Is Energy Subsidy Reform in an Oil-Exporting Small Economy Beneficial to Trade? Illustrations from Kuwait

Abstract

AbstractThis article fills a gap in the literature by quantifying impacts of fossil fuel subsidy reform on trade (inflow and outflow) in an oil-producing, “almost small”, economy, using Kuwait as an example. It employs a two-region economy-wide model with oligopoly behaviour in a general equilibrium framework. The model embodies unique elements of Kuwait's economic structure, idiosyncratic rigidities, and distortions, including oligopolistic industrial structure and labour markets. Simulations show that energy subsidies have minimal effects on trade and on non-energy exports, largely due to the pervasiveness of oligopolies that sustain large markups and their collusive pricing. Reforming energy subsidies generates higher pro-trade effects if implemented during low (not high) oil prices because its negative effects are partially offset by efficiency gains and reduction in oligopoly markups. Yet, contrary to claims by proponents of reforms, these effects remain largely constrained unless appropriate incentives are introduced. These results have important policy implications. In developing oil-exporting economies with pervasive oligopolies, microeconomic reform can be a channel through which to achieve pro-trade effects of energy subsidy reform. Further, benefits beyond export expansion, such as higher economic efficiency, could be better motivators of energy subsidy reform in oil economies.