Middle East and North Africa: Universal cash transfers outperform subsidy systems

MENA: Uniform cash transfers are better than subsidies

●      Handing over the cash card from the apparatus.

-       Countries of the Middle East and North Africa region are characterized by a heavy focus on subsidizing consumer goods, especially water, food and energy, and systems of subsidies are often intended to protect the poor and most needy; but their effectiveness in reducing poverty is limited, and subsidy benefits that aim to protect the poor usually end up benefiting the middle and richer classes more than others. This has been confirmed for energy subsidies.!!

-       But even for food subsidies, leakage of subsidy benefits to the non-poor appears to be widespread...! In Egypt, the food subsidy system covers most of the poor and most needy groups, and middle-income people; and although the targeting mechanism has improved, more than half of households in the richest 20% of the population receive subsidy benefits. In Tunisia, the average per capita share of food and energy subsidies received by the richest households is three times what the poorest households receive.

-       Subsidies artificially depress prices, creating large economic distortions. Despite the rise in global grain prices for example, artificially low bread prices lead to overconsumption, with demand higher than it would otherwise be. Food subsidies misdirect investment on the production side and encourage the creation of parallel markets. Fuel and water subsidies lead to wasteful consumption by failing to give consumers and firms the correct signals to reduce their dependence on these products. This in turn affects the competitiveness of the economy and limits the adoption of cleaner, more efficient technologies.

-       Subsidies impose a heavy burden on public finances, which grows with rising world prices, and they divert already scarce public resources away from priorities like investments in health care and education..... A country like Egypt spends about 1.4% of its GDP on its food subsidy program....., and 2.6% on energy subsidies (Public Social Expenditure Review for Egypt, and International Monetary Fund data for 2020). In 2021, the Tunisian government spent about 1.7% of its GDP on food subsidies and 2.5% on energy subsidies (Ministry of Finance, 2022).!!

-       Despite the drawbacks of subsidies, reforming subsidy systems rarely gains the support of decision-makers, for several reasons, not least the failure to explain the rationale for reform to citizens. The argument often heard is that removing subsidies could lead to unrest and riots. And because well-off people are the biggest beneficiaries of subsidies, have a loud voice, and the capacity to organize protests, this is a legitimate concern for political leaders.!!

-       However, there are approaches that can make subsidy reform acceptable even to the middle class. One such approach is replacing subsidies with cash transfers to almost all citizens. Uniform transfers to everyone instead of subsidies are easier to justify, relatively easier to implement, and progressive in effect (the poor benefit relatively more because their incomes are lower, and—unlike transfers targeted only at the poor and most needy—they take into account middle-class concerns).!

-       If these reforms are accompanied by media campaigns to explain the need for change, and by dialogue with the public, the likelihood of success increases. Adopting a system of uniform transfers increases financial inclusion (recipients need to open bank accounts), and once a uniform transfer system is in place, it can be used to facilitate other reforms such as the introduction of carbon taxes or taxes on sugar and tobacco.

- These ideas are not new; there is a studyfor theWorld Bank recently published that explores the results of providing a universal basic income to everyone, and there are also manyacademicarticles that address this topic. And within the region, Iran has already followed thisrulebook. In 2010, the Iranian government announced that it would largely eliminate energy and bread subsidies. And instead of subsidies, it deposited, even before the reform was implemented, 445,000 Iranian rials per person (40 US dollars in 2011, or 90 dollars on a purchasing power parity basis) into bank accounts already existing or newly created for all registered individuals.

-       This amount became available immediately on the day the subsidy reform was implemented, so the subsidy cut and the payment of compensation were synchronized. The reform received broad acceptance despite gasoline prices rising by 400%, diesel by 900% and bread prices doubling. Because the 2010 price reform lacked a mechanism for automatic price adjustment, subsidies reverted to their previous levels, and in May of this year Iranian authorities repeated the approach by now directing cash transfers to the lowest nine deciles on the income ladder.

-       The case of Iran shows that subsidy reform accompanied by the correct compensation mechanism can be broadly acceptable to the population, and when the necessary infrastructure exists it can be used repeatedly. Like Iran, Jordan implemented similar subsidy reforms in 2015 that included extended compensation for about two-thirds of the poorest households, and the program achieved similar success. More countries in the Middle East and North Africa should draw lessons from these experiences and study whether providing short-term compensation makes price reforms palatable and acceptable.

-       It is always tempting to postpone difficult decisions. But public spending after the waning of the COVID-19 pandemic is under pressure, and with rising world food and fuel prices, many governments can no longer afford the consequences of failing to reform their public expenditures. With universal transfers to everyone as an alternative, there is a realistic path to wean the region's economies off dependency on subsidy systems.!