Eliminating Fuel Subsidy in Indonesia: Designing

Alternative Policies and A Behavioral Approach of

Assessing Households Preferences Among Them

Rimawan Pradiptyo
Gumilang Aryo Sahadewo
Penelitian dan Pelatihan Ekonomika dan Bisnis (P2EB)
Fakultas Ekonomika dan Bisnis (FEB)
Universitas Gadjah Mada
 Fuel Subsidy
Fuel subsidy has been implementing in 39 countries,
mainly oil producing countries, since 1960s and
1970s
General pattern:
Fuel subsidy
Low quality of fuel (gasoline/petrol)
RON 87 90
No international market for < RON 92
Or Both
Even for a net oil exporters, fuel subsidy is a costly
policy
It would create more serious problem for net
oil importers
It would be the worst scenario for net oil
importers who also suffer from budgetary
deficit and current account deficit (double
deficits) owing to maintaining the fuel subsidy
Impact of Fuel Subsidy
It creates tremendous burden to national
budget
Unfortunately the recipients do not feel
that they have been subsidized
It may contribute to the deficit of current
account for net oil importer countries
It increases the vulnerability of a nation
to other countries.
The subsidy has been enjoyed mostly by
middle and high income households who
posses motor cycles and cars
It exacerbates income distribution
Lost opportunity for welfare improvement
due to misallocation of resources
 Fuel Subsidy in Indonesia
Prior to 2004, Indonesia was a net oil Subsidized Petrol Price in Indonesia 2008-
exporter country
A member of OPEC 2013
7000 Rp650
In 1970s was benefited from oil boom
Rp600 0
During Suhartos era, all kind of fuels 6000 0 Rp550
had been subsidized since early 1970s 0
Kerosene 5000 Rp500
Diesel oil Rp450 0
0
Gasoline/petrol 4000
3 times reduction June
Fuel oil within 3 months 13
Aviation fuel 3000
SBYs era
Post Suhartos era, fuel subsidy has
Habibies
been reducing gradually 2000
Era
1998 subsidy to aviation fuel was lifted
1999 subsidy to fuel oil and diesel oil for 1000 Gus Durs
marine transportation was eliminated Era (freely
floating)
2001 subsidy to diesel oil for mining and 0
international transportation was
eliminated
 Fuel Subsidy in Indonesia (contd)
In 2007 subsidy to kerosene had been reduced Energy Subsidy Trillion Rp
substantially and a conversion from kerosene to
gas had been undergone nationally. 300 160
Since 2009, the price of subsidized and non- International
140
subsidized petrol were: 250 Oil Price
RON 88 (Premium) Subsidized Price = 120
Rp4500/liter (US$ 0.45/liter) 200
RON 92 (Pertamax) Non Subsidized = 100
Rp10,200/liter (US$ 1.02/liter)
150 80
RON 95 (Pertamax Plus) Non Subsidized
= R10,500/liter (US$ 1.05/liter) 60
In 2012 fuel subsidy Rp211.9 trillion ($21.19 100
billion) or 61.1% of total subsidy, electricity 40
subsidy Rp94.6 trillion ($9.46 billion) or 27.3% 50
of total subsidy. 20
Food and farming subsidy only accounted
for 5.5% and 4% respectively 0 0
2005 2006 2007 2008 2009 2010 2011 2012
The allocation of energy subsidy in revised Subsidi BBM Subsidi Listrik CPI High
budget 2013 was Rp309.9 trillion ($31 billion)!!
 Pattern of Petrol Consumption
Volume of consumption of petrol 2010 (in 000 liter) 80,000 8,000
75,000 7,800
2,200,000
70,000 7,600
2,100,000 65,000 7,400

2,000,000 60,000 7,200

55,000 7,000
1,900,000
50,000 6,800
1,800,000 45,000 6,600
40,000 6,400
1,700,000
35,000 6,200
1,600,000 30,000 6,000

