The economic cost of fuel subsidies in Ghana

Abstract

Apart from fuel subsidies failing to provide the greatest benefits to the poor, they create overconsumption, market inefficiencies and negative environmental and social externalities. This study extended the comprehensive Harberger formula for deadweight loss (DWL) to account for the cross-price substitution effects between the gasoline and diesel markets, estimated the own-price and cross-price elasticities for gasoline and diesel in Africa, and predicted the DWL or economic cost created by gasoline and diesel subsidies in Ghana. Using the simple Harberger formula yields DWL estimates ranging from GHS 2.03 to 8.58 million per year from 2009 to 2014, but accounting for cross-price effects reduces the DWL estimates, from GHS 1.53 to 7.55 million per year, over the same period. However, because fuel demand is highly price inelastic, the DWL created for every GHS 1 million spent on gasoline and diesel subsidies only represents between 0.5% and 2% of subsidy expenditures. These findings suggest that fuel subsidy reforms would be better motivated by other social problems associated with fuel subsidies, such as the ineffective targeting of such subsidies to poorer consumers and the negative externalities of overconsumption, rather than the economic inefficiencies that fuel subsidies generate.