Subsidy rationalisation and urban mobility

Written by Dr Carmelo Ferlito

First published in New Straits Times on May 24, 2024 @ 10:15am

The debate surrounding subsidy rationalisation is heating up.

While the government keeps on reaffirming the willingness to implement such a much-needed reform, details about timing and mechanism remains in the shadow. 

The lack of clarity at this regard is creating nervousness among political commentators and uncertainty among economic agents, which are in the need of more information in order to properly form their expectations and develop rational plans for the future.

I am convinced that rationalisation is necessary; not simply because universal subsidies are regressive, but mostly because they, like price controls, interfere with the price system: prices are the most important information transmission mechanism in the economy and, if the signal gets jammed by distorting waves, economic agents perceive wrong information, form wrong expectations and take bad decisions.

This is translated into the wrong structure of production. When price interferences last for decades, like in Malaysia, getting rid of them is particularly complicated: the memory of the real tune is almost lost, and that tune may create temporary disturbances to ears which are no more used to it.

I believe that the reason behind the delay in the policy implementation has to be found in the price pressures that subsidy rationalisation will bring along. 

According to the World Bank, a complete removal of fuel subsidy will bring a direct impact of 2.1 per cent on the Consumer Price Index (CPI), while the total (direct and indirect) effect could reach nine per cent. 

Politically speaking, and maybe even morally speaking, it is not easy to take responsibility for a policy which may bring a price increase of nine per cent.

At the same time, to study an effective mechanism to support the most fragile segments of society while maintaining the need to rationalise spending and repristinate a soundly functioning price system, it is not easy at all (at this regard, I believe that a system of purpose-vouchers is better than direct cash transfers).

However, I think we should look at the matter in a more holistic manner: dealing with fuel subsidy rationalisation means dealing with the costs of urban mobility. No matter how gradually, rationalisation will impact transport prices and therefore it is important that such an important structural reform is accompanied by a more general reform aiming at strengthening public transportation.

Vouchers or cash-aids can only temporary support people affected by price increases, and they still represent a financial disbursement for the government, which may have further inflationary effects. It is therefore crucial providing the people with alternative modes of transportation.

It may be objected that also investing in infrastructure is a costly exercise. However, megaprojects (infrastructure) can be economically sustainable if we accept that the process cannot be funded by governments. Peter Newman (Curtin University) proposed the so-called Entrepreneur Rail Model (ERM), which seems the way to follow for future infrastructure development without stressing public purses.

It is a model of development fully funded with private capital, while government’s role would be to ensure land acquisition and the definition of the regulatory framework.

According to Newman, the ERM can be defined as a proposal developed to plan and deliver rail infrastructure on commercial principles, funded by land development and built, owned, operated and financed by the private sector; it is based around the notion of land value creation.

Being an approach based on the discovery of new markets for rails and development, it cannot be implemented by the government, but it needs private enterprises responsive to market signals. The approach requires a shift in focus from revenues via taxation to value creation.

In the traditional approach, the first step in designing rail infrastructures is usually to predict the number of potential users based on the current land use. Under ERM, instead, candidates for developing the project would need to provide an estimate of private capital to be contributed by combining land redevelopment potential and patronage potential for capital and ongoing costs; only then should they produce transit numbers and detailed routes and regeneration plans.

The big difference is that, with the new approach, entrepreneurs would need to exercise their essential function of imagining the future and to develop a project accordingly, while traditional rail development done by governments is based on current conditions. Such an entrepreneurial action is necessary in order to produce the necessary financing.

Currently, under the “welfare state” model of developing infrastructures, land investors or developers come in later and take windfall profit from the land around stations – a sort of transfer of wealth from ordinary taxpayers to a few landowners.

By contrast, in the Entrepreneur Rail Model the development activity can be – and should be – an integral part of the project from the very beginning. This would introduce also a difference in the way in which cities and urban spaces are conceived, from being the expression of centrally planned activities to becoming the result of urban land value creation shaped by entrepreneurial creativity within the market process.

The role of government remains crucial for land acquisition and the regulatory framework, that goes without saying. The bidding process, for example, could be coordinated by those agencies that are now in charge of developing – with poor results – affordable home projects.

In this way, the process would ensure the achievement of public goals while at the same time granting the necessary profitability to attract investors into the project.

The ERM could help Malaysia reshape its urban and extra-urban transportation landscape, creating also opportunities for development in areas that are currently underdeveloped.

Furthermore, it could push Malaysia toward a more sustainable transport system, creating profit opportunities and without harming the government’s purse.

It seems to me, thus, that embracing the ERM would not only bring the development of an urban mobility system which is sustainable from both an environmental and financial perspective, but that would be also able to offer a solid and affordable alternative to commuters affected by subsidy rationalization.

Indeed, fuel subsidy rationalisation has very much to do with energy transition, a transition that needs a clear and affordable alternative in order to happen.