Ways in which product subsidies work report

petroleum subsidies have worked to increase the wealth of the middle class in Ghana while making it harder for members of the poorest classes to increase their wealth and social stability. Another way to phrase this is to note that petroleum subsidies in Ghana have historically worked in a way that is counter-productive to the ways in which product subsidies are generally designed to work. Governmental subsidies of specific products are usually a method to redistribute wealth in a more equitable way. This allows the poorer groups in a nation to reduce their poverty while the wealthiest members of society contribute (if involuntarily) some of their wealth. However, this model of the subsidy process works better with some products (especially food) than with others. The petroleum subsidy process in Ghana has overall had the opposite effect of supporting the concentration of wealth in the upper classes. Because the nation is relatively wealthy, this is less destabilizing than it might otherwise be but overall the reduction of subsidies has been good for the country.

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The nation of Ghana is one of the more prosperous nations in Africa in no small part because it is relatively blessed with natural resources. Certainly it has succeeded better in the post-colonial Africa than many other nations and its economic policy is relatively stable, although it has experienced periods of high inflation. The relative prosperity of Ghana has disguised the effects of governmental policies that tend to exacerbate inequalities, such as subsidies for petroleum. This paper examines the economic effects of petroleum subsidies in Ghana, the ways in which these subsidies were reduced over the last decade, and the ways in which this might change as Ghana ramps up its oil production.

As an economic generalization, subsidies are beneficial to those elements of a society that use the subsidized product at the highest rate. As a result, when the subsidized good is something like corn meal, which is used by everyone but especially by women cooking for their families, the population as a whole — but especially working-class families with many children — benefits. Thus economic subsidies make a nation’s economy more equitable, leading to fewer very poor people and greater social stability.

Petroleum products, on the other hand, tend to be used primarily by people with more money, since they are the ones with cars as well as the ones that buy the more expensive imported products. The wealthier the household, the higher the average energy use will be. Thus the Ghanaian government’s subsidization of petroleum prices has tended to help wealthier households. This has tended to produce a growing middle class in Ghana rather than supplementing the wealthiest members of society. Certainly the former is better for society overall than is the latter, but it is still a subsidy that draws wealth away from the poorest members of Ghanaian society.

In other words, petroleum subsidies in Ghana have had the economic effect of making some of the working class into middle-class members of society while ensuring that most of the poorest people have remained at least as poor as before, and in some cases made them even poorer. The very few truly wealthy people have not been affected in any significant way. The following citation examines this idea.

A consumer subsidy is normally used to protect more vulnerable people who would otherwise be disadvantaged by an existing policy. In that sense, who is the real beneficiary of the petroleum subsidy? A study by ISSER (2004) shows that the transport sector accounts for 80% of petroleum product consumption in Ghana, households for 6.2%, industry for 6.7%, and agriculture for 4.2%. Household consumption is generally limited to LPG (largely used by urbanites) and kerosene. Coming to the transport sector, since rich people have more cars per capita, they consume more petrol per capita than poor people. You can see clearly that rich people travel around with 1-5 passengers per vehicle, while poor people travel around with anything from 5 (in a taxi) to 30 or more (in a large bus). On that score, rich people use more petrol and, therefore, benefit more from a subsidy than poor people, and would, naturally, want it to stay.

The fact that petroleum subsidies tend to benefit the richer members of the population in Ghana over the poor is one of the most important reasons that such subsidies have been politically problematic for the nation, as the following notes:

The subject of petroleum products pricing has always been a contentious one. Ghana like all developing countries is always faced with the problem of a pricing scheme that will be acceptable to the population but which will not also cripple the economy. This notion has therefore influenced all pricing regimes for petroleum.

While Ghana is fortunate in both economic and political terms in comparison with most of its neighbors, it remains a society in which there is significant inequality in terms of wealth. Income inequality is nearly always a destabilizing force. This is one of the reasons why subsidies were reduced in the past decade. However, this is not the only reason. Economic policy — and economic reality — cannot be separated from each other, nor can they be separated from politics and social policy.

Thus when one talks about the political and social aspects of petroleum subsidies in Ghana one is also talking about the economic reality of the subsidies.

In order to understand the real economic costs of oil subsidies in Ghana (or in any other nation) it is necessary to look at what one might call the “downstream” costs. There can be — and generally are — a number of unintended economic consequences for petroleum subsidies. One of these is that there tends to be a higher level of fraud in the petroleum sector when this product is subsidized. Fraud is arguably always higher when there is a higher bureaucratic presence. There is not necessarily the case, but it has probably been the case in Ghana.

The primary way in which fuel subsidies tend to increase economic corruption is that fuel is smuggled from the country in which there are subsidies to countries in which there are no subsidies. The price differential that exists allows the smugglers to earn money by selling fuel at the higher ambient prices in the country that does not have subsidized prices. The same type of cross-border economic gaming of the system has existed for millennia: Indeed, such machinations can be seen as intrinsic to a system in which there is an artificial raising or lowering of the price of a commodity. Reducing or eliminating subsidies is the only way to remove this particular form of corruption.

