Cutting back subsidies to prevent a fuel crisis

Riyadi Suparno, The Jakarta Post, Jakarta

Guess who is the culprit behind the ugly scenes we have witnessed over the past few days? Long queues of motorists at some gas stations and the closure of others due to a fuel shortage.

Some have pointed the finger at the government, which might have been looking for an excuse to push up fuel prices due to rising crude oil prices on the international market.

Others blame Pertamina for deliberately cutting back fuel supplies, premium particularly, as a blackmailing tactic to get an increase in quota.

Out of the two, the second seems to be right. Pertamina did cut back supplies of subsidized fuels, including premium, because Pertamina has reportedly sold more than the quota set by the government and the House of Representatives.

Because when Pertamina sells more than the quota, it has to foot the bill for the excess, and therefore, it decided to cut back supplies. As a result, motorists have been victimized and the government is compelled to consider increasing the quota.

Pertamina argues that it has supplied more fuel than the quota on account of increased demand. Indeed, this sounds logical. However, in basic economics, when prices are increased, demand falls, albeit temporarily. The question is, why did demand surge after the government increased fuel prices?

This happened as the selling prices of fuel in Indonesia do not represent the true costs of production. This is so because of the high fuel subsidy.

From here, we can say that Pertamina is not the one at fault in this messy situation; it is the fuel subsidy.

If the subsidy is behind all these bad things -- including smuggling -- and thus it is considered bad, why then is it still granted and why does the subsidy continue to rise?

Subsidy advocates have argued that Indonesia, as an oil- producing country, should subsidize fuel for the people. After all, the government can afford the subsidy, no matter its size. True, the state budget just shows that.

When the government drafted for the first time the 2005 budget, it allocated Rp 19 trillion (US$1.9 billion) for the fuel subsidy, assuming that crude oil prices averaged US$24 per barrel. The bottom line was a budget deficit of Rp 17 trillion.

Thanks to soaring crude oil prices on the international market, the government was forced to revise the budget and drastically raise the fuel subsidy to Rp 76.5 trillion, assuming average crude oil prices of $45 per barrel. In spite of the jump in fuel subsidy, the budget deficit is projected to increase only slightly to Rp 20 trillion. Why such a small change?

The salient point is the government enjoys a windfall profit from soaring crude oil prices, as the country still exports a huge amount of crude and gas -- about 1 million barrels of crude oil per day.

The government confirmed this on Tuesday, saying the state budget would remain safe even if crude oil prices increased to the as-yet-unthinkable level of $80 per barrel.

Those are convincing facts for subsidy advocates, that the fuel subsidy at whatever level will not bankrupt the government.

However, the cost of the fuel subsidy will not be just Rp 76.5 trillion, or even Rp 100 trillion if crude prices continue to increase above $60 per barrel.

However, the cost also covers what economists call the "opportunity cost" of the subsidy. This could be free education for all, 100,000 new houses for tsunami survivors, thousands of kilometers of rural roads and bridges plus a subway for Jakarta -- you name it.

The government used exactly the same argument of this lost opportunity cost when it campaigned for a fuel price increase earlier this year.

Why then, does the government not present the same argument this time to further increase fuel prices to reduce the ballooning subsidy?

If government officials do not believe what they preach, how can they hope for public trust? After all, they are all politicians -- with only a few showing statesmanship.

Unless restrained by constitutional rules, politicians are prone to excessive expenditure. Politicians like to spend money on programs that please their constituents. They do not like to increase tax, because tax imposes a visible cost on voters. Equally, they do not like to increase fuel prices.

Instead, they like creating debt or seeking loans overseas as debt pushes the visible cost of the government into the future.

If that is the case, this government is no different from the New Order administration, which granted an immoderate subsidy and sought foreign debt to finance it. This will do little for economic progress.

Now, imagine our government has the political courage to float fuel prices on the free market. The immediate reaction would no doubt be massive demonstrations.

Yet, if the government is confident enough in its belief, and is capable of convincing the people, demonstrations would eventually die down and not escalate into mass riots -- which is possibly in the minds of many government officials.

When the government can manage the short-term consequences, the longer-term impact of the further reduction -- or elimination -- of the subsidy would be for the good of the country: No more fuel scarcity, responsible fuel usage, the conservation of energy, and more importantly, more resources available for the government to finance various programs that would expand the size of the "cake of development". Then, prosperity would be enjoyed by all.