Utility Subsidies: On Their Way Out

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Gas (Photo by Michael W. May)

The Argentine federal government has made a series of announcements over the last month stating that drastic cuts will be made to the country’s public utilities subsidy programme, which has been in place since 2003.

The measures will cause a significant rise in the electric, water and gas expenses, first affecting large businesses and wealthy residents before being applied more generally. The policy has already gone into effect (on 1st December) for corporations, while residents in targeted neighborhoods will see increases in their utility bills beginning 1st January. All government public buildings in the city of Buenos Aires will lose their benefits as well.

The cuts initially target high profitability businesses such as financial firms, casinos, international airports, mining corporations, mobile phone companies under national jurisdiction, hydrocarbon extraction companies and water, gas and electric corporations. Companies dealing in agrochemicals, biofuels, natural gas processing and oil refining will also lose their subsidy benefits.

“Nobody should receive a subsidy that they don’t need,” says Federal Planning Minister Julio de Vido. De Vido is in charge of monitoring utilities, energy and transportation in Argentina.

The Reason Behind the Cuts

The government will save an estimated $4.8bn (US$1.1bn) annually as a result of the subsidy withdrawals. This still reflects only a fraction of the $70bn in subsidies – according to private estimates – that the government will spend in 2011.

Public spending increased dramatically in the months leading up to President Cristina Fernández de Kirchner’s landslide re-election this past October, though officials are denying that the subsidy cuts are related to recovering these costs. The state’s goal, they say, is not to curb spending, but to channel money where it is most needed.

“It is not a fiscal matter”, said Federal Economy Minister and Vice-President elect Amado Boudou when announcing the rollback of subsidies. “It has to do with redirecting the subsidies.”

The manner in which the subsidies will be withdrawn supports this claim. Beginning at the start of next year, people living in the most affluent areas of the city will notice their utility bills rise by at least 100%. About 260,000 households in neighborhoods including Puerto Madero, Retiro, Recoleta, Palermo, and Belgrano will be subject to subsidy cuts, as well as gated communities, known as ‘countries’, outside of the capital.

Meanwhile, in a unique move that it sees as a way of personalising subsidies, the government is offering residents in all areas the opportunity to voluntarily give up the benefit. The idea is that those who do not need to pay less, agree to pay more.

Additionally, those who feel that they do need the subsidy can apply to continue to receive it based on their financial circumstances. The government will cross-check consumers’ applications with their social security and tax registers to decide on eligibility.

This rather unorthodox method of attempting to identify residents who truly need the subsidy is only a short-term fix, says Marcos Makón, President of the non-profit group, Argentina Association of Budget and Public Finance Administration (ASAP). “The defining problem,” says Makón, “is knowing exactly what the income level is and what are the specific individual circumstances of families, beginning first with those people who are targeted to lose the subsidy benefit.”

How Did the Subsidies Begin?

Water (Photo: Mouin)

Argentina implemented the subsidy programmes almost ten years ago as a way to spur an economy recovery from a deep recession and help households cope with the soaring inflation that followed the megadevaluation early in 2002.

In 2003, under the administration of President Néstor Kirchner, the late husband of current President Cristina Fernández de Kirchner, the tariffs of privatised utilities were frozen and subsidised in order to help companies provide goods and services at prices that more of the population could afford.

The idea seemed to work: consumer spending power increased, exports became competitive, and the economy grew at an average rate of 8% between 2003 and 2011.

Nevertheless, there have been some drawbacks to the plan.

Professor of Public Finance Martin Besfamille of Di Tella University in Buenos Aires says that the subsidies are universal – meaning that everyone receives the benefits – yet they are not entirely redistributive.

“For example,” says Besfamille, “rich people pay ridiculously low monthly prices for natural gas, while some very poor individuals [who do not have natural gas lines into their homes], have to pay the same price for a tank of liquid petroleum gas whose duration is much less than one month”.

Subsidised services also tend to increase demand. This results in overuse of the service and product waste. To illustrate, the use of air conditioning has increased greatly in the last decade simply because electricity prices are so low that households do not worry about their cost.

Greenpeace, a global environmental organisation, recently voluntarily renounced their utility subsidies as a way of advocating the use of cleaner energy resources. Executive Director Martín Prieto announced in November: “These subsidies should never have existed; nevertheless, it is a good first step in democratizing the access to energy, abandoning fossil fuels and going forward towards an energy revolution based on renewable resources.”

Another disadvantage is that subsidised services frequently have inefficient operations. “Because businesses receive subsidies free of objective considerations (with no strings attached), the quality of their service tends to be low”, says Besfamille.

One can see this in Retiro train station. There are no ticket collectors, so few people buy a ticket. Besfamille says, “Since the tariff of trains has been frozen since 2003, the main part of the companies’ income comes from the subsidies. Therefore, for just 1.20 pesos, it is very expensive to enforce. If the tariff is 4 pesos, the cost-benefit analysis of enforcement changes rapidly.” In other words, for the train company, it is simply not worth the cost of employing ticket collectors to collect fares of such little value.

Electricity (Photo: Martin Terber)

What Should be Done Now?

While many government officials, private economists, and much of the general population seem agree that it is time for subsidies to be eliminated, there is still the question of how the government should handle this removal after eight years. Some say that cutting subsidies should have been done five or six years ago, and in a gradual manner.

There are several factors to consider. Politically speaking, many consumers who have been dependent on the government’s financial help now see the utility benefits as their “right”, and will be looking for other means of compensation. And on the economic side, an abrupt increase in utility costs for consumers will certainly decrease consumption, which is likely to have a negative effect on economic growth.

Withdrawing the long-time subsidies suddenly, which was one of the state’s first major policy decisions after President Fernández’s overwhelming re-election win, will have a bigger impact on inflation than if their removal had been gradual.

Making accurate and financially prudent decisions over subsidy redistributions will require a careful case-by-case evaluation says Makón. “For companies that have high expenses, an abrupt elimination of their subsidies could generate higher prices for their goods and services.” Makón believes that subsidies should help businesses control current costs, but should not be a mechanism for future growth of the company.

Finally, the implementation of subsidy reform is a complicated process. Besfamille raises concerns over the government’s ability to design and enforce a new plan. “In a country where, according to the best estimations, almost 50% of the income tax and 30% of the sales tax is evaded, can someone seriously believe that the government will be able to determine that individuals, who have declared themselves to need the subsidy, are really needy?”

Although no independent assessment of the subsidy reduction plan has been made, the government insists that the economy will not be negatively affected by the cuts. Government authorities say small and medium-sized business, which create the most jobs, will still receive subsidies and will therefore continue to perform well.

More subsidy cuts are expected to be announced in the coming weeks. There is speculation that the heavily subsidized city bus system is next in line to lose government benefits. Without the subsidy, the price of a bus ticket could increase from $1.25 to $4.00.

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2 Responses to “Utility Subsidies: On Their Way Out”

  1. DaVe says:

    Great article! This really explains the whole situation clearly and giving the background on it was great!

  2. Paul says:

    The President’s name is Fernandez de Kirchner. This is the custom in Argentina. She should not be referred to as “Fernandez”.

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