Research Document: Understanding Fuel Subsidy Removal and its Economic and Social Impact

Posted Tue, Jun 6, 2023 9:09 AM

What are Subsidies?

Subsidies are direct or indirect payments made by the government to businesses or individuals. Direct subsidies involve cash payments from the government to the recipient. With indirect subsidies, on the other hand, industries or households enjoy certain economic benefits from government policies such as tax breaks.

Subsidies are generally implemented to promote consumption and production. For instance, if the government makes direct payments to rice farmers, this could increase rice production by reducing the production costs accruing to the farmers. This is an example of an agricultural subsidy.

Benefits of Fuel Subsidy

• Welfare sustenance and affordability: Given the importance of fuel in the daily lives of Nigerians, fuel subsidy makes the product affordable and accessible, as well as sustains the welfare of the people in the face of higher crude oil prices. 
• Lower and stabilise prices: Due to the volatile nature of crude oil prices, which are the primary raw material in the production of petrol, fuel subsidy keeps the fuel price stable and lower for end users.
• Support and sustain industries: Fuel constitutes a major input for many businesses in Nigeria due to inadequate power supply and deficiency in transportation and logistics. Therefore, fuel subsidy sustains many businesses across sectors.
• Stimulate economic growth: With improved access and affordability, fuel subsidy can help stimulate economic activities and growth. 

Cost of Fuel Subsidy

• Opportunity cost on development spending: Fuel subsidy payment diverts part of the resource for developmental purposes towards consumption. Hence, the resources that should have gone into infrastructure, education, health, and security with positive externalities are going into consumption.
• Strain on government's fiscal space: The ever-growing fuel subsidy bills continue to hit deep into government resources. With revenue shortage, fuel subsidy payment means the government will need to borrow to invest in order aspects of governance.
• Market distortion and inefficiency: By nature, subsidy deviates the prices from market clearing prices. Coupled with the opaqueness in the process, the activities in the market are often disrupted as players wait on the government for clearance. The product is often unavailable, and people often buy at higher prices than the market price.
• Disincentivises investment: Fuel subsidy discourages investors in the sector as they cannot guarantee their operations efficiency, profitability, and competitiveness due to market distortions.
• Shortage of supply: The lower-than-market clearing price causes scarcity. It discourages producers and suppliers from entering the market and is often associated with excess consumption. Besides, the fact that neighbouring economies operate at market-clearing prices encourages the smuggling of subsidised products out of the country. Therefore, fuel subsidy causes scarcity of fuel in the market.
• Rips of oil sale benefit: Nigeria is a major oil-producing country but depends on imports for fuel. With fuel subsidy in place, the government is ploughing back its earnings regarding foreign exchange and revenue to fuel imports. Therefore, foreign exchange earnings and government revenue is ripped off on the spot with little to commit to public finance.
• Breed rent-seeking and corruption: Because of the opacity and weakness in oversight of the process, fuel subsidy payment has allowed unethical and corrupt practices such as the inflation of landing costs and padding fuel import bills.