How manufacturing firms respond to energy subsidy reforms?

Abstract

Energy prices increased several folds due to the 2010 Iranian Energy Subsidy Reform. This study assesses the impact of the reform on the performance of manufacturing firms using a detailed micro-panel dataset at the 4-digit ISIC level for the period 2009 to 2013. Since the reform universally affected all firms, the analysis relies on a quasi-experimental framework implementing first an explorative before-after design with structural fixed-effects and second a difference-in-difference analysis exploiting energy-sensitivity. The subsidy removal caused a shrinkage in output and manufacturing value-added of at least 3 and 7%, respectively. This results in a deterioration of profits by nearly 9%. Manufacturing firms have been affected through three channels: increasing costs of direct energy inputs, pass-through costs for inputs from upstream firms and an energy-price-induced demand contraction. To successfully implement an energy subsidy reform while maintaining growth in the manufacturing sector, not only the direct but also the indirect, pass-through effects have to be considered since capital or technology-led responses to mitigate negative repercussions in the short-run are unlikely at large scale. The results can inform price reforms that aim to mitigate climate change