1,500,000
Jan Feb Mar Apl Mei Jun Jul Aug Sept Okt Nov Des
1 2 3 4 5 6 7 8 9 10 11 12 13 14
Pertamax 39,8 39,5 40,3 38,6 36,2 45,7 49,7 70,4 77,2 79,5 74,0 78,7
Premium 1,81 1,68 1,90 1,86 1,92 1,87 1,99 1,91 2,02 1,96 1,94 2,00
volume (KL) harga (Rp/lt)
The graph on the right hand side occurred in Feb 2011 when market price reached
Rp7500/liter whereas the administered price was Rp4500/liter
Subsidized fuel consumption (Ministry of
Energy and Mineral Resources, 2010):
Land transportation: 90%, of which Consumption of
Subsidized Fuel Subsidy (Rp/liter)
Total Subsidy
Private cars: 53% (liters/month)
Received/Month

Motor cycles: 40%

Freight 4%
Public transport 3% 0 Rp4.500 Rp0
World Bank (2011): 50% of the highest
income households consumed 84% of
subsidized gasoline, whereas 10% the lowest
income households consumed only less than
1% of subsidized gasoline. 20 Rp4.500 Rp90.000
The National Socioeconomic Survey
(SUSENAS) 2010 data: 5% the highest
income households consumed 82 liter
subsidized gasoline/month, whereas of 5%
the lowest income households, only 1,7% 100 Rp4.500 Rp450.000
consumed directly subsidized gasoline.
 Rational Consumption
x2 Utility function x2

x*
Budget
Constrain
x*
x1 Contours of
objective x1
function
 Compensated Fuel Consumption
The value of fuel subsidy tends to
increase all the time due to:
Subsidized Economic growth
Fuel Volatility of international oil price
Volatility of exchange rate
Switching from non-subsidized to
subsidized fuel
Fuel smuggling
x** Maintaining fuel subsidy is similar to
x*
maintain a growing time bomb in
the economy!!!
Rp45 Trillion Rp209.9
Trillion
Other goods and
services
2009 2013
However... It is not easy to reduce
fuel subsidy!!!
 Asymmetric impact of fuel subsidy
reduction
Annual Inflation As a normal good, subsidy to
20%
18%
fuel should be eliminated since
16%
RON 88/Diesel increased RON 88 increased from the subsidy creates
14%
From Rp1810/Rp1650
To Rp2400/Rp2100
Rp4500 to Rp6000
misallocation of resources
12%
10%
However any attempt to
8% remove the subsidy will affect
6%
RON 88/Diesel
poor households in term of
4%
2%
Increased from Rp2400/Rp2100 high inflation rate
To Rp4500/Rp4300
0% Although the impact on
04 04 04 05 05 05 05 06 06 06 06 07 07 07 07 08 08 08 08 09 09 09 09
inflation tend to be temporary,
- - - - - - - - - - - - - - - - - - - - - - - many believe that the impact is
AprJul OctJanAprJul OctJanAprJul OctJanAprJul OctJanAprJul OctJanAprJul Oct
Source: Ministry of Finance Indonesia, 2013
lasting longer.
Policy options for the Government
Challenge:
Limiting
subsidized fuel
How to reduce fuel subsidy, and at
consumption
(1)
the same time
Increasing
Regulating
consumption Minimizing the adverse impact of
fuel price
(8)
of subsidized
fuel
fuel subsidy reduction
manually(2) Complexity:
The existence of informal traders
Government
policy
of gasoline/petrol
Regulating
RON 90
options
consumption Distribution of petrol station is
of subsidized
(7) fuel using RFID patchy
Bureaucrats keen on using price policy,
(3)

but politicians tend to use non-price

2 prices
subsidized
Alternative
energy (CNG,
policies for political reasons.
fuel(6) LPG, etc) (5) The problem was more complicated
since
What are the reasonable options??
Any attempt to pursue non-price policies to
Gradual increase reduce fuel subsidy dooms to failure.
RON 90
of price Price discrimination of subsidized fuel also
dooms to failure due to the existence of informal
fuel traders in Indonesia
Fuel subsidy may
Minimum political
be reduced by Two alternative policies:
costs
50% Replace RON 88 with RON 90
the new price as linear combination
The change in between subsidized and non
Minimum cost of price is easily subsidized gasoline/petrol
inflation acceptable by
society Followed by direct compensation to
targeted households
Shocks to Gradual annual increase of subsidized fuel
A better impact to
economy tend to
environment until its price converges to market price
be minimum
 Recent Attempts to reduce fuel subsidy

