Energy Subsidies, Public Investment and Endogenous Growth

Mundaca, Gabriela (2015): Energy Subsidies, Public Investment and Endogenous Growth.

Abstract

This paper deals with impacts of fossil fuel subsidy reform on economic growth, focusing mostly on the countries of the Middle East and East Africa (MENA) region. We first develop a theoretical growth model, and use it to demonstrate that a country can achieve higher levels of economic growth if the government reduces its energy subsidies. Our empirical work confirms the main results from the theoretical model. That is, a country that initially subsidizes its fossil fuels, and then eliminates or reduces these subsidies, will as a result experience higher economic GDP per capita growth, higher employment, and greater levels of labor force participation, especially among the youth. These effects are strongest in countries where fuel subsidies are generally high, such as those in the MENA Region. We here predict that for a given level of subsidy, a 20 cents average increase in the gasoline and diesel price per liter can increase the GDP per capita growth rate by about 0.46 percent and 0.24 percent, respectively. In the MENA countries, savings in subsidies seem to be earmarked by the region’s governments to health expenditures, education expenditures and public investment in infrastructure. These channels appear to be strong contributing factors to higher long-run growth when fuel subsidies are reduced.

• Item Type: MPRA Paper
• Language: English
• Keywords: energy subsidies, economic growth, public investment
• Subjects: Q - Agricultural and Natural Resource Economics ; Environmental and Ecological Economics > Q3 - Nonrenewable Resources and Conservation; Q - Agricultural and Natural Resource Economics ; Environmental and Ecological Economics > Q4 - Energy; Q - Agricultural and Natural Resource Economics ; Environmental and Ecological Economics > Q4 - Energy > Q43 - Energy and the Macroeconomy; Q - Agricultural and Natural Resource Economics ; Environmental and Ecological Economics > Q4 - Energy > Q48 - Government Policy

References

Aghion P. and P. Howitt (1998). “Endogenous Growth Theory.” The MIT Press, Cambridge, Massachusetts, U.S.A.

Arellano M. and O. Bover (1995). “Another look at the instrumental variables estimation of error-components models.” Journal of Econometrics 68, 29 – 51.

Blundell, R. and S. Bond (1998). “Initial Conditions and Moment Restrictions in Dynamic Panel Data Models.” Journal of Econometrics, 87, 115-143.

Clements, B., D. Coady, S. Fabrizio, S. Gupta, T. Alleyne and C. Sdralevich. (2013). “Energy Subsidy Reform. Lessons and Implications.” Washington DC: International Monetary Fund.

Coady, D., I. Parry, L. Sears and B. Shang. (2015). “How Large Are Global Energy Subsidies?” IMF Working Paper, WP/15/105. Washington DC: International Monetary Fund.

Del Granado, F. J. A., D. Coady and R. Gillingham. (2012). “The Unequal benefits of fuel subsidies: a review of evidence for developing countries.” World Development 40(11), 2234 – 2248.

De Hoyos, R.E. and V. Sarafidis. (2006). “Testing for cross-sectional dependence in panel-data models.” The Stata Journal 6(4), 482 – 496.

International Monetary Fund (2013). “Energy Subsidy Reform: Lessons and Implications.” Washington D.C., U.S.A.

International Monetary Fund (2014b). “Subsidy Reform in the Middle East and North Africa. Recent Progress and Challenges Ahead.” Washington D.C., U.S.A.

International Monetary Fund (2014a). “World Economic Outlook: Legacies, Clouds, Uncertainties.” Washington D.C., USA.

Jones, C.I. (1997). “Introduction to Economic Growth.” First Edition. W.W. Norton and Company, Inc., New York, N.Y. 10110.

Jones, C.I. and D. Vollrath (2013). “Introduction to Economic Growth.” Third Edition. W.W. Norton and Company, Inc., New York, N.Y. 10110.

Manzoor, D., A. Shahmoradi, and I. Haqiqi. (2012), “An Analysis of Energy Price Reform: a CGE Approach,” OPEC Energy Review, Vol. 36, Issue 1, pp. 35–54.

Parry I.W. H. and K. A. Small (2005). “Does Britain or the United States Have the Right Gasoline Tax?” American Economic Review, 95(4), 1276 – 1289.

Romer, P.M. (1986). “Increasing Returns and Long Run Growth,” Journal of Political Economy 94, 1002–37.

Romer, P.M. (1990). “Endogenous Technological Change.” Journal of Political Economy 98, 71 – 102.

Roodman, D. (2009). “How to do xtabond2: An introduction to difference and system GMM in Stata.” The Stata Journal 9(1), 86 – 136.

The World Bank (2014). “Corrosive Subsidies.” World Bank Middle East and North Africa Region. MENA Economic Monitor. Washington D.C., U.S.A.