The Impact of Diverting a Fuel Subsidy to the Agricultural Sector on Income Distribution and Poverty

Abstract

Fuel subsidy is one of the various programs and measures undertaken by the government to alleviate poverty and at the same time to promote growth. As a result of a continuous increase in crude oil price at international levels, the burden of fuel subsidy on the government has become bigger. Thus, the government tries to reduce fuel subsidy gradually. The immediate impact of a reduction in fuel subsidy is an increase in the price of fuel at the retail/eve/. Then, there is a chain effect of an increase in price of fuel to the price of other goods and services. The end result is a decrease in purchasing power of the general consumer. To overcome this problem, the government introduces a direct transfer of payment to poor households, but this compensation is too small to counter the increase in the general price level. At the same time, it is found that this program has a negative impact on macro-economic performance and an increase in poverty, income disparity, and the depth of poverty. As an alternative to the direct cash aid to poor households, the government may transfer fuel subsidy to the agricultural sector. The purpose of this study is to analyze the impact of the diversion of fuel subsidy to the non-food crops in the agricultural sector on income and the poverty in Indonesia. This study employs a Computable General Equilibrium (CGE) model. The Foster-Greer-Thorbecke (FGT} index is used to measure various poverty indicators, such as head count, poverty gap and poverty severity indices. The households are classified into four categories; urban non-poor, urban poor, rural non-poor, and rural poor. Our simulation results show that diverting fuel subsidy by a certain percentage to non-food crops is able to increase households' income, thus reducing poverty.