, 2013

The IMF has recently published a report in which it comes out strongly against fossil fuel subsidies, concluding that they disproportionately benefit the wealthy (who consume more), and are a threat to the environment and national economies, sucking funds away from public spending. The IMF has calculated that around $1.9 trillion worldwide, or a total of 8 percent of Government revenue (including that which is raised via taxation), is spent on energy subsidies.

The calculation includes the negative health and environmental externalities of fossil fuel consumption in the $1.9 trillion total, and states that globally, fossil fuel subsidies are now growing so large that they’re negatively affecting public finances and services (particularly in countries that are net importers of energy), diverting significant funds away from social and infrastructural investments such as healthcare, education and social security.

In a speech presenting the findings of the study, IMF First Deputy Managing Director, David Lipton explained that the subsidies divert government funds towards energy intensive industries (as opposed to labour intensive), and made the startling revelation that Some countries spend more on energy subsidies than on public health and education’!

Although estimates regarding the exact amount spent on fossil fuel subsidies vary – the International Energy Agency cites a figure of $623 billion, others have put it at $1 trillion – what is clear however, is that when one also accounts for externalities, our fossil fuel addiction comes at a huge cost.

Subsidies encourage inefficiency

Subsidies reduce incentives to improve efficiency of power generationThe report explains that the subsidies reduce incentives to invest in increasing electricity supply, with reduced supply having a negative impact on economies. Furthermore, subsidies also compensate for inefficiencies in production, distribution and end-use, thereby reducing the incentive for investment in infrastructural or technological efficiency improvements.

The subsidies therefore perpetuate a vicious cycle, as decreased efficiency means increased overall consumption, which in turn results in increased subsidies, which then means less government money is spent on infrastructure, thereby decreasing efficiency further still. The problem is even more acute in countries in which the energy supplier is state-owned, as the state pays for both the inefficiency and the subsequent subsidies.

Removing subsidies will reduce CO2 emissions 

The report argues that the removal of subsidies would therefore encourage reductions in consumption and wastage, representing a significant measure in the combat against climate change. Allowing prices to reflect international market rates and environmental cost would reduce demand for fossil fuels, and the IMF calculates that this would result in a global reduction in CO2 emissions of between 15-30 percent (potentially equating to 4.5bn tons of CO2!), as well as reducing levels of local pollutants and their subsequent negative effects on public health. This is therefore a huge issue for our economy, climate and for the public.

De-politicisation of energy prices

This ‘de-politicising’ of the price of energy, will be a key part of the process of removing fossil fuel subsidies, but the IMF suggests that the process can be attenuated using automatic pricing mechanisms which can act to smoothen sudden price increases for consumers.

Tansparency & communication of policy objectives

The report also proposes strategies for effective energy subsidy reform, explaining the importance of clear communication of the size and effects of the subsidies to be removed and comparing them to government spending in other areas. The winners and losers of the status quo should also be identified, as well as the objectives of any reforms, including where the recouped money will be spent.

Stakeholder consultation & compensating the poor

They also advocate consulting stakeholders when devising subsidy reform policy, and that subsidies should be phased out progressively, for example by targeting certain fuel products first. Most importantly though, the report highlights the need to protect poorer sections of society from the inevitable increase in fuel prices that the removal of the subsidies will engender. This could be achieved via compensation, or through social programmes or public investments (e.g. subsidised public transport, or even the elimination of state school fees, as was done in Ghana, or professional training for unemployed miners, as in Poland).

Subsidies suppress investment in renewable energyIncreasing investment in renewables

Lipton also explained that removing the subsidies would strengthen incentives for ‘research and development in energy-saving and alternative technologies’, meaning that the energy efficiency and renewable energy sectors would also greatly benefit from the removal of the subsidies.

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