Monday, July 14, 2008

Mitigating the impact of the fuel prices increase

A heavily and, in parts, incorrectly edited version of the following article appeared on the opinion pages of The Jakarta Post on 27 May 2008. It was later cited at on 28 May 2008. I reproduce an unedited version for your reading pleasure.

On Friday, the Indonesian Government raised the price of petrol (BBM) by 28.7 per cent. International prices for oil have risen sharply over the last few years and maintaining a constant low price for petrol is a drain on the nation’s coffers. The economic and social consequences of the decision are significant. Obviously, the price of transportation will increase. Subsequently, the price of goods and services that rely on transport will also increase. This will include many of the essential goods and services that Indonesia’s poor struggle to afford even at today’s prices. The impact, therefore, will be particularly severe among the socially disadvantaged in Indonesia.

Despite this negative impact, the decision to increase fuel prices is appropriate, equitable and inevitable. The reality is that it is the wealthier strata of Indonesia’s society that uses more fuel and fuel dependent goods than Indonesia’s poor. Consequently, the subsidy, as it is currently structured, is of greater advantage to the rich than the poor. It seems ridiculous that a country with so many people that are socially disadvantaged is diverting money that could be used for development, health, education and the delivery of core government services towards a subsidy that benefits the wealthy. Undoubtedly, a better use for the money would be to enact policies that aim to improve the lot of Indonesia’s poor.

A further issue with the fuel subsidy is that its level is dependent on world oil prices. Each year, the Government commits an uncertain (but always large) amount of its budget to the subsidy. The resources required to maintain the subsidy fluctuate each year as a result of factors totally beyond the Government’s control. There are very few governments in the world that would be willing to have a large part of their fiscal policy determined by world oil prices. The pursuit of such a policy is economically negligent and the decision to remove the subsidy on this basis should also be applauded. Other policies, that provide greater certainty and control in the use of the Government’s money, can be better targeted at achieving strategically advantageous policy outcomes.

In order to counteract the impacts of the petrol price rise the Government has proposed a direct cash transfer (BLT) to Indonesia’s poor. While this policy should be welcomed, it cannot be seen as anything more than a short-term and, in the fullness of time, meaningless gesture. The BLT will provide immediate assistance to poor people affected by the price rise. However, in the face of rising prices for every day goods and services, the reality is that this assistance will soon be forgotten.

Therefore, it becomes extremely important for the Government to develop strategic policies for the use of its financial windfall resulting from the subsidy reduction. Amidst the hype surrounding the decision to increase prices, the long-term policy options have been infrequently discussed in policy circles and the media. Positive impacts from the decision to increase petrol prices are totally dependent on the policies that can now be pursued by the Government as a result of its substantially improved financial position.

There will be a variety of opinions as to the most appropriate policy application for the Government’s additional resources. Of course any government decision regarding resource allocation is contestable. However, it seems that there are a number of options for the use of the financial windfall that are relatively uncontroversial and will accrue substantial long-term benefits.

Perhaps the most important strategic use of additional money is a substantial investment in public education. In the long-term, all Indonesians will realise benefits accruing from investments in education. Time and time again such expenditure has been shown to have undeniably positive impacts on living standards, particularly among the socially disadvantaged.

As part of an expanded education programme, the Government should consider investments in the tertiary education sector. Indonesia’s universities suffer from underinvestment and inefficiency. Yogyakarta alone has countless universities and higher education institutions. Undoubtedly some resources could be used to rationalise these innumerable organisations to ensure that universities offer greater quality rather than quantity. A significant emphasis should be placed on the improvement of teacher and medical training. Investments in these areas will assist the Government in the delivery of better quality social programmes in the future.

The Government also should take steps to improve social assistance directly targeted at Indonesia’s poor. Rather than direct cash transfers, this assistance should be focussed on improving access to essential services through investments in hard and soft infrastructure. This assistance should include housing assistance where necessary as well as improved access to healthcare and clean water. Rural development programmes that improve access to efficient and sustainable farming technologies should also be expanded. Such programmes have the effect of reducing the already significant pressure on food prices. The windfall from the subsidy, through investment in such strategic programmes, should be sufficient to provide a limited social safety net for Indonesia’s poorest.

There are several other issues that should be considered by the Government as it prepares to reduce the fuel subsidy. One important consideration is the best structure, from an economic perspective, for the subsidy reductions. Should the subsidy reduction occur in the form of a large reduction, as occurred in 2005, or should the government consider a staged subsidy reduction over an extended period of time? Given that inflation is already high and is under increasing pressure as a result of higher food prices among other things, it may be better to articulate a plan for a staged reduction in the fuel subsidy. One-off subsidy reductions, such as the 28.7 per cent increase, have a relatively large inflationary impact when compared with smaller staged reductions in the subsidies that give individuals and businesses more time to adjust to changing conditions. The staged approach, while having the same policy effect, may mitigate the impact on Indonesia’s poor.

A final issue that requires consideration is whether the Government has the best institutional arrangements in place to maximise Indonesia’s domestic oil production and, thus, contribute to lower global oil prices. Indonesia has significant oil reserves that are not being exploited because the Government policies provide minimal incentive for exploration. The Government should consider reforming tax and bureaucratic structures that currently deter investment. As part of such reforms, the Government should consider reforming the inefficient behemoth that is Pertamina. Pertamina should have to adhere to best practice corporate governance and compete with other oil companies in order to drive the most efficient exploitation and distribution of Indonesia’s oil resource. The Pertamina stranglehold of Indonesia’s oil industry promotes inefficiency and poor service standards. The monopoly should be broken in favour of well-regulated competition that maximises business efficiency, consumer welfare and government revenue.

In conclusion, it is important for the Government to think strategically about the policy issues surround fuel subsidy. It should not squander an opportunity for meaningful reform with a focus only on direct cash transfers and other short-term measures.

The writer is an advocacy consultant to the Indonesian Consumers' Organisation (YLKI).

No comments: