Welfare Effects of Energy Subsidy Reform in Developing Countries

19 Pages Posted: 5 Jun 2020

See all articles by Loek F. M. Groot

Loek F. M. Groot

Utrecht University - School of Economics

Thijs Oostveen

affiliation not provided to SSRN

Date Written: November 2019

Abstract

We analyze the potential welfare effect of energy subsidy reforms. The income distributions of eleven developing countries from different geographical regions are simulated using the assumption that income is lognormally distributed. We use the concept of the compensating variation to measure how much compensation is required to compensate consumers for a price increase in formerly subsidized goods. The behavior of consumers is modeled by a standard Cobb–Douglas and a quasilinear utility function. In the Cobb–Douglas case, a fixed fraction of income is spent on the subsidized good, which does not change after a price increase. With quasilinear preferences, the optimal amount of the subsidized good does not vary with income, but does change as prices change. We show theoretically and empirically that the required compensating variation can be set below the saved expenditures on subsidies, so a budget neutral reform can have a positive effect on social welfare.

Keywords: basic income, energy subsidies, subsidy reform, welfare, distributional impact, compensating variation, cash transfers

Suggested Citation

Groot, Loek F. M. and Oostveen, Thijs, Welfare Effects of Energy Subsidy Reform in Developing Countries (November 2019). Review of Development Economics, Vol. 23, Issue 4, pp. 1926-1944, 2019, Available at SSRN: https://ssrn.com/abstract=3618496 or http://dx.doi.org/10.1111/rode.12619

Loek F. M. Groot (Contact Author)

Utrecht University - School of Economics ( email )

Kriekenpitplein 21-22
Adam Smith Building
Utrecht, 3584 EC
Netherlands

Thijs Oostveen

affiliation not provided to SSRN

No Address Available

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