Looking for a Way out the Subsidies Labyrinth in Argentina
This article is based on the CIPPEC paper “Buscando la diagonal. Cómo reducir los subsidios protegiendo a los sectores vulnerables”
In the midst of a heated electoral campaign, subsidies are at the centre of the political debate in Argentina. Shock or gradual approaches to reform those transfers have emerged as the buzzwords of the moment as the presidential race heats up.
Focus on subsidies is undoubtedly merited given their sharp rise from 1.4% of GDP in 2006 to 5% in 2015. Indeed, they are now equivalent to four times the national education budget and almost twice the total investment in infrastructure. Energy subsidies explain roughly 70% of the total, while the remainder majorly goes to transportation, water and sanitation and state-owned companies.
Of this figure, higher-income sectors absorb up to 30%, whilst their lower-income counterparts receive just 10%. What is more, more than half of the subsides are allocated to the Buenos Aires Metropolitan Area (BAMA) where subsidies per inhabitant double those received in the less developed provinces of northern Argentina.
Subsidies are at the heart of macroeconomic imbalances currently faced by Argentina. The cheap energy policy initiated in 2003 has resulted in a rise in consumption and lack of supply, generating an energy trade deficit of more than US$ 6 billion. Spending on subsidies is financed by transfers from the Central Bank to the Treasury, which are, in turn, the principal cause of inflation that could reach an annual rate of 24% in 2015. The increase in demand for dollars, fuelled by inflation and energy imports, have resulted in the adoption of capital controls, a policy measure that goes a long way to explain the deterioration of the Argentine economy in the last three years.
In this context, how can Argentina escape the subsidies labyrinth? In order to understand the social and economic implications of reducing subsidies, we conducted with Magdalena Barafini from CIPPEC a micro-simulation exercise that combines household income and expenditure data from the latest Household Expenditure Survey (2012), aggregate consumption of energy and public transport, tariff scales and budgetary information about subsidies expenditure in the BAMA.
The aim of this exercise was to size-up the medium-term effects of hypothetical price increases for residents of the Buenos Aires Metropolitan Area based on two indicators: (a) the potential fiscal savings caused by a drop in subsidies; and, (b) the change in household income, in particular those of relatively low-income, and, therefore, the incidence of poverty and poverty intensity in the Metropolitan Area. The exercise also analysed how the adoption of a social tariff scheme could mitigate the possible socio-economic effects of an increase in energy and public transport tariffs in the BAMA.
Our calculations suggest that a shock policy could be fraught, resulting in an increase of poverty in the BAMA of around 2%, reducing middle-class households´ incomes by 5%, doubling the share of gas, electricity and public transport in low-income households’ expenditure, alongside an immediate 4% inflation hike. What is more, a 40% devaluation would require a subsidy increase or force an even greater tariff adjustment. Nevertheless, the precedent set by the 2009 rise in gas prices (which spawned a series of protests and legal complaints in the city of Buenos Aires, leading to the indefinite deferral of the adjustment measures) raises serious questions about the political feasibility of shock policies.
On the other hand, a gradual adjustment policy would result in more modest fiscal savings but would serve to mitigate the potential social repercussions of the rise in tariffs. An essential component of this gradual strategy would be the adoption of a social tariff, based on the monetary transfer programs run by ANSES (the National Social Security Administration) such as the Universal Child Allowance, the ´Household Plan´ (Plan Hogar), the ´Progress Program´ (Programa Progresar), family allowances as well as retirement plans and minimum pensions.
Such a strategy would cover around 80% of low-income households, equivalent to 40% of the households in the Buenos Aires Metropolitan Area, and could be reinforced via self-identification mechanisms. In addition to protecting the most vulnerable sectors of society and improving fairness in the allocation of subsidies, this strategy would also offer incentives for private investment.