Economic Impacts of Subsidy Rationalization Malaysia

Khalid Abdul Hamid and Zakariah Abdul Rashid

Chapter 9 in Energy Market Integration in East Asia: Theories, Electricity Sector and Subsidies, pp 207-252 from Economic Research Institute for ASEAN and East Asia (ERIA)

Abstract: Subsidy rationalization efforts by governments remain constrained as many policy plans have been delayed based on argument that subsidy policies have objectives that go beyond economic rationale. This paper examines Malaysia’s energy subsidy experience, in terms of the direct and indirect effects of subsidy distribution and reallocation, and considers whether the rationale for subsidy policy in the case of energy has been justified. Subsidy removal impacts how efficient an economy performs in terms: of energy product prices; cost of production; transportation services; government budget; household consumption: and general level of prices. As a subsidy row is non-existence in the 2005 published Malaysian input-output (I-O) table which would inform current policy, we create a subsidy row in the form of total fuel subsidy which has been constructed to assess the expected impacts of phasing out fuel subsidies in the short, medium and long run. This study employs Leontief’s and a computable general equilibrium (CGE) model based on national and social accounts of the Malaysian economy, disaggregating and constructing a hybrid energy I-O matrix and partitioning the I-O table into energy and non-energy blocks. An explicit representation of the impacts of energy products; especially those which have received greater amounts of subsidy is embedded in this modelling. The modelling informs energy pricing, the domains of government intervention in energy markets, and the international experience in mitigating the negative impact of energy pricing reform. Features of the petroleum sector in the Malaysian economy and its interactions with the main economic variables are considered. I-O analysis is used to set a reallocation scheme using changes in wage levels and value added impacted by total fuel subsidy particularly on autonomous spending by households and growth. Finally, the CGE analysis, which is superior in substitution effects compared with I-O analysis, will explain the overall macroeconomic impacts of phasing out subsidies and the impacts of reallocation into related sectors using government expenditure. In conclusion, policy options reliant on cheap energy inputs and delays in subsidy rationalization pose a significant threat for Malaysia’s continuing economic competitiveness in the region.

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