Fuel subsidy and the fallacy of "harga keekonomian"

The government finally says that the current (subsidized) gasoline ("premium") price is at its "harga keekonomian". This term supposedly means economic price, though they might be thinking of economic cost. And in other occasions it is made parallel to market price. All associations are false, for reasons below. The government also says that as the consequence, it is time now to scrap the fuel from the subsidy list.

Let's start with the second one, the good one. That is, the plan to remove gasoline from subsidy list. This means -- and I think the government should really make it explicit -- that the price would follow directly from the market dynamics. Meaning, when it (the crude oil price) is down like now, the domestic gasoline also becomes cheaper. But, when it is up (and there is reason to be prepared that it might swing up again), the domestic price should also follow suit . Now, many people are of course happy with the reduced price. But I bet they won't accept a rise even when the market price is up (a parliamentarian's remarks in Kompas today is a case in point). That's the real challenge the government should tackle. Say it out loud: taking the fuel out from the list means exposing the people to the two sides of market price: up and down, not just the latter.

Why did I say this subsidy removal was good? For one, it would lessen the burden on the budget so there would be more resources to spend on more sensible posts, e.g. basic education, etc. Second, in the long run it will be good for the environment. If you just care about the environment, aiming for taxing fossil fuel consumption makes sense. Of course it's hard enough already to go that direction all the way from a subsidy regime. Scrapping the subsidy now opens the door to start, at least gradually, thinking about taxing the fossil fuel consumption for environment purposes (I say this as if we don't have a tax on fuel consumption; well we do, but in effect what we have been having thus far is a net subsidy). That way, you discourage pollution and encourage fuel efficiency and hopefully create incentives for the development of energy alternatives.

Now, why the notion "harga keekonomian", or more precisely the statement like "the current price has hit the harga keekonomian (as in economic price/economic cost)" is a fallacy?

First, what do they really mean by that term? An article in Kompas today (06/12/2008) spells that out quite helpfully. Assume the crude oil price is $46. The crude price would translate to Singaporean MOPS price of $56. This Mean of Platts Singapore (MOPS) is the assumed relevant price for fuel in the region, which is traditionally $10 higher than the "world" crude price quoted in, say, London. Presumably the $10 addition is to take care of production and transportation costs. Then Pertamina has its "magic alpha". This is an item that is supposed to cover procurement costs, operational costs, etc. It might also have some profit margin in it, and that is why I call it magic: it's never really clear how they got to decide the alpha -- now set at 9%. So now the MOPS plus alpha is $61.04 (never mind the small miscalculation by Kompas there, the idea remains). That translates into the fuel price of $0.38 per liter. Assuming you need Rp 12,000 for every dollar, that becomes Rp 4,607 per liter. Now, add the 10% value added tax and 5% vehicle fuel tax (this is the tax I was referring above). Finally you end up with Rp 5,321 per liter. Compared that to the current administered price of Rp 5,500. That is why many people demand more cut: after all, why fix a price above the "harga keekonomian"? (By the way, they seem to completely forget that they want just exactly the opposite for rice). What's wrong with this? The calculation above seems pretty straightforward and sensible, yes?

Except that it is not about economic price (or economic cost for that matter). It is accounting price. Everything under the term accounting price or costs can (and should) appear on the bookkeeping. But there is an implicit cost that one has to consider when referring to "market price", the price that matters. This implicit cost is the opportunity cost. It does not appear in the accounting report, but it should register in the head of every sane decision maker. What is it, really? Opportunity cost is the value of the next best alternative. Which is forgone for you have decided to do something else. Again, what is it, really? For simplicity, think about selling fuel at home or at neigbour across the street. By selling it at home, you forego selling it to the neighbour. This is good if the price at home is actually higher than the price there. But otherwise, you're making a loss -- well let me be precise: economic loss (even though you might !score an accounting profit!).

But why in the world do we care about economic costs? Because if you don't, the market will punish you: smuggling, black market, etc. We have news from Kalimantan already. Yes, economic price and hence market price is more difficult to measure, especially when the market itself is rather distorted. But if you insist that the current price is already at (or even above) the economic price, would you put your money where your mouth is? Because if it were true, you need not be worried at all. Just leave it, the price, free to float and see what you would actually pay at the gas station. After all what happens in Kalimantan (as well as the still ongoing smuggling in many places) is a litmus test to see whether or not we have really hit the market price. Maybe tomorrow, or next week, or never. But today, I am afraid we have not.