Welfare effects of energy subsidy reform in developing countries

L.F.M. Groot, Thijs Oostveen

Research output: Contribution to journalArticleAcademicpeer-review

Abstract

We analyze the potential welfare effect of energy subsidy reforms. The income distributions of eleven developing countries from different geographical regions are simulated using the assumption that income is lognormally distributed. We use the concept of the compensating variation to measure how much compensation is required to compensate consumers for a price increase in formerly subsidized goods. The behavior of consumers is modeled by a standard Cobb–Douglas and a quasilinear utility function. In the Cobb–Douglas case, a fixed fraction of income is spent on the subsidized good, which does not change after a price increase. With quasilinear preferences, the optimal amount of the subsidized good does not vary with income, but does change as prices change. We show theoretically and empirically that the required compensating variation can be set below the saved expenditures on subsidies, so a budget neutral reform can have a positive effect on social welfare.
Original languageEnglish
Pages (from-to)1926-1944
Number of pages19
JournalReview of Development Economics
Volume23
Issue number4
DOIs
Publication statusPublished - Nov 2019

Keywords

  • basic income
  • energy subsidies
  • subsidy reform
  • welfare
  • distributional impact
  • compensating variation
  • cash tranfers

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