Subsidy Systems in MENA Nations Need Reform

10.30.2017 | Barbara Gallets
Buying bread with subsidy cards at a bakery in Cairo. via REUTERS/Mohamed Abd El Ghany

The subsidy systems in some Middle East and North African (MENA) nations need an overhaul. In countries such as Lebanon and Egypt, poorly structured subsidies exacerbate extant problems caused by high fiscal deficits, growing populations, and unmet citizen expectations. At least, that was the key message I took away from the CIPE webinar I attended on September 26. Because subsidies affect the economic capacity of millions of low-income families, CIPE hosted a webinar focusing on electricity subsidies in Lebanon and bread subsidies in Egypt to generate dialogue on the topic. My blog aims to highlight the main points from the webinar, which was facilitated by Patrick Mardini of the Lebanese Institute for Market Studies (LIMS) and Reem Abdelhaliem of the Faculty of Economics and Political Science at Cairo University.

Governments implement subsidies as a means to pacify discontented populations. The hope is that if the sticker price of essential commodities—such as bread, rice, oil, and electricity—is kept artificially low, citizens will have less of an incentive to protest poor economic conditions. While this may ease discontent in the short term, the subsidy systems in place often do more harm than good. By keeping prices low, the government bears consistent losses and passes those on to its citizens by elevating taxes and providing lower quality services. Furthermore, widespread corruption within the subsidy system exacerbates economic disparity and prevents the subsidies from benefiting its intended beneficiaries: the poor. Mardini and Abdelhaliem both discussed this during the webinar, using Lebanon and Egypt as prime examples.

In Lebanon, electricity production is delegated to the state-owned enterprise, Electricité du Liban (EDL). According to Mardini, it costs EDL 200-300 Lebanese Pounds (LBP) (0.13-0.20 USD) to produce one Kilowatt-hour (kWh) of electricity. However, EDL subsidizes this cost and charges 35-200 LBP (0.02 and 0.13 USD) per kWh used. The government loses 2-2.5 billion USD every year by maintaining the electricity subsidy. This is 45% of the Lebanese Treasury’s total deficit. The fact that 45% of electricity produced by EDL is lost due to graft (25%), bribes (5%), and technical inefficiencies (15%) exacerbates the already staggering cost the government bears.

Egypt subsidizes essential food items, including wheat, sugar, and oil. These subsidies cost the government 85 billion Egyptian Pounds (4.79 billion USD) in FY2016-2017, with more than 65% subsidizing the cost of bread. According to Abdelhaliem, the Egyptian wheat flour subsidy policy was replaced in July 2017 with a subsidy on loaves of bread. This change occurred due to the level of corrupt practices tied to subsidized flour: 30% of flour meant to feed Egypt’s poor was siphoned off and sold on the black market for a profit prior to July 2017.

Governments in most MENA countries face similar debt because of subsidy programs. An Iraqi participant’s comment highlighted this: subsidies including electricity, food, and social security cost the Iraqi state approximately 13 billion USD every year.

The evidence presented in the webinar suggests that the cost of implementing and maintaining government subsidies on essential goods and services not only creates a deficit in the treasury, but it also prevents government investment in critical infrastructure and service provision. Governments lose more money on subsidies than is worthwhile given the high opportunity cost of maintaining those subsidies. This is evident in the cases of Egypt, Lebanon, and Iraq, where the government implements poorly designed subsidies in an attempt to combat poor service provision and alleviate poverty.

Implementing subsidies gives the impression that the government is assisting citizens by lowering the cost of basic commodities. However, as Mardini pointed out, the government does not bear the cost of these subsidies by itself. Although it appears the government is helping its constituents, citizens are really paying for the full cost of the good being subsidized, albeit indirectly. To pay for subsidies, the government relies on the taxes it requires citizens to pay and, as costs increase, the government raises taxes to cover its increased expenditures. CIPE Egypt Program Director Randa AlZoghbi mentioned that many businesses – especially small ones – opt to remain informal to avoid high tax rates and, as a result, the government receives less tax revenue. This, in turn, limits how much the government can spend on public services. This vicious circle dominates economic policy and is reflected in miscalculated policy decisions.

Not only do citizens pay for subsidies through taxes, but they also pay in lost alternative opportunities. Were subsidies removed or modified, the government could invest that money to improve public services falling under the government’s purview, such as basic public education and health services. As it currently stands, public services in Egypt, Lebanon, Iraq, and elsewhere in the region are chronically underfunded and desperately need investment to improve quality.

