Energy Subsidies: Lessons Learned in Assessing their Impact - UNEP

Energy Subsidies: Lessons Learned in Assessing their Impact and Designing Policy Reforms
2.4 Analysing the Impact of Subsidies and their Reform
The underlying principle of policy making for sustainable development is to take into account
the overall well being of both individuals and society as a whole. Progress towards integrated
assessment of the impact of government policies is therefore essential so that the different
determinants of well-being can be considered together. The economic, environmental and
social changes that result from reform of energy-subsidy policies, therefore, need to be
identified and evaluated within a common framework. In practice, however, that is by no
means straightforward. Estimates of the effects of reform should, therefore, be treated with
caution.
2.4.1 Economic, Environmental and Social Effects
The measurement of the economic impacts of removing subsidies can be conducted in two
ways. The first, based on a partial equilibrium approach, looks at the net gains in consumer
and producer ‘surplus’, which broadly measure the net benefits of consuming and supplying
energy after accounting for the price paid by consumers and the production costs paid by
producers. The second uses a more general equilibrium (GE) approach, taking account of how
markets are linked, so that the effects of energy prices changes on the labour and product
markets are accounted for. In this case the measured effects of the changes in subsidies are
usually reported in terms of changes in GDP.
Both approaches have been widely used for a considerable period of time in estimating
various policy impacts, to also include those of energy subsidies and their reform. The first
approach is limited in that it does not take account of inter-sectoral linkages and does not
measure changes in the distribution of income, which have to be addressed separately. In
using it to measure changes in economic welfare, it is important to allow for market
imperfections. For example, if the market supplier has market power, this must be accounted
for in the measurement of surplus.
The second approach does address inter-sectoral linkages but not, generally, the income
distribution issue. It has the disadvantage of being considerably more complex and the data
demanding to use (if the data are not available, its use based on estimated values may be less
accurate than the partial equilibrium approach). 12
The complexity of what happens with energy subsidies is better understood with specific
examples. It is often argued that energy-subsidy reform may be expected to result eventually
in higher market prices to consumers. This, in turn, would normally result in lower demand
for the energy source in question and, therefore, lower output. Employment levels would fall
in that sector as a consequence. This fall in production and in revenue could result in a lower
gross domestic product (GDP) and lower economic welfare. However, the picture is usually
more complex. The money previously spent on maintaining the subsidy would now be free
to be used in other ways. It could, for instance, be returned to firms or individuals in the form
of support for environmental protection programmes or tax cuts, which would free up income
for them to spend on other goods. Thus, while the composition of GDP may change, it is not
certain whether the total would rise or fall.
12 It is a common misperception that the GE approach assumes perfect markets and perfect information. It does
not, and indeed many of the models now available allow for failure in market clearance, when this is critical.
Moreover, if one sector has monopoly power, this can and has been modelled with success. A further discussion
of results from such models is given in the Annex to this chapter.
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