There seems to be no stopping the increase of the prices of oil products. With this certainty already considered a given, can something be done to minimize its adverse effects? This Policy Notes argues that there may still be one way of lessening these negative effects through the use of the instrument of tariffs on imported oil products.oil price

Cororaton, Caesar B.

English

Research Papers in Economics

No. 2000-10 August 2000
Philippine Institute
for Development Studies
Caesar B. Cororaton*
Policy Notes
PIDS Policy Notes are observations/analyses written by PIDS
researchers on certain policy issues. The treatise is holistic in approach
and aims to provide useful inputs for decisionmaking.
Jennifer P.T. Liguton helped in repackaging this Notes based on
PIDS Discussion Paper Series No. 2000-32 with the same title by the
author. The views expressed are those of the author and do not nec-
essarily reflect those of PIDS or any of the study's sponsors.
Oil Price Increase:
Can Something be Done to
Minimize its Adverse Effects?
__________
*The author is Senior Research Fellow at the Philippine Institute for
Development Studies.
n the last 20 months, petroleum products had gone
through several rounds of price increases in the
Philippines. By July 2000, in fact, the average price
of diesel fuel has increased by 59 percent from its Janu-
ary 1999 level while the pump price of gasoline products
has risen by an estimated 46 percent over the same
period.
Because petroleum products are widely used and
are basic to almost every human activity, increases in
their prices have far-reaching effects and get translated
into increases in the general price level of services and
commodities, wages and others.
Not surprisingly, therefore, the series of price in-
creases has triggered public protests, in particular, the
"welga ng bayan" by public utility operators and fueled
debates and discussion on the merits of the present
deregulated price policy on oil products in the domestic
market.
Two reasons were cited for the increases. One is
the increase in the world price of crude oil in the interna-
tional market. And two is the depreciation of the peso-
dollar exchange rate.
The Philippine government tried to delay the price
increases and to reduce the rate of increases as much
as possible through dialogues and moral suasions with
the big oil companies in the country. However, these did
not help much and the round of increases continued un-
til the latest one sometime in mid-July this year.
The question now is: with the certainty of the oil
price increases already a given, what has been done to
mitigate the adverse effects of such increases? And has
the government exhausted all means to lessen, if not
totally eliminate, the negative impact?
This Policy Notes touches on the second question
and argues that there may still be one way of lessening I2
Policy Notes
August 2000
the negative effect which the government may adopt. This
is through the policy instrument of tariffs on imported oil
products.
In a series of simulation exercises which we recently
ran, using the Philippine computable general equilibrium
model (PCGEM),1 we looked into various scenarios where
certain policy instruments or combinations thereof were
considered to see if and how they could help lessen, if
not totally eliminate, the negative effects of the oil price
increases.
Based on our computations, it shows that reducing
the tariffs on imported oil products, which is one form of
lessening regulation, would lead to the best consequence
and would result into a lesser negative impact on the
whole as evidenced in the:
k lower reduction in gross domestic product (GDP),
k lower increase in prices, in particular, petroleum
prices,
k lower negative implications on the government
budget balance,
k lesser income inequality effects, and
k lower negative welfare effects.2
————————
1The Philippine computable general equilibrium model (PCGEM)
is a nonlinear general equilibrium of the Philippine economy. The model
has 34 production sectors, 3 factor inputs (labor, variable capital and
capital), and 10 household types in decile groupings. Labor and variable
capital are endogenous, while capital is fixed.
2One caveat, though, is that as in any economic model, the policy
implication here was derived with all other things held constant except
for the variables analyzed. In reality, of course, everything is dynamic
and constantly changes.
Effects of the oil price
increases
As previously men-
tioned, the recent increases
in the prices of oil products
were brought about by the
actual change in the world
oil price which reached
148.8 percent increase and the depreciation in the peso-
dollar exchange rate which registered 4.8 percent from
the period January 1999 to May 2000.
To be able to show how tariffs on imports may be
used as a policy instrument to mitigate the negative ef-
fects of the oil price increases, it is best to spell out the