Recommendation 2012 Plan to implement Juni/13

from UGM-ITB-UI dual price of
was refused (gradual Plan to increased fuel subsidized fuel was Increased RON 88
increased of price by Rp1500 was cancelled price by Rp2000 and
Rp500/liter annually) cancelled due to diesel for Rp1000
massive
demonstrations
2011 Apr/13
Behavioural Aspects of Removal of Fuel Subsidy
Evidences showed that individuals placed
higher valuation to goods that belongs to
Status them (Kahneman et al., 1990, Knetsch,
quo bias 1994)
Loss
aversion
Households in Indonesia feel as if they
have been endowed with the subsidy
Interte
mporal therefore households are going to perceive
decisio
n elimination of the subsidy as a loss.
GoI attempts to phase-out fuel subsidy
failed, even under the pressure of
budgetary burden, which create strong
Fossil Fuel Subsidy inertia in policymaking and households
response toward the policy.
 Loss Aversion
People tend to perceive forgone gain
to be more acceptable than losses
(Thaler and Benartzi, 2004) however it
is quite difficult to frame elimination
of the subsidy scheme as forgone
gain.
Idson et al. (1999) showed that the
peoples intensity toward gain is greater
than that toward nonloss and peoples
intensity toward loss is greater than
that toward nongain.
For example, those who consume no
subsidized fuel at all is going to
perceive elimination of the subsidy as
non-loss.
Intertemporal Choices
Individuals have difficulties integrating
intertemporal choice prospect into their
existing plan. Caplin and Leahy (2001)
suggested that uncertainty about the future
influence individuals emotions that lead to
time inconsistency.
Furthermore, we are not good in making
future plans (Bone et al., 2003; Hey, 2005).
This insights suggest that individuals should
not be confronted to policy options with many
number of intertemporal variations.
We integrate a time dimension in the policy
options to test whether individuals opt to incur
the loss immediately or delay it.
 Problems and Objectives
The GoI has been facing tremendous
budgetary pressure due to fluctuations in
international oil price.
The adverse impact of the plan to the welfare of
low-income households due to inflation
Is the concern of adverse impact to low-income households justified?
No attempt has been made to inquire households preference.
No individuals would want to lose the subsidy.
Formulation of exit strategies must be based on acceptability, not on popularity.
OBJECTIVES:
To observe the most acceptable exit strategy for eliminating fuel subsidy scheme
based on households perspectives.
A guidance to develop a larger scale research project
Recommendation for policy makers
 We explore the use of experimental method to answer the problem

2 Experiment subjects
Literature review and
interview with relevant Construct choose between
stakeholders hypothetical hypothetical scheme
1 policy scheme 3

Hypothetical policy schemes are based on these scenarios:

