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Lucas Davis has estimated the economic cost of global fuel subsidies. It’s a short and easy to read paper and I think as valuable as any complex paper written in economics. He is estimating only a portion of the economic cost of fossil fuel policy – asking what the “dead weight loss” is due to the existence of consumption subsidies for diesel and regular gasoline around the world. For students thinking back to their supply and demand diagrams, this is a very straightforward theoretical exercise. If we can estimate the shape/slope of the global supply and demand curves for gasoline, and we can impute what the price of gasoline “should” be if there are not subsidies, then we can estimate how much economic loss there is because of the over-consumption of gasoline encouraged by these subsidies.

A very brief reminder. When someone subsidizes a good, it will make consumers more likely to purchase it. Yes, the consumers will like this “gift” … so what is the “social” problem? The problem is that for some units of gasoline, the value enjoyed by consumers is actually lower than the true opportunity costs of producing and delivering and selling the gasoline. Had consumers actually been reacting to the real opportunity cost of the gas and not the subsidized price, there are units that they would never have purchased. It sounds like this is a simple economic curiosity, but dead weight losses are real and true losses. The point of the exercise is to measure how much more value could have been generated for the world had we not “wasted” consumption on extra gasoline and instead had we directed our activities to goods and services that we valued more than their costs.

When Davis does the analysis he comes up with a total global dead weight loss due to fuel consumption subsidies equal to $110 billion per year around the globe. Your mileage may vary about how large this is – the global economy is nearly $90 trillion in size and the global gasoline sector is about $2 trillion. My view is that these are large losses – consider for example that these losses are incurred year after year after year after year. So, if one were to capitalize the value of these losses at prevailing interest rates, you’d find that the present value of the dead weight loss, should they continue on forever, would be close to $3.7 trillion. Yikes. Most of these losses are concentrated in the poor countries that actually subsidize gasoline. The US is not among them. No European nation is among them. The nations include places like Saudi Arabia and Venezuela.

You might have expected to open this paper and read about how awful US production subsidies are. After all, it is hard to read any article on American energy policy that doesn’t argue that American fossil fuels are subsidized and hence we need to subsidize alternatives at least to level the playing field. How true is this? Well, this paper does not estimate global fossil fuel production dead weight losses. But several points should be made:

  1. To the extent that fossil fuel production is subsidized in the United States, it is tiny compared to the amount of consumption subsidized worldwife. Davis, in the paper, asserts that the US production side subsidies are about $4 billion annually. But that is not really a charitable reading of the data. Where do these subsidies come from? They are not subsidies generally unique to fossil fuels, but rather available to many large industrial businesses. These subsidies come from among other things tax deductions and favorable depreciation rules that are available to non-fossil fuel businesses, including alternative energies, as well. So the point is that American production subsidies are small in comparison to global production subsidies. American alternative subsidies are surely huge too, for what it;s worth.
  2. That said, another concern with fossil fuel consumption subsidies is not just that they encourage the consumption of gas that people “don’t really value” but rather we are subsidizing something that already produces negative neighborhood effects, to coin Milton Friedman’s use of the term externalities. So with each extra gallon of gas burned as a result of the subsidies, we produce even more external cost that does not get compensated for by any benefit anywhere. When Davis adds in what economists know about these external costs, it turns out that the global cost of fossil fuel consumption subsidies rises to about $76 billion annually.
  3. I suspect lots of people will read these figures and conclude that we ought to stop the subsidies of fossil fuels. And I’d concur. However, if these simply arguments are convincing, why are we not just as assertive in our desire to end other subsidies, including on things like ethanol which fall right into the same category as fossil fuels, but other goods such as education? Having been a professor for a decade now, it is very clear to me that at the margin we have a lot of people consuming education whose value is less than its opportunity cost, including by yours truly.
  4. What I would like for readers to consider is one more thing. Sure, there are huge external costs of fossil fuels, particularly in their combustion’s impact on human health. Is there ANY case to be made that the production and consumption of fossil fuels produces positive external effects? You don’t need my spiel here about it, I’d like for you to think about it. Studies like Davis’, while excellently done, are intentionally examining only the costs of fossil fuels. Surely there are benefits, and surely there are places where policies are in place that reduce consumption below optimal levels. For example, a gallon of gasoline in Turkey is approaching $10 per gallon. A gallon of gas in England is around $8 per gallon. Even under the worst case estimates of the health damages from combustion of fossil fuels AND the worst case estimates of the cost of carbon due to global warming AND the worst case estimates of the impact of driving on traffic and delays in transportation, you do NOT get anywhere from the equilibrium untaxed-unsubsidized price of gasoline all the way up to $8 to $10 per gallon. Not at all. So, beyond examining the positive externalities of gasoline, we’d have to ask the question of how much underconsumption of gas there is around the world and net that out of our calculation. I really look forward to that being done not just for countries like the UK that clearly have set tax rates too high, but for much of the poor world that is not in places like Venezuela and Saudi Arabia where fossil fuels are not widely available. What is the human cost of global fuel and energy poverty? Is there any economist out there, any policymaker out there, who is taking an unbiased and cool approach to figuring this out? I am not holding my breath, and students looking for a terrific research project that they would like to work on with me are strongly encouraged to think about this.

One Response to “Global Fuel Subsidies”

  1. Harry says:

    I think that would be a great project, WC. It would quantify more precisely the trillions of dollars of annual waste of collectivism, and make me more convinced that Caesar Chavez was misguided in his national energy policy.

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