The Political Economy of Reforms
Once adopted, subsidies are hard to remove. Usually countries have to conduct reform by piecemeal changes with constant reversals. Fear of loss of economic rents and political power are common factors behind reluctance to reform subsidies (Commander 2012). The Republic of Yemen was not an exception. In at least two occasions, increases in fuel prices caused violent public protests that led to a reversal of reforms. In this section, we discuss the factors affecting reform paths and try to identify the lessons learned.
Modern Republic of Yemen was established in 1990 by uniting the Arab Republic of Yemen (YAR) and the People’s Democratic Republic of Yemen (PDRY). The state-society social contract was very different under the two former states. Lack of resources made the population in YAR (north) unite along tribes, while in the PDRY (south) the state was much stronger and controlled by one party. Oil rents and political patronage allowed political powers to unite the country, changing the voice of different religious, regional, and tribal groups. One result was that elite groups captured the key sectors of the economy and less-powerful groups could benefit either from fuel subsidies or from the illegal trade of subsidized products. The patronage system created by petroleum products made the reform of subsidies on these same products politically very complex (World Bank 2005; Salisbury 2011).
Falling oil production after 2000 and the poor performance of non-oil sectors shrank the resource base and contributed to the evolving political, social, and economic crises that culminated in the 2011 protests and the departure of President Ali Abdullah Saleh in 2012. The United Nations and the Gulf Cooperation Council have helped to bring about a peaceful transition in the Republic of Yemen, but the situation is still very fragile and has not yet been resolved.
The success of subsidies reform depends on timing, institutional capacity, communication campaigns, and the overall micromanagement of reforms. In the Republic of Yemen, the failure of the 2005 subsidies reform seems to be associated with bad timing because it coincided with tax reforms. The compensation scheme designed to accompany price increases could not work because it took almost three years to increase the size of benefits. If the cash transfer program had been implemented on time, it could have reduced the opposition to reforms and increased the likelihood of success.
The increase in energy prices in 2010 and 2011 happened in the context of abrupt changes in supply and retail prices in the black market higher than international prices. An effective public campaign kept the public informed the public about the benefits of reforms to ensure adequate supply (IMF 2013). As a result, these episodes of subsidies reforms were not accompanied by public protests and violence.
Given that the amount of subsidies depends on international commodity prices and that subsidy is a politicized topic, international organizations proposed a system of automatic fuel prices adjustment. Such a measure may help to depoliticize the process of energy pricing, avoid drastic changes in domestic prices, and allow governments to preserve and increase the savings from a subsidy reform when international prices go up (IMF 2014).