"The Politics of Fuel Price, Approaching Indonesia's 2019 Election Year"

Economic policy is rarely immune to the poisons of politics, which are ever stronger when an election approaches. Political candidates and parties become economically populist---in this case catering to popular demands when they are not always sound or sustainable---to help their reelection prospects.

Look no further than our own government as we near the 2019 election year. President Joko Widodo is already rolling out a series of price controls, along with some subsidy increases, as he is set to run for another term and face potentially tough competition from Prabowo Subianto.

Jokowi is reinforcing price controls across a wide range of commodities which include rice, sugar, coal, electricity, and oil fuel. Among them, oil fuel might be the most significant considering the sheer amount of fiscal cost it imposes, as well as Indonesia's long history of fuel subsidies and attempts to reform it.

Fuel price controls have even stirred drama; Pertamina's boss was fired soon after complaining about their implications. So what are the economic implications of fuel price controls, and how could we possibly circumvent them?

The Comeback of Fuel Subsidy

Indonesians are notoriously dependent on fuel subsidies, which cost an exorbitant Rp2600B in 2006-2016. The price of fuel in Indonesia is among the cheapest in the world and it was considered political suicide to change that. So it was a bold decision that Jokowi cut fuel subsidies soon after securing office. He reduced the budget for fuel subsidies from Rp46.79B in 2014 to Rp7.15B in 2017.

To be fair, the real amount of subsidy reduction might be less than the mentioned figures because Pertamina was still obligated to provide Premium at a ceiling price outside Java, Madura and Bali (Jamali). In other words, the government was shifting part of the subsidy burden from the national budget (APBN) to Pertamina.

Nevertheless, Jokowi's decision was applauded by many, not least because much of the fund was reallocated to ambitious infrastructure projects, which are considered more productive. The adverse impact of the subsidy cut on consumers was also subdued by the drop in world oil price that same year.

But with the presidential election incoming, fuel price control is being summoned back. Jokowi will be increasing subsidies by $588 million in 2018 in order to keep the prices of subsidized fuel fixed. The price freeze is promised to last until the end of 2019, conveniently after the election is over. 

Moreover, the Ministry of Energy and Mineral Resources (ESDM) will be imposing a form of price control on non-subsidized fuel. Previously, fuel retailers such as Pertamina and Shell were free to set prices for non-subsidized fuels based on market prices. Now they will have to obtain government approval before changing those prices, with exception for industrial fuels.

While this is not an absolute price ceiling, it allows the government to forbid fuel retailers from raising prices on the grounds of limiting inflation and protecting consumers, even when the market price of oil is currently rising. Since these fuel prices receive no subsidy, it would be the fuel retailers that foot the bill (although there was a plan for a compensation fund from the government).

At the same time, the government is cancelling $20 billion worth of infrastructure projects to pay for social welfare programs.

The price control might please voters, but it has received its fair share of criticism. First of all, this could reverse effort to reduce the public's excessive dependence on fossil fuel, which is undesirable because Indonesia is a net importer of oil and the sustainability of its supply is uncertain. Secondly, this could damage market confidence in Indonesia's commitment to fiscal discipline.

Jokowi's planned subsidy hike is relatively marginal in amount, which means that Pertamina will again be the sacrificial lamb. Pertamina is already losing billions of potential revenues from having to provide Premium outside Jamali, which is sold at below-market prices. Its finance will only deteriorate further with Jokowi's BBM Satu Harga program and recent instruction to start supplying Premium in Jamali again.

According to basic economics theory, price control distorts the market by eliminating the incentive for producers to supply the demanded amount. But the story is different when the producer is Pertamina, a state-owned enterprise.

If Pertamina was a private producer, it would respond to the price control by reducing supply, causing a deadweight loss in the form of a shortage. But since Pertamina is strictly instructed to maintain supply at low prices, the deadweight loss manifests in the bleeding finance of Pertamina.

Pertamina claimed that its net loss reached Rp3.9B in the first two months of 2018. The loss of potential revenue limits Pertamina's ability to make long-term productive investments, which could mean shortages in the future. Furthermore, the health of our state-owned enterprises really affects market sentiment towards Indonesia.

Prescription for Voter Myopia?

If these price interventions are likely to bite back, why is it being done every time? The root cause is the tendency of voters to favor short-term gains. This is especially true for a developing country such as Indonesia, where the majority of the population is still economically insecure, hence their myopic time-preference.

Tackling pernicious price controls, therefore, requires addressing this inherent nature. This might require more than educating voters, whose judgment is easily convoluted with non-economic considerations, but also structural measures on the political system.

One idea is to bind the government to certain policy decisions of their predecessor that require long-term consistency. Indonesia's Law No. 17 of 2003 about State Finance already caps the budget deficit at 3% of GDP, which could supposedly discourage wasteful spending, but the government was still able to shift fiscal burden to state-owned enterprises.

This loophole might need to be closed, such as by enforcing the government's obligation to compensate the losses of state-owned enterprises from price controls. Furthermore, there could be safeguards on projects with long-term value so they could not be easily sacrificed to fund populist welfare programs. These measures could be a way to replicate China's development success through consistent long-term planning, without becoming authoritarian.

However, the inefficiency of short-term policies does not justify downplaying the concern of voters over their short-term livelihood. It is not symmetric to compensate the removal of a short-term welfare program, in this case fuel price control, with long-term infrastructural projects. Instead, subsidy reform must be complemented by alternative welfare programs that are efficient and targeted.

To be fair, Jokowi did enhance Indonesia's social safety net through BPJS and KIS, but they received less spotlight than his infrastructure projects. As a result, it seemed more that fuel subsidy was being traded with bridges and roads instead of free healthcare.

In the end, the blatantly political nature of Jokowi's decision might also be why it is excusable. Jokowi's agenda for economic development, in particular constructing a badly needed network of hard infrastructure, requires commitment beyond five years. Since his political opponents do not exhibit as much ambition in infrastructure projects, it becomes critical for him to secure another term.

At the same time, Jokowi's image of humble, pro-poor populism has been waning. He is increasingly associated with his more neo-liberal policies of inviting foreign workers and instituting private student loans. So if populist price controls are the only way for him to restore his grassroots image and win the upcoming election, we should accept them as a necessary evil for Indonesia's long-term development.

Disclaimer: The views expressed in this article are those of the author and do not necessarily reflect the official stance of Kanopi on the issue.

Oleh I Gede Sthitaprajna Virananda | Ilmu Ekonomi 2016 | Kepala Divisi Kajian Kanopi 2018