Tyranny of numbers

Off target in subsidy reform

Posted in General, Inequality, Macroeconomy, Poverty by Djavad on December 6, 2009

This week the bill to target subsidies, intended mainly to reduce subsidies for energy products, left Iran’s parliament (majlis) for the Guardian Council.  The Council has the last word on matters legislative, and may well decide to kill the bill because the government does not want to implement it with the modifications added by the parliament.  President Ahmadinejad, known more for its populist inclinations than pro-market sentiments, has taken an unlikely position to reform Iran’s $60 billion subsidy program (more than 15% of national income) on energy, food, and a few other items.  But the dispute over who should control the revenues saved from the bill’s implementation (the subsidy fund, for short) threatens to derail this historic effort to wean Iranians off cheap energy.  If the bill survives the Guardian Council, it is sure to die in implementation.  Raising prices for basic commodities in the highly charged post-election political atmosphere of Iran is difficult enough, an unwillingness government is not likely to forge ahead with doing so. 

At stake is control over as much as $20 billion per year of new revenues from the targeting program (see my previous post).  It has divided President Ahmadinejad’s adminstration from even his the conservative-dominated parliament, which decided it would subject the expenditures out of the subsidy fund to the same rules as for other government expenditures.  But a strong reason why the populist president would even want to engage in subsidy reform is being able to redistribute the proceeds.  Why would Ahmadinejad take the political risks of an unpopular program if he cannot use the funds as he likes to? From the beginning, his adminstration has tried to evade restrictions on expenditures that he believes prevent him from reaching redistributive goals.  That is exactly why he abolished the Management and Planning Organization in December 2006, and why he would like to have as little majlis oversight over the subsidy fund. 

The bill is entitled “targeting subsidies”, but it removes subsidies for everyone.  The targeting comes separately as cash payments to those below the median income irrespective of how much energy they use.  Real targeting would price discriminate, selling cheap only to poorer consumers.  It is the cash payments feature that is redistributive, taking money from energy users those above the median income to pay everyone below the median.  The bill is thus a combination of what is often seen as a pro-market reform (see this recent article from a popular Persian website) and redistribution.  This redistribution is not populist in nature, though it may appear as such, because it is simply redirecting public funds that now subsidise the rich and the middle class to the poorer half of the population. 

The fear by many inside and outside the parliament is that the subsidy fund may be directed to serve the government’s political needs rather than the needy.  So the parliament decided to subject expenditures of revenues from selling energy products to domestic consumers to the same rules that govern spending revenues from selling them to foreign buyers.  However, from the point of view of the government this is putting it in a politically precarious position, especially following the fallout from the disputed June election.  Having the freedom to spend the money how and where it sees fit would give the government the courage to go forward with the largest redistribution scheme since the 1979 revolution.  It makes sense to me that if the government is to bear the brunt of the criticism from increasing prices on energy products, it should have some discretion over the subsidy fund to use it effectively and in a timely manner to redress imbalance from rising prices.   This may not be good fiscal practice, but it may be a necessary price to pay to get the process of subsidy reform underway. 

How we got to this stage is not as important as how we move forward.  If the chance to reform Iran’s subsidy program is lost now it may not return for many years.  The threat of losing momentum for the reform or its total abandonment is real enough.  The Guardian Council is a conservative establishment and it would not be breaking with tradition if it sided with the Ahmadinejad government and rejected the bill.  Even if the bill were approved as is, its implementation would suffer.  I am reminded of the Egyptian food riots of 1977, when the US pressured Hosni Mobarak to remove food subsidies, which he was resisting.  There were rumours at the time that government agents were among those bashing phone booths in Cairo to make a point. 

It has taken the better part of two decades since the end of the war with Iraq for the public debate inside Iran to reach the conclusion that selling energy products at a fraction of their cost to poor and rich alike is bad social policy and even worse economic policy.  Cheap energy has ruined not only the air people in large cities breathe, it has also ruined their lifestyle.  In what other country with a productive middle class can you find them during a weekday driving around in heavy traffic after 10 pm?  In addition, the energy subsidies are also highly regressive.  My calculations show that the Gini coefficient of inequality for fuel subsidies is about twice that of income in general, and more than half the gasoline subsidy goes to individuals in the top 10 percent of the income distribution, compared to 4 percent for the bottom decile.  In comparison, the bread subsidy is actually slightly progressive, with more than 10% going to the poorest decile.  Add to these observations that Iran’s inequality is higher than all other large Middle Eastern countries, such as Egypt and Turkey, using the subsidy reform to improve it may not be such a bad idea.

Two important questions face Iranian policy (and opinion) makers at this time:  First, will an unwilling President Ahmadinejad press on with raising energy prices in the coming months and years if the initial attempt to do so proves politically costly?  Second, if the chance to reform Iran’s subsidy program is lost now, how long would it be before we get this close to subsidy reform?  My answer to the first question in ‘no’ and to the second ‘several years’.  Considering how costly it is to the environment to carry on with cheap energy, and how important it is to improve the distribution of income by redirecting subsides, if there a middle ground between the level of discretion sought by the government and the level of control desired by the legislature, the chance to seize it should not be missed.

