For social justice, government must reform fuel subsidies

If Egypt is to achieve social justice and an efficient economy, the government must strengthen its regulatory capacity, remove subsidies that go to private, energy-intensive industries and create a targeted subsidy policy for the poor, economists and social justice advocates say.

An untargeted subsidy policy puts a serious strain on the government’s finances and mainly benefits the rich – those who can afford high electricity consumption. With a high budget deficit of 8.6 percent of GDP for 2011-12, subsidy reform would go some way toward alleviating fiscal tensions and achieving a measure of social justice, according to economic reformers and a report by the Egyptian Initiative for Personal Rights (EIPR).

In the revised 2011-12 budget, LE100.5 billion – over 20 percent of total government expenditure – is allocated to fuel and electricity subsidies, while LE57.2 billion goes to all other subsidies and grants, of which food subsidies constitute only a small fraction, according to the Egyptian Center for Economic Studies.

A 2005 World Bank study found that wealthier Egyptians receive twice the amount of subsidies as poor citizens.

The transitional government has recognized the need for reform. The first post-Mubarak budget made small cuts to fuel subsidies with measures such as curbing butane gas subsidies to non-residential users, according to the Carnegie Endowment for International Peace. The savings will be about LE3.5 billion over the coming year.

But this is not bold enough for some social justice advocates. “The 2011-12 budget was a very clear extension of the [former Prime Minister Ahmed] Nazif years, and the military council is not looking for new problems, but maintaining the status quo,” Amr Adly, the EIPR report’s author, told Al-Masry Al-Youm.

The economic and social orientation of the forthcoming elected government also remains uncertain. But it is hoped that they will have the political will, unlike their predecessors, to reform and achieve social justice – one of the key demands behind the revolution.

“Under the previous regime, the political will for a regulated market and removal of subsidies to energy-intensive industries was not there,” Adly said.

A flawed industrial model

Part of the problem is that the competitive advantage of Egyptian industry is based on cheap, subsidized oil, the EIPR report shows. This is surprising given that Egypt’s oil production is in decline. The country produced 678,300 barrels per day in 2009, down from 718,550 barrels per day in 2008, according to the US Energy Information Administration.

Nevertheless, Egypt’s subsidy policy places it among the world’s highest subsidizers of energy, alongside major oil producers such as Saudi Arabia, Kuwait, Qatar, Venezuela, Libya and Bahrain.

“Subsidizing oil is the least efficient use of it, because its low prices lead to over-consumption. Oil-subsidizing countries don’t spend enough money on technological innovations to reduce oil consumption, because it is cheaper not to,” Adly said.

Egyptian industry is also largely privatized and made up of monopolies. “It is not appropriate for a poor, developing country to subsidize major multinational producers in the case of cement, and local tycoons in the case of iron and steel,” Adly added.

The decision to support energy-intensive industries, such as cement, steel, iron and fertilizer producers, with subsidies also does not make sense given that they are not labor-intensive, and therefore do not create many jobs.

Nazif and his technocratic government implemented this economic model in line with the International Monetary Fund and World Bank’s recommendations of creating export-led growth and attracting foreign direct investment.

Monopolies and private interests

By 2004, the cement sector was comprised of 12 companies all belonging to the private sector, with the exception of the National Company for Cement. The majority of these companies belong to foreign investors with six corporations owning nine companies that produce 80 percent of Egypt’s annual cement output. Two companies, Switzerland’s Holcim and France’s Lafarge, produce 30 percent of this.

In the case of iron and steel, the major monopolist was former President Hosni Mubarak crony Ahmed Ezz, whose steel company Ezz Steel produced 69 percent of Egypt’s total output. Ezz, the former chairman of Egypt’s national assembly budget committee and a senior member of the then-ruling National Democratic Party, has been sentenced to ten years in prison for profiteering from his political position.

Anecdotal evidence suggests that Ezz lobbied hard against reducing energy subsidies and stopping imports, because it would have affected his regional competitiveness.

According to Adly, former Trade and Industry Minister Rachid Mohamed Rachid made policies that went against Ezz’s business interests, such as deciding to allow Turkish steel imports. But Ezz was more powerful than Rachid in formulating the law, many believe. Rachid has been sentenced in absentia for profiteering and squandering public funds.

“The Nazif government didn’t want to cause upheaval among the people by raising oil prices, and it didn’t have enough regulatory capacity to force the industry not to pass the higher prices on to the consumer,” Adly said.

On the question of whether Egypt’s energy intensive industries would lose their regional and international competitive advantage if subsidies were removed, Adly said it depends on the industry.

“The cement sector should not be affected because its cost of production depends on inputs such as laborers and raw material, the latter of which is very cheap in Egypt. Demand for cement is also very high in the domestic market, and profit margins on exports should still be high. The iron and steel industries would be affected though,” he said.

On the whole, energy-intensive industries can afford increased prices in energy and electricity as a result of subsidy reductions, a 2008 study by Abdallah Shehata Khattab, an economics professor at Cairo University, concludes.

The argument, however, shouldn’t just be based on economics, but take into account the social and moral basis, Adly said, particularly as energy subsidies have so far failed to help the poor.

Reallocating resources for the poor

Egyptian policymakers can learn from the experiences of other countries, such as Jordan (1991-1999), Mexico (1997) or India (1997), all of which successfully replaced untargeted subsidies with poverty-alleviation programs, Carnegie’s July 2011 report on the Egyptian economy says.

Fuel subsidies affect poverty differently, Carnegie points out. The World Bank’s 2005 study finds that eliminating petrol and natural gas subsidies would have only a very small impact on the poor, even increasing the incidence of poverty by .15 percent. In contrast, the elimination of the liquefied petroleum gas subsidy altogether would raise the incidence of poverty by 4.4 percent.

The World Bank, Carnegie and EIPR reports recommend phasing out subsidies gradually, while strengthening the social safety net to offset any poverty rises. Low-income groups also need to be identified through methods such as testing electricity consumption or a census.

Any strategy to reduce energy subsidies in Egypt will have to be accompanied by a strengthened regulatory capacity so that higher prices are not passed on to consumers, and a cash distribution program to poor people in order to mobilize support for the move, Adly said, particularly as "big capital" is already lobbying against it.

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