Subsidizing the petroleum industry also provides artificial protections for this economic sector, which may itself bring about corruption within the industry, or at least inefficiencies. Thus any needed reform in this industry tends to be put off. Another cost of subsidization of petroleum (or any other product) is that the government may be forced to borrow money to do so and thus pay interest on its borrowings. It is also prevented from using this borrowed money for any other purpose. And — at least as important — subsidizing a commodity may also lead to economically unwise behavior on the part of individuals. In the case of fuel use, wastefulness is not just economically problematic but environmentally problematic.

To provide a subsidy, a government must increase its borrowing, raise additional revenue elsewhere, or reduce spending on other public goods. If the subsidy is used to stabilize or lower final prices, it frees consumers from having to adjust their purchasing behavior to the costs of supply, instead giving them financial incentives to overconsume the subsidized commodity. The result is the well-known deadweight loss.

Using a reduction in taxes to lower final prices, because it leads to a loss of revenue, similarly requires a government to raise additional revenue or reduce other public spending. If tax rates were set near the optimal level overall before the price rise, this policy also results in a loss of welfare.

Given the many downsides of economic subsidies, it may seem puzzling that the Ghanaian government would have put such subsidies into place. However, while it is true that subsidies tend to be detrimental in the long-term, sometimes economic pressures on the majority of the population can be so great in the moment that the government feels that subsidies are the best response.

Economic Stability in Ghana — For Now

As noted above, one of the most problematic aspects of fuel subsidies is that they tend to exacerbate social instability. Ghana has been to some extent sheltered from this because of its relative wealth. International assessment of Ghana gives it relatively high marks for a nation in Africa. The Failed States Index ranks it as the second least-failed state on the continent after Mauritius. (It ranked as the 53rd least-failed state in the world in the same 2009 assessment.)

Perhaps even more important to the current issues is the fact that the Ibrahim Index of African Governance, with ranks African governments on the ability of those governments to deliver needed goods to their people.

This index ranks Ghana relatively high on human development and safety and security and human rights protections. Again, it is important to stress that such political assessments are also economic ones. The fact that Ghana ranks fairly low on sustainable economic development is a direct result — at least in part — of economic subsidies. It is this particular point of its assessment that reveals one of the effects of petroleum subsidies in Ghana.

Despite the fact that Ghana has twice the average per capita income of the poorer countries in the region, it is a very poor country by Western standards. Nearly 30% of the population live on less that the international poverty line (the equivalent of $1.25 a day). The poorest citizens are primarily women from the northern parts of the country. Such women are among the least likely to be helped by a petroleum subsidy.

Ghana’s per capita income has barely doubled over the past half century.

The government’s current economic priorities include macroeconomic stability, private sector competitiveness, human resource development, and good governance and civic responsibility.

In general, the FBI finds that the government has practiced “sound macro-economic management,” which, along with consistently high prices for its major export products gold and cocoa, helped sustain GDP growth in 2008 and 2009.

Key to the country’s economic policy on petroleum products is the fact that in 2007 an oilfield that may contain up to 3 billion barrels was discovered.

This would seem to be a fact that would reduce the costs of petroleum products, which should benefit all the population. However, this is likely not to be the case. While the current subsidies are biased slightly in the direction of redistributing wealth upward, the expansion of the oil industry has the potential to make society far more radically unequal. This is a brief explanation of the economic complexities that occur when a subsidy on a vital product is lifted.

African nations have a very poor record of using income from oil revenue: No African nation has a truly good history of good economic policy vis-a-vis petroleum. A snapshot of the ways in which African governments have used oil revenue to enrich a very small percentage of the revenue going to the population at large and most of it used to enrich the government itself. This record of corruption is reflected in a series of letters to the BBC the say after it reported Ghana’s announcement of the oil find. The following letters are representative:

I am happy for Ghana and pray this discovery doesn’t bring disunity in the country just as in the case of Nigeria. In Nigeria the money realized from this oil had not been used for the development of the country rather it had gone to the pocket of few, selfish individuals (leaders).

Ishaya Nubunga, Taraba, Nigeria

I work for Chevron and I am Ghanaian. I have seen oil mismanaged in Nigeria, Equatorial Guinea and Angola. Why should Ghana be any different? After all look how we have managed our other natural resources like gold and diamonds… The reality is that all or most of the revenue will be lost through corruption, mismanagement. Thank God for oil – I don’t think so. I would trade this for zero corruption, less brain drain, better management any day.

Anonymous

Ghana is indeed a blessed nation. However their leaders should not make this discovery of black gold as a means to enrich themselves as most of our previous and some of our current African leaders are doing. God bless Ghana and its people.

Brinsley Johnson, Freetown, Sierra Leone

Let’s hope Ghana does spend the oil money on roads and hospitals, not on palaces and armies as in most oil states.

Steve, London, UK

The view from Nigeria and other oil-rich African nations is not optimistic. Given the higher-than-average degree of transparency of recent Ghanaian administrations and its rational response to the reduction of subsidies, there is some hope that Ghana will be able to absorb its new wealth with a greater-than-usual degree of grace. Thus, once again, economic policy in this area will only be successful when married to successful political policy.

