98 Pages Posted: 20 Apr 2016
Date Written: March 1995
Six case studies show that raising energy prices to eliminate subsidies does not harm the poor, growth, inflation, or industrial competitiveness. And public revenues improve.
When domestic energy prices in developing countries fall below opportunity costs, price increases are recommended to conserve fiscal revenue and to ensure efficient use of resources. Using six case studies, Hope and Singh investigate the effect of energy price increases on the poor, inflation, growth, public revenues, and industrial competitiveness.
The effect on households in various income classes depends on the energy commodity's share in the household budget and the price elasticity of demand. For energy as a whole (electricity and fuels, traditional and commercial), budget shares often decline with income. So in terms of income distribution, taxing energy is not ideal. But commercial fuel consumption increases greatly with income, so any subsidies applied will largely benefit nonpoor urban households. For each commercial energy source (electricity, kerosene, diesel, and gasoline) proportionate household spending will generally be lower, and some energy sources will be luxuries.
In no instance does energy spending exceed 10 percent of the typical household budget for any income group.
The effect on industry is generally modest, since cost shares for energy typically range from 0.5 to 3 percent (with the typical value being 1.5).
In addition, many industries are flexible enough to substitute when energy prices increase. Energy prices tended to increase in adjustment and liberalization programs, and industrial output usually increased even with the higher energy prices. This suggests that the effect of the price increase is modest compared with the effects of other changes in the environment. There are exceptions, of course, such as energy-intensive industries with limited possibilities for substitution.
Estimating the effects on public deficits is straightforward, even with uncertainty about demand elasticities: Energy price increases reduce the drain on public resources significantly.
It is harder to trace the effects on inflation and growth in national income. The effects on inflation will generally not be severe, and inflation may even be reduced in the intermediate to long run, through lowered public deficits. Income growth rates were generally higher after the years of energy price adjustments than they were in the years before the price increases (with one exception) and the years of the price increases (with one exception). Income growth rates were higher during the years of price increases than before in about half of the case-study countries.
This paper - a product of the Public Economics Division, Policy Research Department - is part of a larger effort in the department to study the distributional and environmental effects of energy pricing policies. The study was funded in part by the Bank's Research Support Budget under the research project Pollution and the Choice of Economic Policy Instruments in Developing Countries (RPO 676-48).
Suggested Citation: Suggested Citation
Hope, Einar, Energy Price Increases in Developing Countries: Case Studies of Colombia, Ghana, Indonesia, Malaysia, Turkey, and Zimbabwe (March 1995). World Bank Policy Research Working Paper No. 1442. Available at SSRN: https://ssrn.com/abstract=569215