Making Sense of Fuel Subsidy Reduction in Malaysia

On 28 February 2006, the Malaysian government announced the reduction of fuel subsidy by 30 sen. For many Malaysians, this announcement was a shocking news. The official reason for the reduction of subsidy given was that the money saved (RM4.4 billion) would be used to fund improvements in the country's public transportation system.

My immediate impression of the statement was that the money saved would be spent on development expenditures for the next five years. The five-year development plan, the Ninth Malaysia Plan (9MP), should be out by month. At this stage, I am sure officials from the Economic Planning Unit, Prime Minister's Department, would have computed the total development expenditures for the next five years. This could pose some problems to the government's effort to achieve a balance budget, a policy it announced a few years ago. In other words, the government savings from subsidy reduction would come in handy for 9MP expenditures. Hence, the government's reason for the subsidy reduction may imply that a the transport sector will be a key focus area in the 9MP. Alternatively, it could mean that the governemnt would find it difficult to balance its budget in the next five years without the fuel subsidy reduction.

There are many arguments why it makes sense to reduce fuel subsidies. One argument whch is attractive from an economics point of view but may not be fully appreciated by the general public is that any reduction of fuel subsidy tantamounts to reduction in the distortion of allocation of scarce resources (fuel, in this case). This implies that people would use an optimal amount of fuel if fuel prices accurately reflect their scarcity. If we take into account the impact of fuel consumption on the environment (externalities, pollution), we should even consider imposing additional taxes on petrol consumption.

The government has also repeatedly stressed that the fuel subsidy reduction would not burden the lower income groups as only the wealthier segment of society would be affected. This is probably not 100 percent true. Our society is not divided into two classes - poor and rich. I think the middle class and the poor will bear the brunt of the reduction in fuel subsidy. The poor would include those currently using motorcycles for work especially in the rural areas. There may not be sufficient transport alternatives in this sector. Unless the government can guarantee the current public transportation system is improved quickly and sustainably, the cost borne by the poor and middle class could be significant. This would include the increased travel time incurred by the poor and middle class who are now 'forced' to use an inefficient public transportation system. Ideally, the government should have guaranteed an improved public transportation system BEFORE it decides the reduce fuel subsidy. In other words, if you force people to use the public transportation system, you must at least guarantee that the supply of such services is adequate and of acceptable quality. Furthermore, as our previous investments in this sector indicates, large investments do not always guarantee that we will have an efficient transportation system. Good regulation including the placement of appropriate incentive systems for private sector participation is important.