Truth to the People

When the Ghanaian government determined in 2004 and 2005 that it could no longer continue the petroleum price subsidies at the same rate, government officials prepared carefully for the announcement that fuel prices would increase by 50%. This was a major shift in economic policy. The following summarizes the process that the government used:

In 2004, when it became apparent that world oil prices were unlikely to come down much and that Ghana could not maintain for long its policy of subsidizing petroleum products, the government launched a poverty and social impact assessment (PSIA) for fuel.

Guided by a steering committee of stakeholders from ministries, academia, and the national oil company, the PSIA was completed in less than a year. By the time the government announced the 50% price increases in February 2005, it could use the PSIA findings to make its case for liberalizing fuel prices to the public — including the fact that the price subsidies most benefited the better-off.

This underscoring of the fact that the subsidies were benefiting wealthier members of society was key in helping the poorer people accept the fact that they would be paying more for their own fuel.

While the poorer people would be aware of the price that they themselves were paying, they would also be comforted — for such is human nature — they had been made aware by the government that the middle class and the wealthy were suffering more than they were. The wealthier members of the society would bear the greater burden in terms of higher fuel costs, but they were also the ones most able to bear these increased costs and were no doubt constrained from too-public complaints about the increases because they did not want to underscore had long they had been benefiting from the subsidies.

The government acted as transparently as possible in reducing the subsidies, and this too should be seen as a hopeful sign for the country’s economy as it shifts increasingly towards oil production. The government also worked in ways to protect the poorer members of society by reducing the effect of higher prices in other ways:

The mitigation measures, transparent and easily monitored by society, included an immediate elimination of fees at government-run primary and junior secondary schools and a program to improve public transport. While the trade unions remained opposed to the price increases, the public generally accepted them, and no large-scale demonstrations occurred.

Ghana has been able to make the bridge from highly subsidized fuel prices to a much freer economy in this sector, using transparency and government aid to the poor to make the process as democratic and humane as possible. What will happen in the future — in other words, will Ghana become another Nigeria? — is impossible to know.

Bibliography

Adam, Mohammed. Petroleum Products Pricing In Ghana — Economics Or Politics? http://www.ghanaweb.com/GhanaHomePage/NewsArchive/artikel.php?ID=171021

http://www.modernghana.com/news/116404/1/the-case-for-deregulation-of-the-petroleum-sector-.html

http://www.ghanaweb.com/GhanaHomePage/NewsArchive/artikel.php?ID=171021

http://www.modernghana.com/news2/117383/1/the-case-for-petroleum-sector-deregulation.html

http://www.ghanaweb.com/GhanaHomePage/NewsArchive/artikel.php?ID=171021

https://www.cia.gov/library/publications/the-world-factbook/geos/gh.html

Ghana ‘will be an African tiger’,

http://news.bbc.co.uk/2/hi/africa/6766527.stm http://www.ghanaweb.com/GhanaHomePage/NewsArchive/artikel.php?ID=171021

Kojima, Masami, and Robert Bacon. 2001. “Abuses in Fuel Markets: How to Protect Consumers and Public Health.” Viewpoint Series, Note 237. World Bank Group, Private Sector Development Vice Presidency, Washington, D.C.

Least Failed State index, Foreignpolicy.com

Mo Ibrahim Foundation, http://www.moibrahimfoundation.org/en

UK’s Tullow uncovers oil in Ghana, http://news.bbc.co.uk/2/hi/business/6764549.stm

The Case for Petroleum Sector Deregulation,

http://www.modernghana.com/news2/117383/1/the-case-for-petroleum-sector-deregulation.html

Mohammed Adam. Petroleum Products Pricing In Ghana — Economics Or Politics?

http://www.ghanaweb.com/GhanaHomePage/NewsArchive/artikel.php?ID=171021

Robert Bacon and Masami Kojima, Phasing Out Fuel Subsidies, 2006.

Masami Kojima and Robert Bacon, Abuses in Fuel Markets: How to Protect Consumers and Public Health, 2001.

Masami Kojima and Robert Bacon, Abuses in Fuel Markets: How to Protect Consumers and Public Health, 2001.

Least Failed State index, Foreignpolicy.com

Mo Ibrahim Foundation, ?

http://www.moibrahimfoundation.org/en

/section/the-ibrahim-index/scores-and-ranking http://hdr.undp.org/en/media/HDI_2008_EN_Tables.pdf

FBI World Factbook, ?

https://www.cia.gov/library/publications/the-world-factbook/geos/gh.html

factbook/geos/gh.html?

FBI World Factbook, ?

https://www.cia.gov/library/publications/the-world-factbook/geos/gh.html

factbook/geos/gh.html?

FBI World Factbook, ?

https://www.cia.gov/library/publications/the-world-factbook/geos/gh.html

factbook/geos/gh.html?

UK’s Tullow uncovers oil in Ghana, ?

http://news.bbc.co.uk/2/hi/business/6764549.stm

Ghana ‘will be an African tiger’, ?

http://news.bbc.co.uk/2/hi/africa/6766527.stm

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and Public Health, 2001.


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