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Microeconomic realities of a fuel subsidy cut
Jakarta Globe - October 22, 2014
Both Joko and his running mate Jusuf Kalla used this argument during their election campaign, saying the funds could be allocated to infrastructure development, education and other essentials.
While the macroeconomic rationale for abolishing fuel subsidies appears to be iron-clad, the microeconomic realities on the ground may be vastly different. This is especially true in an economy lacking both adequate infrastructure and mass-transportation facilities.
To say Indonesia is in serious need of infrastructure development is an understatement. Our infrastructure quality ranked among the worst within the Association of Southeast Asian Nations (Asean) in the 2010-11 Global Competitiveness Report.
According to the report, the country scored 3.7 out of 7 overall, with our roads standing at 3.5 and our railroads at 3.0. By comparison, Malaysia scored 5.7 overall with its roads and railroads at 5.7 and 4.7 respectively.
Research by Standard Chartered in 2011 came to the conclusion that Indonesia's poor infrastructure is the main reason our gross domestic product growth has so far failed to reach its optimum growth rate of 8 percent. Worse, it is also the chief culprit for high inflation, which Indonesia is prone.
The causal link between dismal infrastructure and inflation in Indonesia is real enough, even on Java, where most of the country's infrastructure is located. Due to the poor condition of roads, the distribution of goods from urban to rural areas relies heavily on small vehicles such as pickup trucks and often motorbikes.
The narrowness of most of our rural roads also rules out bulk-haulage by big lorries, which could significantly cut transport costs. That there are no railroads to most rural centers is another factor that puts cost-efficient transport out of reach.
Hence, the economically viable distribution of goods and essentials, as well as transport of people, depend mostly on the available road network, part of which has not been upgraded since colonial times.
So the substantial fuel price increase of more than 40 percent envisaged by the government will inevitably drive inflation up considerably in rural areas.
While the government may justify the subsidy cuts by channeling the funds into major infrastructure projects, it will be years, even decades, before their benefits can manifest. In the meantime, it is the poorest of Indonesians who will be asked to bear the brunt of high inflation when the subsidies are cut.
It is also important to bear in mind that most of the nation's poor work in the informal sector of the economy.
Indonesians in this category don't work in factories or companies that comply with the minimum wage regulations. So even when there is a general order for a wage rise in the formal sector, most workers in the informal sector may not benefit from it.
The proposed fuel subsidy cuts may also adversely affect small-scale entrepreneurs in the informal sector. This category includes all the self-employed, albeit non-income-tax paying, food hawkers, technicians and other tradesmen and women. Most of these rely on the motorbike – and cheap petrol – for increased mobility.
For many Indonesians, the theory of the trickle-down effect of economic growth is far from real. In a country where quality health care and education are out of most people's reach, cheap fuel may seem like the long-promised sweet fruit of progress. So, when it is taken away, the bitter taste of betrayal is hard to swallow.
If the government is convinced that there is no other way but to cut fuel subsidies, it must soften the blow through policies that deliver immediate social benefits.
Indeed, it must do more than that. Finance Minister M. Chatib Basri told the media a few weeks ago that fuel subsidies are an unnecessary burden on the national budget. Economists have likened it to literal money burning.
By the same token, the government's score on efficiency leaves much to be desired. Unwieldy and yet growing in size, our civil service consumes more than half of the national budget and somehow manages to remain ineffectual compared to private-sector counterparts.
Vice President Kalla once told the press that the current subsidy system is prone to siphoning by the so-called petro-mafia. Yet, so far nothing has been done to ascertain the extent of their illicit operations, or whether this corrupt practice is a major contributor in the ballooning size of fuel subsidies. Nor have any of the perpetrators been brought to justice.
Joko's upcoming policy on fuel subsidies will no doubt become one of the defining moments of his presidency. He frequently pledges to devote himself to the people. Let us hope the new fuel subsidy policy will be consistent with this pledge.
[Johannes Nugroho is a writer from Surabaya.]
Source: http://thejakartaglobe.beritasatu.com/opinion/microeconomic-realities-fuel-subsidy-cut/.
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