Balancing Popularity and Policy: How Fossil Fuel Subsidy Cuts Impact Leaders

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The recent IMF working paper authored by Mariza Montes de Oca from the International Monetary Fund, Achim Hagen from Humboldt University’s PECan Research Group, and Franziska Holz from the German Institute for Economic Research and Norwegian University of Science and Technology, examines the political costs of fossil fuel subsidy removal in Latin America. Using Bolivia and Mexico as case studies, the researchers assess how subsidy phase-outs influence presidential approval, uncovering negative impacts that vary in intensity and duration across countries. Their analysis, grounded in difference-in-differences approaches and a probabilistic voting model explores the political implications of removing fossil fuel subsidies, which, despite their environmental drawbacks and financial burden, remain widespread due to their political utility and stability. The authors find that subsidy phase-out often leads to a significant but temporary decline in presidential popularity, with reactions heavily shaped by income levels and public trust in government. The findings indicate that wealthier segments, which benefit most from subsidies in these countries, show the most opposition to subsidy cuts, while low-income groups, although benefiting less from subsidies, also resist the changes due to low trust in government.

Bolivia and Mexico: Contrasting Political Reactions The paper details two different approaches to subsidy removal in Bolivia and Mexico, with contrasting political repercussions. In Bolivia, a sudden price increase of up to 80% in 2010 triggered massive public backlash, protests, and strikes, leading the government to rescind the policy just days after implementation. The strong response reflected a significant political cost, with a sustained 19% decrease in presidential approval. In contrast, Mexico adopted a gradual removal strategy, introducing small monthly price increases from 2009 to 2014. While this approach led to negative reactions, particularly from high-income groups, the gradual nature of the policy helped mitigate extreme public backlash, although approval ratings still dropped by about 2% on average in Mexico. The authors conclude that the impacts on presidential popularity were severe in Bolivia, while Mexico experienced more moderate and shorter-term effects.

Fossil Fuel Subsidies: A Regressive Form of Support The analysis reveals that fossil fuel subsidies are regressive, as wealthier citizens benefit disproportionately from these subsidies while poorer groups rely on them less. However, since these subsidies keep fuel prices stable, citizens generally perceive them as direct benefits from the government, fostering political support. The researchers use a probabilistic voting model to highlight how this economic support becomes entrenched: wealthier groups who receive larger subsidies resist their removal, as the economic loss they would experience outweighs potential benefits to public resources. At the same time, poorer citizens tend to oppose subsidy removal even though they receive a smaller share of the benefits, largely due to mistrust in government. This lack of trust is significant, as it drives lower-income groups to prefer immediate, tangible support, like fuel subsidies, over indirect public goods or services, which they doubt will be delivered effectively. Thus, the authors argue that subsidy removal can destabilize the political equilibrium and result in decreased political support, especially if trust in government institutions is low. The study points to the pivotal role that trust plays in how citizens react to such reforms, suggesting that efforts to build or maintain trust in government are essential for policy changes to gain public acceptance.

The Moderating Power of Trust in Government A key insight of this study is the moderating effect of public trust in the government on the political consequences of subsidy removal. In countries with high trust in leadership, citizens are more likely to support subsidy removal, even if it leads to increased fuel prices. The analysis shows that trust can soften negative reactions from high-income groups and, in some cases, even reverse the decline in presidential approval. This dynamic suggests that trust-building measures, such as transparent communication of subsidy removal benefits, could help mitigate the political costs of reforms. In Mexico, where trust in government was relatively high during the gradual phase-out period, the negative impact on approval ratings was less severe than in Bolivia, where distrust in government was already widespread. The research implies that governments interested in pursuing similar subsidy reforms should consider strategies to increase or sustain public trust, particularly among low-income groups, as it can shift public opinion toward greater acceptance of these measures.

Limitations and Scope of the Findings While the study provides valuable insights into the political economy of fossil fuel subsidies, the authors acknowledge limitations in the data and the specific cases studied. Presidential approval ratings were only available for Bolivia and Mexico during the treatment period, which constrains the generalizability of the findings. Moreover, the study focuses on gasoline subsidies and does not address other forms of carbon pricing, such as excise or carbon taxes, which might yield different political responses due to their broader impact on fossil fuel types and economic sectors. Nonetheless, the findings suggest that effective policy communication and gradual phase-out strategies may be essential for balancing the fiscal, environmental, and political considerations in subsidy reform.

Towards a Trust-Driven Approach to Climate Policy The study highlights how political risks associated with subsidy removal are a crucial aspect of climate policy, especially in countries with limited fiscal space and high inequality. By linking subsidy removal to enhanced public benefits and improved trust, policymakers may create a more favorable environment for reform, aligning public sentiment with climate and fiscal objectives. In sum, this research underscores the need to consider public trust and income disparities in designing policies that address both climate change and economic inequality.

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Balancing Popularity and Policy: How Fossil Fuel Subsidy Cuts Impact Leaders

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