A Sustainable Economic Recovery From COVID-19: The G-20 Must End Fossil Fuel Subsidies Now
The world economy is entering a deep economic recession, as massive lockdown efforts across the world have brought industry and services to a grinding halt. To support a rapid and sustainable economic recovery, the Group of 20 (G-20) must act immediately and end fossil fuel subsidies.
The problem with fossil fuel subsidies
Fossil fuel subsidies were a massive economic problem already before the coronavirus. According to the International Energy Agency (IEA), in 2018 governments around the world spent US$400 billion dollars to subsidize fossil fuels. These subsidies are not only a drain on public finances, but also an environmental problem. When governments subsidize fossil fuels, they encourage people to consume more oil, gas, and coal than under market prices.
This consumption contributes to air pollution and climate change. If we take these externalities into account, fossil fuel subsidies reached US$ 5.2 trillion, according to the International Monetary Fund (IMF). They are that harmful that the IEA named them as 1 of 5 measures to reform to avoid catastrophic climate change. As a result of their various negative impacts, fuel subsidy reform was also turned into a sustainable development goal.
Governments simply cannot afford these fossil fuel subsidies in a global recession. The IMF predicts a 3% contraction of the global economy in 2020. This contraction means lower tax revenue and additional demand for social security benefits, as unemployment spikes. At the same time, health care systems are under great strain because of coronavirus infections.
The good news is that today’s historically low international oil prices create a political opportunity for decisive action. In April 2020, international oil prices fell below US$ 20, a level not seen in decades. Our research shows that low oil prices have historically given governments an opportunity to dismantle fuel subsidy mechanisms.
On one hand, low energy prices reduce the risk of inflation from fuel subsidy reform. Removing fossil fuel subsidies would not significantly increase consumer prices and contribute to economic hardship. Prices might even decrease in the short term. Removing fossil fuel subsidies when oil prices are high would save huge amounts of money in the long run, but the immediate effect could be an inflationary spiral, as any industries that use oil as an input would be forced to raise their prices. These especially include agriculture, transportation, and heating.
On the other hand, because consumers’ energy costs are low with or without subsidies under low prices, the political backlash could be limited. Even without fossil fuel subsidies, households and firms would have access to affordable energy. In such circumstances, the risk of a popular backlash against fuel subsidy reform would be minimized on the short term.
In 2014, large economies such as India, Indonesia and Malaysia followed this strategy. When international oil prices collapsed in the summer from above US$ 100 to below US$ 50 in January 2015, governments abandoned decades of price controls on strategic fossil fuels. These moves may have been politically opportunistic, but they showed that even bold fuel subsidy reforms are possible under low oil prices. One notable example of reform during the Covid-19 crisis is Nigeria, which has reformed fossil fuel subsidies earlier this month.
A rapid and sustainable economic recovery
When international oil prices will rise again, governments that have dismantled fossil fuel subsidies will avoid a costly and unproductive expense. Although fossil fuel subsidies are not a great expense when international oil prices are low, they will again cause serious problems under higher oil prices. In the recent past, such subsidies have often accumulated to 5 to 15% of total government expenditure. Virtually all governments around the world will face a very difficult fiscal environment in the coming years. Their ability to survive in a weak world economy would be far better without such costly fossil fuel subsidies.
Without fossil fuel subsidies, governments also have more fiscal space to pursue an economic stimulus for the future. Every dollar spent on fossil fuel subsidies is a dollar not spent on something far more useful, such as critical infrastructure, food security, and healthcare. By removing fossil fuel subsidies, governments release resources needed for a rapid economic recovery and a sustainable, resilient future.
To protect poor households from growing energy costs, governments now have access to far better targeted social policies. Instead of fossil fuel subsidies, governments can invest in social policy, such as unemployment benefits, or simply transfer money to poorer households. Modern technology allows targeted transfers to those in need, whereas fossil fuel subsidies tend to benefit middle class and richer households that consume vast amounts of energy for transportation, air conditioning and non-essential appliances.
The necessity of international cooperation
To succeed in fossil fuel subsidy reform, the G-20 must finally lead. G-20 economies committed to phasing out fossil fuel subsidy reform in 2009, but little progress has been made. Fossil fuel subsidy reform however is easier under international peer pressure and with access to lessons from other countries.
If the G-20 leaders were to commit to fossil fuel subsidy reform, they would launch a wave of reforms across the world, with substantial economic, environmental, and social benefits. Other governments would recognize the opportunity to follow a global trend. With everyone removing their fuel subsidies, any lone defector would pay a high reputational cost for their failure to follow.
G-20 leaders could also offer technical support. The basic idea of fuel subsidy reforms is simple, but effective implementation depends on navigating complicated economic and political realities. Cross-country exchange of lessons learned could greatly facilitate reforms in countries with little previous experience.
Tom Mourenhout is Adjunct Assistant Professor at Columbia University’s School of International and Public Affairs. He also consults for the Energy Subsidy Reform Facility of the World Bank and is a Senior Associate at the International Institute for Sustainable Development. He is a Fellow of the Initiative for Sustainable Energy Policy (ISEP).
Johannes Urpelainen is the Director and Prince Sultan bin Abdulaziz Professor of Energy, Resources and Environment at the Johns Hopkins School of Advanced International Studies. He is also the Founding Director of the Initiative for Sustainable Energy Policy (ISEP). He tweets at @jurpelai.