Mideast energy subsidy reforms succeed against the odds

As government reforms of energy subsidies trigger chaos in OPEC-member Ecuador, similar reforms are quietly succeeding in other oil-exporting countries.

Credit: 123RF.com/Rice University

Across the Middle East and North Africa, a series of energy subsidy reforms have raised prices on fuel and electricity in at least nine countries.

Large increases in prices that have been fixed, in some cases, for more than 50 years challenge academic theories that model governance in the region, according to a new research paper by an expert in the Center for Energy Studies at Rice’s Baker Institute for Public Policy.

“Too Much of a Good Thing: Subsidy Reform and Tax Increases Defy Academic Theory on the Rentier Middle East,” authored by Jim Krane, the Wallace S. Wilson Fellow for Energy Studies, highlights four critical developments.

Academics have long held that the oil kingdoms of the Middle East are subject to a strict set of governance conditions, Krane said. Autocratic rulers cultivate support from their citizens by providing them with welfare benefits and subsidies, funded through oil export revenues, or rents. These rents were sufficient to eliminate taxes and provide generous subsidies, which allowed regimes to avoid accountability links with taxpayers, Krane said.

“These governments have launched new energy policy that does not follow the script laid out by academic theory,” Krane wrote. “Energy subsidies wound up making these countries extremely energy intensive, so governments had to act.”

Academics had deemed such subsidies as “rights of citizenship” and argued that regimes could not retract them. Those academic claims have now been disproven by the reforms since 2014, Krane’s paper shows.

“Citizens are largely accepting their losses without making demands for democracy,” Krane argues. “These developments imply that rentier theory needs updating.”

Krane said that, first, at least nine Middle Eastern governments have partially retracted energy subsidies that provided citizens with cheap fuel, electricity and desalinated water.

Second, Saudi Arabia, the United Arab Emirates and Bahrain imposed a 5% value-added tax (VAT) on goods and services, including energy and food. Other countries, including the three remaining Gulf monarchies as well as Egypt, Algeria and Iran, have levied VATs or announced plans to do so. “For autocratic regimes that fund their national budgets with oil and gas export rents, the imposition of taxes and retraction of subsidies run counter to social contract stipulations enshrined in the rentier literature,” Krane wrote.

A third development also confronts theoretical conventions about linkages between rent and Middle Eastern autocracy, Krane said. “It turns out that rentier theory’s claim about oil’s influence on politics also works in reverse,” he wrote. “Yes, oil rents probably do increase the durability of autocratic regimes, but autocratic governance (at least in oil exporting Middle Eastern countries) also appears to increase demand for oil. That is because regimes stay in power not just by distributing oil rents, but also by distributing oil itself, a practice that stimulates demand. The Middle East’s oil exporting states tend to be both autocratic and oil-intense, a notion that has largely been ignored in the literature.”

The fourth development is that the growing burden of domestic demand for oil and gas has begun to threaten the core rentier structure, Krane said. “High rates of energy demand growth are eventually incompatible with steady exports,” he wrote. “It now appears that a common manifestation of rentier social policy — energy subsidies — risks undermining the rentier economic structure, the rent lifeline that funds the state.”

Krane said one should acknowledge that the domestic subsidization of primary exports has also burdened the economy. “Left intact over the long term, domestic resource distribution can undermine the rent stream and destabilize the governance structure,” he wrote. “Regimes should be expected to take action to lessen the strain.”

Academics’ central misunderstanding about subsidies is that they are inflexible, Krane said.

“By portraying subsidies as rights, theory implies that they cannot be reformed without upsetting stability,” he wrote. “On the contrary, I argue that subsidies are ultimately more destabilizing to rentier systems than the corrective retrenchment actions that have occurred since 2014.”

A new social contract theory

Krane said citizen benefits can be more accurately depicted as “customary privileges” that may be restricted in ways once considered illegitimate: toward low income citizens or “reasonable” levels of consumption, or replaced by alternate handouts. “As long as aggregate patronage remains roughly constant, regimes appear to have some control over the type of welfare goods and services they provide,” he wrote. “In other words, social contracts are less rigid than portrayed in the rentier literature.”

Krane said these amendments provide a theoretical allowance for the reforms that have already begun in the rentier heartland of the Gulf. “Thus modified, theory can anticipate the likelihood for regimes to continue to streamline social welfare policies in the interest of preserving power,” he wrote.

Krane said scholars should acknowledge the resource curse hypothesis that declares “oil bolsters autocracy” has a follow-up stage, whereby autocratic policies incentivize domestic oil demand. “That is because energy is leveraged as a tool of state development and political control,” he wrote.

“The practices of rentier policymaking have expanded beyond the boundaries assumed by academics,” Krane wrote. “We may be witnessing the top-down imposition of a new social contract featuring increased regime flexibility in social policy, implemented under a heightened level of repression. These developments do not signal a reduced regime reliance on rents or the demise of rentier or ‘allocative’ governance. World Bank data show a continued large role for oil rents in gross domestic product and for rent distribution via public wages in these countries.”

Krane said the levying of low-level taxation and reductions in energy benefits look more like coordinated course corrections. “Regimes are streamlining bloated social contracts to contain the distortionary effects of policies that have remained in place since the 1970s,” he wrote. “At that time, poverty alleviation was a much larger concern. Today, oil intensity is a countervailing worry for younger ruling elites updating rentier governance for new generations.”