Latin America Pays for the Price for Fuel Subsidy

Before sitting down in the library, to get on with my dissertation reading, I quickly paged through the Financial Times – one of the few, if only, British newspapers that tends to print interesting Latin American politics/economic articles. Today there was an interesting analysis piece about how Latin American governments are facing increasing pressures to cut fuel subsidies in the face of the ever-increasing oil prices. “Latin America pays the Price for Fuel Subsidy.”

Here in the U.K. a day doesn’t go by without further doom and gloom reports about the negative effects oil price increases are having on the average Brit, especially as they go to fill-up at the petrol station. A news story that is being played out across much of the world.

However in Latin America - as had been the case, up until recently, in Asia – governments have been subsidising petrol prices to tune of some ridiculously large billion-dollar sum. In this way Latin American motorists can still enjoy petrol prices a little as 5p a litre, whilst the rest of the world’s motorists have to dig deeper and deeper into their pockets to fill up their cars.

source: The Financial Times 17/06/2008

Why are they doing this? Perhaps Latin American governments are aware of the vital importance access to cheap petrol is for so many of their citizens. Any sudden increase in prices will surely effect these nations in more ominous ways than we in the West would be effected by such price changes. The FT rarely does economics with a ‘human face’ so these issues don’t get much of a mention in the FT piece. However what they do focus on are the possible consequences a sudden increase in petrol prices may have on inflation.

The reason for the lack of reform is pretty clear. Of all regions in the world, Latin America has most reason to fear the effects of inflation. During the 1970s, 80s and early 90s the pace and scale of price rises corroded the social fabric of many countries. Inflation rates of 100 per cent a year were commonplace, wrecking the ability of governments and businesses to plan for the future. As Guillermo Ortiz, the governor of the Mexican Central Bank, said: “Latin America has gone through high inflation for so long. Lowering the rate has been a cherished achievement.” In Chile, which imports almost all of its fuel needs and where annual inflation was running at 8.9 per cent in May – three times the central bank’s target – the new price subsidies will cut that rate by 0.3 percentage points, according to Angel Cabrera, a local consultant.

An interesting point.

However as the price for oil rises, the subsidies have to increase, and are subsequentlybecoming a conseiderable fiscal burden, which in itself may well curtail government spending in other important areas. The question is whether this outweighs the threat of higher inflation and the problems that would arise from that?

The FT ends by highlighting how cheap access to petrol does little to motivate a lower use of petrol in the long-run, something which mus be a desirable end in itself - be it to combat climate change, to free up some of Latin America’s clogged up innercity roads etc.

More seriously, the subsidies are distorting incentives. While higher oil prices have stimulated many developed countries to save energy and make more efficient use of resources, there has been no sign yet of this happening in Latin America. In Venezuela, for example, domestic petrol consumption is estimated to have doubled over the last five years to around 600,000 barrels a day. The low cost also creates incentives for smugglers, who sell petrol across the border in Colombia, where fuel is much more expensive.