MALAYSIANS have become accustomed to subsidised products and services. It is a challenge to remove the subsidy and be replaced by a new rationalised subsidy and non-subsidised price culture where domestic prices of goods and services would align with international prices.
Good intentions; bad outcomes. Like many countries around the world, Malaysia has been imposing price controls/ceilings and subsidies to serve social and economic objectives.
These include to protect vulnerable consumers/households against the impact of price increases; to help stabilise prices and ensure adequate supply of essentials; as part of a price-support programme to maintain the income of producers during the harvesting shock or the supply-demand disruptions.
While the well-intended price subsidies and controls offer some relief and protect consumers against price, income and supply shocks, the untargeted price subsidies come with high economic and fiscal costs in the long term.
Price controls and subsidies can dampen productive investment and growth, discourage greater work efforts and cause the government to incur heavy fiscal burdens.
It reduces the fiscal capacity as the huge financial resources spent on subsidies have diverted the budget’s allocation from other areas such as education, healthcare, infrastructure, housing and the care for the elderly.
When initiating the price-subsidy reform, there are two forms of resistance.
First, the resistance comes within the government and politicians on fear of facing political backlashes from their voters, and hence could pay a heavy political price for introducing unpopular measures.
Second, society resistance as people are concerned about the dampening impact of implicit and explicit from the subsidy removal on their income and living standard.
Hence, the government needs to keep regular engagement at all levels, communicating with the public and community on the economic and opportunity costs of not undertaking price reforms.
Where there is a lack of public confidence in the government’s governance of fuel subsidy savings to implement programmes that compensate the lower and middle-income households, they will find the targeted spending less credible and will resist to subsidy reform.
Stable environment
The timing and pace of reform depends on political and economic environment. Rapid reform requires a stable political and conducive economic environment.
If the political and economic conditions are challenging, especially if inflation pressures and cost of living still persist, the government can undertake a sequential and gradual approach to reform and they need to be carefully communicated and sequenced to ensure political and social acceptance.
In this regard, replacing price control and the rationalisation of subsidies with expanded and better-targeted social safety nets must be implemented gradually to smoothen the impact on the economy; allowing households, producers and businesses to adjust and cope with the price and cost impact arising from the removal of price controls and subsidy rationalisation.
Lowering real income
There is a trade-off between rapidly slashing subsidies and mitigating the impact on the vulnerable households. While the elimination of subsidies will result in immediate budget savings and correct the distortion of resources, it can also result in lowering real income of the low-income households.
The social impact of price-subsidy reform can be limited by establishing cost-effective and well-targeted social protection mechanisms so as to mitigate the effects of reforming implicit and explicit price subsidy reform.
The mechanism comes in the form of providing cash compensation to the targeted users in lieu of the subsidy cut. This can be merged with existing cash transfer scheme (for example, by increasing the amount of cash assistance).
By doing away the generalised subsidies and the target group is carefully selected and the scheme is effectively implemented, the targeting efforts can produce fiscal savings from price-subsidy reform despite giving the compensation.
Targeting by social category can be done through targeted cash or near-cash transfers such as limiting benefits to the poor; children or pensioners, or to households in certain geographical regions.
Coupons can be allocated to allow targeted households to consume a certain “lifeline” amount of subsidised food or fuel products. Social safety nets are more cost effective and have a much more profound impact than generalised price subsidies.
In deciding how to target compensation and price subsidies, the government needs to adopt a more holistic approach and have the ability to determine and identify the targeted group; the administrative cost and capacity as well as economic cost to deliver the assistance and implement the targeted scheme; and more importantly, the political support for implementing the targeting scheme.
The design of the targeting mechanism must meet the goals of efficiency and equity in ensuring the needy and deserving group will receive the adequate protection and income support when implementing the price subsidy reform.
Means test
This requires the ability to design and implement an effective means test. A means test sets an income threshold above which benefits are phased out.
Target benefits to population groups will be on the basis of socioeconomic and demographic characteristics. Categorical targeting goes by the level of income and cost of living, while geographical targeting is for those residing in specific areas within a country.
Shifting from universal-access subsidy programme to targeted programme requires a comprehensive and transparent mechanism with clear objectives to identify poor households and to deliver benefits.
The introduction of automatic pricing mechanisms; and phased-in price increases to smoothen adjustment – the government can consider linking the subsidy or cash benefit to a self-targeting work requirement.
The form of assistance can be made in-kind or monetary through food-for-work programmes; attending short-term training; and the requirement for self-improvement.
Such self-targeting programmes provide an exit incentive, that is the recipients can opt out of the programmes once their financial/income conditions have improved.
The implementation of difficult subsidy reform needs a strong political courage. Transparency and stakeholder dialogues are the cornerstone of a subsidy reform in determining its design, passage and implementation.
Transparent and extensive communication is needed to explain why we have to shift from product subsidy to targeted households so as to benefit the vulnerable households; how the resources saved from a universal subsidy programme will be redeployed for other priority spending such as investment in infrastructure, pension funds for an ageing population, provide better healthcare and education for future generations and help combat climate change.
In addition, the government needs to regularly publish information on the size of the targeted social assistance programme and how this affect its budget.
Lee Heng Guie is Socio-Economic Research Centre executive director. The views expressed here are the writer’s own.