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10 Responses

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  1. babak said, on November 4, 2010 at 6:05 am

    I found your text very informative.would u know:whether i can find a copy of the bill(subsidy reform ) full text in english on internet to study for a academical research

    your assistance would be very valuable &appresiated.

    good luck

    babak

  2. AmirSN said, on January 13, 2010 at 11:34 pm

    I found your articles and also the book chapter in “The Contemporary Iran :Economy, politics and society” very informative. Many thanks, I am looking forward to reading more 🙂

  3. […] as the reform of subsidies progresses through the Iranian parliament, majlis,and goes to the Guardian Council for enactment, […]

  4. a said, on December 17, 2009 at 1:10 am

    What is strange for me is why a populist government wants to do such a non-popular move? Other than possible political claims about making the system more fair to poorer people (which I don’t think is convincing), there should be a reason why they are really interested in this. Redistribution and gaining some populist vote can be a reason (though what will this give the current government? he can not be president next term!), but I think there is a more fundamental reason that they have started talking about this now. I don’t think it was among programs they announced during the election. My guess is:

    1. because of fall of oil prices they can not continue with their current redistribution program, and fuel subsidies are costing a lot,

    2. they want to reshape the structure of economic, eliminating/weakening the forces against them and supporting their own forces,

    3. making themselves less sensitive to foreign sanctions and forces.

    I think the real answer for your question (will the current government go ahead with the reform even if it does not get what it wants completely) is essentially dependent on the government’s incentive for this reform, e.g. if the main reason is 1, then they have to do it, so the will agree to less than what they are asking for. I don’t underestimate the fact that Ahmadinejad usually does what he says, but he may be forced to do this reform if they are really under pressure.

    Also I think what the current government does by subsidies can caused much deeper problems in the economy which may take even longer to fix.

  5. حسین عباسی said, on December 8, 2009 at 12:44 am

    “It makes sense to me that if the government is to bear the brunt of the criticism from increasing prices on energy products, it should have some discretion over the subsidy fund to use it effectively and in a timely manner to redress imbalance from rising prices. This may not be good fiscal practice, but it may be a necessary price to pay to get the process of subsidy reform underway.” I disagree. This discretion is not the necessary price.
    The type of control over the budget that government asks for is not only unconstitutional, but also unnecessary for the success of the plan. First, according to the Constitution, any public spending should be based on annual budget bills approved by the Parliament and is subject to the supervision of Divan Mohasebat. Second, I can not see why parliamentary supervision makes the plan less successful. After all, the parliament did not restrict the range of spending (which I believe is too wide). It added the required supervision, which, I believe, is necessary to prevent massive deviations (the executive will deviate from the plan anyway!)

    • Djavad said, on December 8, 2009 at 10:29 am

      Dear Hossein,
      I am not sure if you are saying it is not necessary to pay the price because the government is bluffing and will go ahead with the reform anyway, or that the price is too high and is therefore better to risk losing the momentum. Both are matters of opinion, of course, but I wanted to understand your point more clearly.

      BTW, I am not sure if the constitution prevents one-time, specific funds to be set up with some discretion. Which is why I regard the dispute more a matter of a political rather than a consitutional crisis.

      • حسین عباسی said, on December 9, 2009 at 6:00 pm

        I agree that removing subsidies from the economy is valuable enough to pay big prices. But I dont think that this price is the parliament’s control.

        The Constitution says: “All sums collected by the government will be deposited into the government accounts at the central treasury, and all disbursements, within the limits of allocations approved, shall be made in accordance with law. ”

        Any expenditure should be approved by the Parliament. So the discretion that the government asks for is unconstitutional.

        Also I believe it is too high a price. If government is allowed to spend almost half of the budget ($10-20 B.) without any supervision, (as was requested in the Bill), it can be very dangerous.

        Moreover, I believe that this plan is completely doable under the supervision of the parliament. Government’s emphasis on not being supervised makes me suspicious.

  6. Djavad said, on December 6, 2009 at 9:49 pm

    Thank you for your careful reading and letting me know of the repetition, which I corrected.

    I like your suggestions for the compromise. But politics in Iran does not reward compromise as well as it should.

  7. masoud said, on December 6, 2009 at 9:25 pm

    Another informative post. Sentences 2-4 of paragraph 5 are identical to sentences 1-3 of paragraph 6, but it’s worth reading twice anyway. I think by Ahmadinejad is determined to get his way by hook or by crook, even if it takes the next two years, and I wouldn’t bet against him. I think ultimate legislative control, with a special short term assignation of these powers to the executive, coupled with strong reporting requirements, would probably be the best compromise. In any case, I don’t think the ‘system’ is going to tolerate a long drawn out battle over this.

    Masoud

  8. […] Original post: Off target in subsidy reform « Tyranny of numbers […]


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