Home Opinion Why direct support is more efficient than subsidies and how to transition

Why direct support is more efficient than subsidies and how to transition

Safety nets versus subsidies

by Haneen Sayed

Before the Beirut port explosion, which took the lives of close to 200 people, injured thousands, and destroyed swaths of the capital, the Lebanese people faced a deteriorating economic and social situation: the banking crisis, the COVID-19 pandemic, and a 10-year humanitarian crisis caused by the unprecedented influx of displaced Syrians.

The pre-explosion economy was already in a severe contraction, with real GDP growth in 2020 expected to be well into the negative double digits. Job losses were very high with more than 220,000 jobs temporarily or permanently lost between October 2019 and February 2020, according to local publisher Infopro. More recent results from web-based surveys conducted in April-May 2020 by the World Food Programme showed that one out of every three Lebanese has been pushed into unemployment, while one in five respondents faced income reductions.

The severe contraction of the Lebanese economy is estimated by the World Bank to result in more than a doubling of extreme poverty to 22 percent in 2020 from 10 percent in 2012, and an increase in overall poverty to 45 percent in 2020. This translates into approximately 1.7 million people (350,000 households) falling under the overall poverty line, of which 841,000 people (156,000 households) will be under the extreme/food poverty line.

To partially mitigate the impact of the crisis on households, the Banque Du Liban (BDL) allows wholesalers and the government to import wheat, medication, and fuel at the rate of LBP 1,507 per USD for 85 to 90 percent of the value of the items (versus the market rates). In May 2020, a basket of key essential food and non-food commodities was also included in the subsidy scheme, providing the rate of LBP 3,900 for 100 percent of the value of the items. The cost of this scheme in 2020 – being the difference between the BDL rate and that of the black market – is estimated by the BDL to be in the billions of dollars, creating a drain on scarce foreign exchange reserves.

In addition, the Government of Lebanon (GOL) has been running other subsidy schemes prior to the economic crisis to ensure basic services to portions of the population and support the income of specific economic groups. These included, but are not limited to, the annual budgetary transfer to Electricité du Liban (EDL), wheat (price) subsidy, interest rate subsidy, rent subsidy, tobacco subsidy and other in-kind subsidies. The average annual budgetary transfers to EDL alone over the past decade averaged 3.8 percent of GDP.

By contrast, Lebanon spends very little on social safety nets (SSN) for the poor and vulnerable. In 2020, such programs are estimated by World Bank staff to reach no more than 0.35 percent of GDP – far less than the 1-2 percent that most countries spend.

Direct support to families versus general subsidies

Governments do often use generalized subsidies to lower cost of living for poor households and to shield households from price fluctuations – hence, Lebanon is not alone in its approach. However, subsidies are a blunt and inefficient instrument. They can be regressive, benefiting the rich more than the poor. IMF studies show only 7 percent of fuel subsidy spending in poor countries benefits the poorest quintile of households, while 43 percent benefit the richest quintile.

In Lebanon, only 24 percent of the poorest quintile own motor vehicles versus 80 percent of the richest quintile, according to Household Budget Surveys administered by the Central Administration of Statistics in 2011 and 2012, hence much of the gasoline subsidy is consumed by the rich. Subsidies are also unpredictable on state budgets, prone to leakages, and difficult to target. They can also have distortionary effects on economic incentives.

International experience shows that a shift in government expenditures from generalized subsidies to direct support to the poor could result in an improvement in public welfare. Hence, the recent policy direction of the Government of Lebanon and the BDL to shift away from price support (FX subsides on commodities and price controls) towards direct transfers to households through a social assistance program is a step in the right direction. The price supports are unaffordable during the current crisis and are inefficient as policy instruments to help the poor and vulnerable.

However, the shift must be planned in advance and well implemented. To do so, several steps need to be taken in advance. Firstly, an assessment of the size of the price subsidy in question and understanding who benefits from it is needed. Secondly, the impact of the subsidy removal on households, especially of the poor and near-poor, and on businesses needs to be understood. Thirdly, it is critical to understand the readiness in terms of adequacy and efficiency of the existing social protection system, and social safety nets (SSN) in particular such as the National Poverty Targeting Program (NPTP).

Finally, to ensure the reform is implementable, financing of the fiscal cost of the alternative compensation scheme needs to be ensured. With high level commitment, the four steps, if commenced immediately, could be achieved in 6 months.

In Lebanon, the removal of subsidies must be accompanied by a large scale-up and strengthening of Lebanon’s SSN program such as the NPTP to reach at least all the 156,000 extreme-poor households. While the NPTP has demonstrated the ability to channel targeted social assistance to poor and vulnerable Lebanese households in the form of e-card food vouchers and health and education benefits, its impact is limited by low coverage of the poor and underfunding.

The current NPTP provides e-card vouchers to 15,000 households, and health and education benefits to around 43,000 households representing only 1.04 percent and 4.5 percent of all Lebanese households, respectively, already short of the estimated share of extreme poor and poor households even at pre-crisis levels (16 percent and 37 percent, respectively).

But reaching only the 156,000 extreme poor households with social assistance will not be sufficient to cushion the impact of price increases brought on by subsidy reform on the Lebanese population. Lebanon
may also need to consider a broad-coverage SSN program that will reach the middle class (between 60-80 percent of the population). To achieve this, several critical considerations need to be taken into account.

Firstly, Lebanon needs to invest in building the systems that must underlie an effective and transparent SSN program. A key feature of such programs is the development of a national integrated social registry – based on a unique identifier – which would serve as a gateway for people to be considered for inclusion in one or more social programs based on an assessment of their needs and conditions. Such a social registry could reduce transaction costs and increase access for citizens, produce cost-savings and efficiency of user programs, and serve as a powerful platform to coordinate social policy.

In addition, a robust grievance redress mechanism that receives citizen’s complaints and addresses them adequately must be in place. Furthermore, third-party monitoring of the program and stakeholder engagement is important for transparency and credibility of such programs.

The vital role of communication

Secondly, a well-prepared communication and out-reach campaign must precede and accompany any subsidy reform program (i.e. transforming the subsidy into a broad-coverage SSN program). International experience
demonstrates that well-planned and consistent communication is critical for successful subsidy reforms.

Making effective use of available channels to provide transparency and clarity on the role of the program, its objectives, operation rules, and results, are necessary to tackle information asymmetries and concerns of different sectors of the population. Reforms can succeed only if an informed public accepts and supports the reform’s rationale. Clearly communicating who will be impacted, and how, is vital to generate public buy-in.

Finally, and maybe most importantly, the SSN program must be adequately funded through the GOL budget. This poses a particular challenge for Lebanon at this juncture as there is no room in the budget for additional spending. Hence, it is critical to embed subsidy reform in an IMF program where reforms will be committed to and where re-prioritization is made from wasteful spending to the much needed SSN program. International funding can help fill the short-term funding needs until Lebanon can create the fiscal space in the budget to self-finance its SSN program. Ultimately, there is no other path than for Lebanon to undertake much needed reforms that will reduce poverty and bring social stability

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Haneen Sayed

Haneen Sayed is the Lead Social Protection and Jobs Specialist for the World Bank.

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