When oil was $147 (about Rs7,190) a barrel, there was a spate of articles commenting that subsidies in China, India and Indonesia were bad news for oil consumers in the rest of the world, as this would cause demand to grow unchecked. The reduction of such subsidies was seen, among experts in developed countries, as the single action which would reduce the price of oil.
At the time, a criticism of subsidies suggested that countries such as India should put free markets before economic growth and populism. This focus on oil subsidies seemed to divert attention from the major cause of oil demand, that is, the development of a lifestyle which had become reliant on cheap and abundant oil.
Oil has always been a strategic sovereign policy issue. During World War II, US president Franklin D. Roosevelt had met the ruler of Saudi Arabia to enter into an understanding to ensure oil supplies, a relationship that endures till today. Oil has always been the lubricant smoothening the Great Game of war (Britain in Mesopotamia in the 1920s, the US after World War II, the US in Iraq now).
Given that some governments are prepared to wage war for oil, it should not be very surprising that governments in India or China are using much more innocuous tools such as subsidies to help their millions rise out of poverty.
Economies worldwide have known that the uninterrupted economic expansion in the US after World War II was due to cheap oil, most of which was domestically subsidized. Even today, the US subsidizes oil companies in many ways which include lower taxes, lower royalties, low interest rates on oil infrastructure construction bonds and accelerated depreciation rates.
The fact that the Indian government subsidy is more visible does not worsen its economic case for the same.
Further justification for such a subsidy comes from the International Monetary Fund, which has concluded that an increase in oil prices by $5 a barrel can result in a 0.25% drop in output in the long run.
It should, therefore, not be considered surprising that when a country such as India after several decades of relative stagnation hit upon a good growth path it should choose to subsidize oil.
Finally, there’s an argument that unlike in the 1950s we all now know the scarcity of oil and there is a joint responsibility to have the political will to do something about it.
Undoubtedly, such a responsibility behoves us, but domestic political pressures do continue in the face of reason.
Thomas Friedman, writing in his book Hot, Flat and Crowded, says even now the US levies a 54 cent a gallon tariff on ethanol imports from Brazil (this keeps the corn lobby happy) but a 1.25 cent tariff on oil from Saudi Arabia (keeps consumers happy). Oil in the US, according to The New York Times, is cheaper than milk or bottled water.
In contrast to this situation, the political imperatives for subsidies before India and China, which are pitched into a globally competitive world with relatively few competitive advantages, are much stronger.
These subsidies are, thus, not the equivalent of a free kick into the goal as suggested by some, but rather merely a chance to play in the game. If half the world’s populations can achieve even a fractionally better life, the subsidy will have been worth it, for their own nations as well as for others.
Given that energy subsidies are not just a freebie but an economic imperative for developing countries, it would make sense if there were acceptance that the burden of belt tightening may need to fall rather more heavily on those who have for many years benefited from relatively cheap oil. What has changed, now that oil is below $50, is that there is a window of time, for a smoother transition to different technologies and to a new lifestyle.
Consumers in the US and elsewhere can rest assured that it is unlikely that developing Asia will ever fully copy the American model of gas-guzzling vehicles, and also that energy conservation will kick in for Asia at a much earlier point in the industrialization cycle.
For some months, thanks perhaps to the drop in oil prices, there seemed to be a silence on these issues, which seemed to suggest the relegation of energy efficiency from the agenda. However, it is heartening to note, that one of the first policy actions of the new US administration, has been to call for greater fuel efficiency and support a variety of green technologies. It is further gratifying to see that the administration has not suggested in its policy statement that increased demands from India and China were the cause for high oil prices, and has squarely placed the responsibility for bringing about this change on US lawmakers and consumers.
One hopes that this foretells a move away from the subsidy bashing of 2008, and presages a move towards accepting the facts, that is, that the most achievable solution to the problem of demand for oil will be a reduction in use by those who use more rather than by squeezing those who have less.
This is a statesmanlike start to solving a tricky problem and one can hope that US lawmakers will support their new President in this critical initiative.
Govind Sankaranarayanan is CFO, Tata Capital Ltd. He writes on issues related to governance. The views expressed in this column are personal. Write to him at firstname.lastname@example.org