A political economy theory of fossil fuel subsidy reforms in OECD countries

Abstract

Fossil fuel subsidies continue to be a considerable barrier to meeting the targets of the Paris Agreement. It is thus crucial to understand the political economy of fossil fuel subsidies and their reform. To understand these mechanisms in the developed world, we use a database of different types of fossil fuel subsidy reforms among Organisation for Economic Co-operation and Development (OECD) countries. We find evidence for four intertwined processes i) a market-power mechanism: higher market shares for renewables ease fossil fuel subsidy reforms, and ii) a policy mechanism: reforms reduce the levels of fossil fuel subsidies. Importantly, both effects are contingent on iii) a polity mechanism where institutional quality influences the feasibility and effectiveness of political reforms, and iv) a feedback mechanism where systemic lock-ins determine the effectiveness of market competition. Our results even suggest that reforms carried out by effective governments with low corruption control are associated with increasing subsidies per capita. Renewable energy support can however provide a leverage point to break path-dependencies in fossil fuel-based economies. This turns out to be more effective when coupled with improvements to institutional quality and the insulation of political processes from pro-subsidy interests.