Straight Vs Gradual Elimination
Reallocation to wide-ranging (non-earmarked) programs Vs
Reallocation to specific (earmarked) programs
 Community Preference-Based Strategy
How do community assess
alternative policies:
Elimination of the subsidy
Reallocation of the resources
Individuals have difficulties to
perform monetary valuation of
alternative policies (Rutherford, et al,
1998, Kahneman, et al, 1999)
Kahneman et al (1998) found
consistency in individuals
assessment of relative values
This study used paired
comparison choices
It is a conventional
psychometric method for
ordering preferences among
objects of interest (David,
1988; Chuenpagdee et al.,
2001).
Output: ordering of
preferences among stated
alternative (David, 1988).
 Laboratory Based Survey
Challenges:
How to use paired-comparison
choices to respondents? Experiment
How to use experimental approach
to design a policy recommendation Laboratory-
that is applicable in real sector? Based
Survey
Laboratory-based survey is a combine
method between a survey and an
experimental method in order to Survey
measure households preferences
among alternative policies
 Laboratory-Based Survey (contd)
Participants faced 10 pairwise comparisons in the first sessions and 45
pairwise comparisons in the second session.
Participants faced 36 prospects comparisons in the third session and the
results from this session is drawn randomly by the participant to determine
her/his reward.
The time for each participant to finish the survey range from 60-75
minutes.
The maximum reward for participants was Rp200,000 or about US$23.
Participants who obtained random draw of zero or negative payoff are
allowed to choose between a souvenir or Rp15,000 (about US$1.80).
 Subjects of Laboratory-Based Survey
The experiment was conducted in Yogyakarta, involving 335 subjects,
representing 335 households.

Households who do not Households who only posses

posses motorcycle or car motorcycle
(Reference Group)

Households who posses cars

Households who posses low- which price is twice to those of
budget MPV low-budget MPV or posses
more than one car
Sampling Procedure
Proposed Alternative Policies
 Alternative Policy Options
Pairwise choices of
Elimination of Fuel Subsidy:
Session 1 : 10 questions
Session 2 : 45 questions
Straight vs
Fuel Subsidy
Gradual
Elimination
Elimination
Pairwise Choices of Decision
Making Under Risk
Session 3 : 32 questions
Child Vaccination and other
government programs
Mass Rapid Transportation (MRT) dan
other government programs
Paying for Foreign Government Debt
dan other government programs
Child Vaccinations and Mass Rapid
Transportation (MRT)
Various Government Programs
 Notes
Respondents were limited Status quo bias options,
only to head of such as, no subsidy
households or a member reduction will take place,
of households who has were excluded from the
income
options
Students were not included
in sampling frame as Reallocation of subsidy in
majority of students have term of direct transfer was
been financed fully by their also excluded from the
parents. options.
Example of Pairwise Choices in Session 1 and 2
Example of Pairwise Choices in
Session 3
A B

Rp 200.000 ; 80% Rp 175.000 with Certainty

Rp 0 ;20% (100%)
A & B Are the
Choose A Choose B
Same
 Characteristics of the Subjects
Gender Income
Age
Group Male Female (Average)
(average) Total
N % N %
No motor
42.17 34 36.2 60 63.8 94 Rp677,431
vehicle
Motorcycle only 31.97 115 71.4 46 28.6 161 Rp1,835,038

Car 39.13 54 67.5 26 32.5 80 Rp6,397,491

Total 38.1 203 60.60% 132 39.40% 335 Rp2,517,399

Education level
Group No formal education Elementary Junior-high High-school Higher education
N % N % N % N % N %
No motor
vehicle 11 11.7 31 33 28 29.8 23 24.5 1 1.1

Motorcycle only 1 0.6 7 4.3 27 16.8 93 57.8 33 20.5

Car 0 0 1 1.3 3 3.8 21 26.3 55 68.8
28
Total 12 3.6 39 11.6 58 17.3 137 40.9 89 26.6
 Analytical Tool
Kahneman et al (1998) found consistency in individuals
assessment of relative value
The relative value can be used to determine the socially acceptable
policy
There are various ways in measuring relative value across
alternative choices
Analytical Hierarchy Process (AHP)
Scale of relative important (Dunn-Rankin, 1983, Cheunpagdee, 1998,
2001)
Results from Session 1
Result from Session 2
 Does Vehicle Ownership Matter?

The regressor in specification 1 uses group dummy variables, which corresponds to the 4 groups according to ownership
of vehicle. The regressor in specification 2 is a more specific grouping, where value of 1 indicates ownership of at least 1
car and of 0 otherwise. We do not report the pairwise dummies. 32
Marginal Effect of Direct vs Gradual
Elimination
Result (contd)
So.. For whom did they fight for??