FUEL SUBSIDY REMOVAL IN NIGERIA: Alternative Options for Re-targeting the Budgetary Gains Samuel Chinedu OMENKA samuel.omenka@yahoo.co.uk +234-803-837-3456 and Professor A. ADENIKINJU adeolaadenikinju@yahoo.com +234-802-344-0018 A Paper Prepared for Presentation at the 6th Nigeria Association of Energy Economics (NAEE) Annual International Conference on Energy Resource Management in a Federal System: Challenges, Constraints and Strategies Sheraton Hotel, Lagos, Nigeria April 22 – 23, 2013. Outline Introduction The literature Methodology and Data Results and Discussions Conclusion Introduction Higher energy prices! An important concern for policy makers Shocks to global fuel prices High Fiscal Deficits Rationale for existing energy subsidy Scheme? Increasing Poor People Global market conditions and national fiscal state daunts fuel subsidy policy Sustaining a high level of fuel subsidy: A huge fiscal burden, despite oil wealth Global Carbon Emission Sets back: poverty reduction investments increases social inequality promotes smuggling , and inefficiency in petroleum production, processing , and distribution http://www.iea.org/weo/Files/ann_plans_phaseout Introduction continued Year Poverty Level (%) Est. Total Population (Million) Poverty Population (Million) 1980 27.2 65 17.1 1985 46.3 75 34.7 1992 42.7 91.5 39.2 1996 65.6 102.3 67.1 2004 54.4 126.3 68.7 2010 69.0 163 112.47 2011* 71.5 168 120.12 Source: National Bureau of Statistics, HNLSS (2010) *The 2011 figures are estimated What does theory says? Any Empirics? (Amegashie, 2006; Lipsey and Lancaster, 1956; Hope and Singh, 1995; Coady et al., 2006) Uncertainty-driven research questions: what are the macroeconomic and household impacts of fuel subsidy removal; which households group benefits from the policy-shift; is a gradual approach more rewarding than a one-shot shift? Policy-shift caused fiscal and social tension due to uncertainties How about the potency of reallocation policy to mitigate the cost of readjustment? The Literature Partial Equilibrium Models (DRI, 1994; Birol et al., 1995; Hope and Singh, 1995; IEA, 1999) Considers only the market directly impacted by the subsidy reform, and estimated price, output and demand changes in that market CGE models Multi-country (Larsen and Shah, 1992; Burniaux et al., 1992; Steenblik and Coroyannakis, 1995; OECD, 2000; Saunders and Schneider, 2000; and Burniaux et al., 2009) Single-country (Clarke and Edwards 1997; Jensen and Tarr, 2002; Clement et al., 2003; Nwafor et al., 2006; Yusuf and Ramayandi, 2008; Dartanto, 2011; Breisinger et al., 2011) CGE models Capable of providing useful insights into the impacts of subsidy reform but unable to address questions relating to intersectoral linkages as well as macro questions relating to international competitiveness. Capable of capturing distributional changes in employment, consumption patterns and real incomes among different income groups in economy. Comparability of results in relation to the size of the subsidies is very limited in multi-region CGE models The Literature continued Economic Effects Household Effects Burniaux et al., (1992), Larsen and Shah (1992), Clarke and Edwards (1997), IEA (1999), Saunders and Schneider (2000), OECD (2000), Jensen and Tarr (2002), Hartono and Resosudarmo (2006), Burniaux et al., (2009), Breisinger et al., (2011) Most studies find evidence that fuel subsidy reforms have negative household effects: Freund and Wallich (2000) for Poland; Clements et al., (2003) for Indonesia; Coady et al., (2006) for Mali and Ghana. Other include Oktaviani et al., (2005), Yusuf and Ramayandi (2008) Economic effects (usually measured in terms of changes in GDP) from subsidy reform are positive at an aggregate level due to enhanced price incentives that leads to better resource allocation. Some studies report net increases in GDP or real income by the end of the model run, while some others report (per annum increases in GDP or income over the course of the simulation period. Re-targeting of Budgetary Surplus Targeting option matters! Targeted direct transfer of saved money increases poorest households