AlZoghbi pointed out that the continuation of subsidy programs to the exclusion of the private sector limits growth. Removing subsidies and limiting government involvement in previously subsidized industries would create private sector employment opportunities and lower production costs. Allowing for competition within those sectors would also manage the cost and quality of the previously subsidized good or service. For example, Mardini stated that the Lebanese private sector could employ approximately 30,000 more people if the subsidy on electricity were lifted and private companies were allowed to compete for customers. Furthermore, with the subsidies in place, the cost of local production is 23% more expensive than it could be otherwise.

One of the main themes underlying the entire webinar discussion was the question of who subsidies truly benefit. The subsidy system as it stands in countries like Egypt and Lebanon subsidizes the commodity, offering it at a reduced price for everyone regardless of income. Although the intention is to assist those in poor socioeconomic conditions, the benefits of the subsidies often fail to reach their intended recipients.

Corruption practices among people in positions of power prevent the benefits of subsidies from reaching the poorest in society. As Abdelhaliem and AlZoghbi indicated, the people who control the subsidized good find ways to use the obscurity of the subsidy system to their advantage. This disproportionately affects the poorest in society as, not only can they not afford the commodity without the subsidy, but corruption practices also limits the amount of subsidized good distributed. The increased economic pressure placed on families exacerbates the stratification in society and further limits upward mobility. Rather than easing the economic burden on the poor, subsidies fail to truly assist the poor because the benefits of the program rarely reach them.

During the webinar, Mardini stated that up to 99% of people in Lebanon tap into electricity not generated by EDL. Seventy percent of those depend on a subscription to electricity generated on the black market, 22% on private generators and 7% on generators shared among building residents. Because the state monopolizes the formal electricity market and cannot supply adequate service, the informal market works to mitigate the deficit that causes daily blackouts. Since this is expressly illegal, fair competition is impossible and black market electricity costs up to eight times more than its true production cost. Furthermore, the risks of being caught selling electricity illegally prevent informal businesspeople from buying larger, higher quality generators to improve service.

Similarly, in Egypt, up to 30% of the subsidized wheat flour was sold on the black market for profit before the introduction of subsidies on the finished bread product according to data presented by Abdelhaliem. After the subsidy system was changed in August 2017, the subsidy transferred from the flour to the finished loaf of bread and the government introduced the subsidy cards to improve service. Although these changes decreased wheat theft by 41%, corrupt businesspeople continue to find creative ways to falsify increased demand to receive larger payments from the government.

Corrupt business practices thrive in a subsidy system where the commodity itself is subsidized. Antiquated processes and an unclear supply chain that employs corrupt businesspeople and government officials open the subsidy system to exploitation. Because the subsidy is applied to the commodity itself, it is easy for distributors of the subsidized good to cheat the system for a profit, not only enriching themselves, but also hurting the poor, worsening already poor services, driving up costs, and pushing people into the informal market.

By the end of the webinar, participants recognized that some countries in the Middle East must reevaluate and restructure the mechanisms employed to implement subsidies. The system in place allows for too many opportunities to exploit the system and negatively impacts the people the subsidy is meant to help. In some cases, such as that of electricity production and distribution in Lebanon, Mardini and his organization, LIMS, advocate that the government completely remove the electricity subsidy and allow other companies to compete for customers. Free competition will reach the optimum balance between supply and demand and will help decrease the cost while simultaneously improving the quality of electricity provision. In other cases, such as the food subsidies in Egypt, Iraq, and Lebanon, participants agreed that the subsidy system should be restructured to subsidize the individual instead of the commodity. Providing direct assistance only to the neediest would allow those people to enjoy the benefits of the subsidy system without the subsidy causing unwarranted deficits.

Patrick Mardini of the Lebanese Institute for Market Studies (LIMS) and Reem Abdelhaliem of the Faculty of Economics and Political Science at Cairo University, the hosts of the webinar, also wrote blog posts on subsidies in the MENA region, which can be found here and here, in Arabic. CIPE Program Officer Seif ElKhawanky also wrote an Arabic-language blog post on the need for subsidy reform in the region. If you wish to view or participate in the Arabic language discussion on subsidies in the Middle East and North Africa, visit CIPE’s Arabic-language Facebook page.

Barbara Gallets is a Program Assistant for the Middle East and North Africa team at CIPE.