welfare in rural areas more than urban areas (Jensen and Tarr, 2002; Coady et al., 2006; Hartono and Resosudarmo, 2006) Impact of the transfer depends on service delivery (Breisinger et al., 2011) Direct transfers plus investment in infrastructure or human capital (Dantarto, 2011) Use savings to finance government deficit or reduce the rate of indirect tax (Yusuf and Ramayandi, 2008) Methodology and Data Theoretical structure • based on the neoclassical theory of general equilibrium – Leon Walras (Arrow and Debreu, 1954, and McKenzie, 1959; 1981) + Nwafor, 2007) structuralist features (Dorosh, 1996, • The standard model: a recursive dynamic CGE model (Decaluwe et al., 2010) The SAM • Nigeria’s 2006 SAM (Nwafor et al., 2010):11 sectors, 3 factors, 3 tax accounts, 4 household categories, a firm, government, S-I, and ROW accounts. Innovation! Methodology and Data Households Rural Poor Labour Capital Land Transfers from ROW continued Households Rural Non-poor Labour Capital Land Transfers from ROW 4% 1% 15% 18% 35% Govt Transfers Land 1% 14% 47% 77% 3% Households Urban Non-poor Households Urban Poor Labour Capital Govt Transfers Transfers from ROW 1% 3% Capital 17% Labour Capital Govt Transfers Transfers from ROW 2% 9% 12% 34% 55% 84% % Share of income for each household category Transfers from ROW 9% Labour 59% Methodology and Data continued Consumption Share by Household Category 60.00 50.00 Percentage 40.00 30.00 20.00 10.00 0.00 H-R-P H-R-NP H-U-P H-U-NP food 50.47 20.91 29.95 9.28 ocrop 26.95 27.01 21.63 20.81 live 0.07 0.09 0.08 0.08 otheragr 4.11 5.28 4.75 4.57 man 12.73 31.73 26.78 29.02 roil 0.54 0.70 0.89 1.37 transp 0.77 2.14 1.94 4.26 ser 4.36 12.14 13.99 30.61 Methodology and Data continued Eight blocks: Production, Income and Savings, Demand, Producers supplies of product and International trade, Prices, Equilibrium, Gross domestic product, and Dynamic equations blocks Production: Multi-level cascading specification: CI + VA --- Leontief production function; VA: labour and composite capital --- CES; MPL and MPK = their price; land is fixed throughout; capital is fixed in the first year; labour is free to migrate across sectors Income and Savings: Households (4), assumed to have Stone-Geary type of preferences, earn income from L, K, and TR. Savings is linear function of income; Govt revenue is made up of direct and indirect taxes, as well as transfer income from ROW Demand: Specified as Stone Geary LES (offers some degree of flexilibility w.r.t substitution possilibilities ) International Trade: ROW and domestic economy relationship based on Armington assumption of imperfect substitution (minor exception – refined oil); producer decides how much to export and sell domestically based on CET function Dynamics: between-period relationship driven by population growth and capital accumulation. Nigeria and the Small Country Hypothesis + Departure from the pure hypothesis (PE.FOB) Methodology and Data Model Closure neoclassical closure : labour continued Numeraire: nominal exchange rate (exogenous, thus) C.A Bal: Current account is held fixed while foreign savings is allowed to adjust endogenously to ensure external balance Government Bal: G.E is fixed in real terms as well as all tax rates. Its budget adjusts to ensure P.E equal R. S-I closure: savings-driven (savings rates of domestic institutions are fixed so investment passively adjusts to ensure equilibrium supply is held fixed and assumed to be mobile across sectors wage is allowed to adjust to clear the market. capital is also kept fixed but immobile only in the first period Simulation Scenario return to capital is SIM1com determined endogenously in SIM2grad the model to clear the SIM1gov market for capital supply SIM2ind Results and Discussions macroeconomic effects Increase in several % Change from Base year value 30.00 25.00 20.00 15.00 10.00 5.00 0.00 SIM1com SIM2grad GDP YG SG IT 0.88 0.62 1.31 0.98 14.95 11.90 27.94 22.06 AGGE X 1.42 1.03 AGGI M 0.99 0.73 AGGY H 0.65 0.44 INFL 0.58 0.45 macroeconomic aggregates Less pronounced with a gradual removal of fuel subsidy Interestingly, one-shot subsidy removal makes more macroeconomic sense! Results and Discussions Increase in aggregate output Total Aggregate Output 3.00 2.15 2.00 1.00 0.00 -1.00 0.44 FOOD 1.62 1.20 except transport output DP rises? VA rises but DIT falls Changes in relative prices of factors Declines more in SIM1com 0.92 0.31 MAN Sectoral Effects TRANS SER -2.00 -3.00 -3.26 -4.00 Price of local product (Domestic Market) -3.92 SIM1com SIM2grad Price of basic domestic commodities increase Food price declined 4.00 3.50 3.00 2.50 2.00 1.50 1.00 0.50 0.00 -0.50 3.67 2.99 1.54 0.86 -0.05 -0.06 FOOD 0.66 MAN SIM1com TRANS SIM2grad SER 1.20 Results and Discussions Sectoral Effects Labour Demand Effect Labour is affected more in sector that depend more on petroleum products as intermediate input Changes in relative prices of factors 4.00 2.06 1.62 2.00 0.00 -2.00 -0.61 FOOD-0.43 MAN 2.00 SIM1com 2.25 1.47 2.11 1.63 1.53 1.50 0.81 1.00 0.61 0.50 0.00 FOOD MAN SIM1com TRANS SIM2grad SER -5.64 -6.81 -8.00 Demand for capital 2.07 TRANS -4.00 -6.00 2.50 1.02 0.80 SER SIM2grad General increase in demand of capital Results and Discussions The worst hit: Poor Households income effect 0.60 households (esp. HRP) HUNP least affected One-shot approach to the policy shift appears favourable Result is plausible given fall is income sources returns 0.76 0.80 0.63 0.51 0.32 0.40 0.56 0.42 0.54 0.36 0.20 0.00 HRP HRNP SIM1com Household Effects HUP HUNP SIM2grad One-shot approach to the policy shift appears favourable It is distributionally progressive Rural households benefits more from the reform Households consumption effect 0.30 0.30 0.16 0.15 0.20 0.04 0.03 0.10 0.00 -0.10 HRP HRNP -0.20 -0.30 SIM1com HUP HUNP -0.05 -0.17 -0.21 SIM2grad % Change from Base year value Results and Discussions 20.00 18.00 16.00 14.00 12.00 10.00 8.00 6.00 4.00 2.00 0.00 Macroeconomic Effects Increase in several GDP YG SG IT SIM1gov 0.67 SIM2ind 1.06 0.89 1.25 8.23 9.45 15.96 18.94 SIM1com SIM2grad GDP 0.88 0.62 YG 1.31 0.98 AGG EX 0.51 0.81 SG 14.95 11.90 AGGI M 0.45 0.59 AGG YH 0.58 0.94 IT 27.94 22.06 INFL 0.75 0.71 macroeconomic aggregates However, increasing investment is specific sectors generates more growth SG; IT; AGGYH AGGEX AGGIM AGGYH INFL 1.42 0.99 0.65 0.58 1.03 0.73 0.44 0.45 Results and Discussions Total Aggregate Output 4.00 2.00 0.00 SIM1com 3.75 0.15 0.20 FOOD MAN 2.15 TRANS -3.92 SER 1.20 0.82 1.16 0.84 MAN FOOD 0.44 Sectoral Effects TRANS SER -2.00 Price of local product (Domestic Market) -4.00 SIM1gov -3.81-3.70 SIM2ind 5.00 4.01 4.05 4.00 3.00 1.65 1.89 2.00 1.00 0.00 FOOD SIM1com -0.05 MAN 0.86 TRANS 3.67 SER 1.54 -1.00 0.24 0.42 FOOD 0.86 MAN -0.63 SIM1gov TRANS SIM2ind SER Results and Discussions Labour Market Effects 2.00 0.00 -2.00 FOOD SIM1com -0.61 MAN 2.06 TRANS -6.81 SER 1.02 0.75 1.07 0.59 -0.47 -0.68 FOOD MAN Sectoral Effects TRANS SER -2.18 -4.00 -6.00 Demand for capital -6.21-6.23 -8.00 SIM1gov FOOD SIM1com 2.07 SIM2ind MAN 2.25 TRANS 0.81 SER 2.11 12.00 10.00 8.00 6.00 4.00 2.00 0.00 11.27 1.101.56 1.14 FOOD MAN TRANS SIM1gov SIM2ind 0.080.42 1.181.60 SER Results and Discussions Household Income Effects 0.90 1.00 0.80 0.60 0.94 0.56 0.54 0.96 0.90 SIM1com HRP 0.51 Household Effects HRNP 0.63 HUP 0.56 HUNP 0.76 0.64 0.54 0.40 0.20 0.00 Household Consumption Effect HRP HRNP SIM1gov HUP HUNP 0.39 0.40 SIM2ind 0.20 0.00 -0.20 0.40 0.26 0.07 HRP HRNP -0.08 HUP -0.15 -0.40 SIM1com HRP 0.30 HRNP 0.15 HUP 0.03 HUNP -0.17 HUNP-0.03 -0.42 -0.60 SIM1gov SIM2ind Conclusion This paper analyzed the general equilibrium effects of petroleum subsidy removal using a recursive-dynamic CGE framework. Increase in several macroeconomic aggregates; however, increasing government expenditure reduces the macroeconomic gain Growth-effects are more when gains are invested in agriculture and manufacturing sector Interplay in sectoral activities also determine household effects Increases in households income (NP benefits more) Rural households gain more in terms of consumption One-shot approach to the policy shift appears favourable CAVEATS!!! The political economy perspective Shocks to international price of oil not considered THANK YOU