economic and welfare effects of the two root sources of
the oil price increases at the outset.
Macroeconomic effects Macroeconomic effects
In terms of the macroeconomic effects, two impor-
tant points need to be highlighted. One is that in terms
of internal revenues (taxes), the government coffers ex-
perienced a decline. And two is that as far as tariff rates
(on imports) are concerned, the government had a sud-
den "windfall profit."
What explains this difference?
In view of the change in world oil prices, real GDP
declined by -2.3 percent. Because of this negative growth,
an economic slowdown was experienced, thereby caus-
ing direct (domestic) tax government revenue to decline.
"...Reducing the tariffs on imported oil
products, which is one form of lessening
regulation, would lead to the best
consequence and would result into a lesser
negative impact on the whole."
"...The recent increases in the prices of oil products were brought
about by the actual change in the world oil price which reached 148.8
percent increase and the depreciation in the peso-dollar exchange
rate which registered 4.8 percent from the period January 1999 to
May 2000."3
Policy Notes
No. 2000-10
Meanwhile, tariff rev-
enue is basically a function
of import volume, world
price of commodities, tariff
rate and the exchange rate.
When the price of crude oil
increased in the world mar-
ket, the country's level of
oil imports suffered a huge
decline. Despite such de-
cline, however, the rev-
enues earned from tariffs nonetheless increased, what
with the overwhelming 148.8 percent increase in the world
price of oil. As such, even if tariff rates stayed the same,
tariff revenues increased by almost 20 percent, giving
government a "windfall profit" in terms of revenue.
Income Income
Meanwhile, as far as incomes of the people are
concerned, the simulation results show that they went
down, the impact of which may be described as regres-
sive. This means that the decline in incomes was much
larger among the poorer segments of the population (rep-
resented by hh1) than among the upper segments (hh10).
The percent decline among hh1s registered -2.6 percent
while among the hh10s, -2.3 percent. Nowhere is this
more clearly manifested than in the Gini ratio wherein
the coefficient rose from 0.43992 to 0.44048, signify-
ing a further deterioration in income inequality.3
Welfare effects Welfare effects
With regard to overall welfare as denoted by two
welfare indicators,4 the results show that the world oil
————————
3Gini ratio is a measure of the level of income inequality. The closer
the ratio approaches the value of "0.5," the greater is the level of income
inequality. Conversely, the more it declines from the value of "0.5," the
lesser inequality exists.
4The two welfare indicators are: (1) one approach takes the new
prices and incomes after the world price change is introduced and asks
how much income must be taken away or added in order to return house-
holds to their pre-change utility level; and (2) another approach looks at
the old or pre-world price change level and computes the change needed
to achieve new equilibrium utility levels.
price increase is welfare-
decreasing. However, in this
case, the decline in welfare
is much bigger among the
higher income classes than
among the lower income
groups. This is understand-
able since richer house-
holds use larger amounts of
everything than the poorer
ones.
Tariffs as a policy tool
Looking at the abovementioned negative effects of
the oil price increases, can something be done to mini-
mize such impact?
A number of proposals have recently surfaced, one
of which is the proposed national oil exchange scheme
which is equivalent to the reimposition of regulation or
re-regulation.
"...Incomes of the people went down, the
impact of which may be described as
regressive...The decline in incomes was
much larger among the poorer segments of
the population than among the upper
segments."
Re-regulation could generally take two forms. One
is through quantitative restrictions while another is
through the price system. The setting up of an oil ex-
change is an example of quantitative restrictions whereas
the imposition of new or higher taxes, tariffs and the like
is one means of re-regulation working through the price
system.
What our study did was to analyze the impact of
reducing the tariff levels, a form of reducing regulation
"Despite the decline in the level of oil
imports, the revenues earned from tariffs
nonetheless increased... As such, even if
tariff rates stayed the same, tariff revenues
increased by almost 20 percent, giving
government a "windfall profit" in terms of
revenue."4
Policy Notes
August 2000
For further information, please contact
The Research Information Staff
Philippine Institute for Development Studies
NEDA sa Makati Building, 106 Amorsolo Street
Legaspi Village, Makati City
Telephone Nos: 8924059 and 8935705;
Fax Nos: 8939589 and 8161091
E-mail: ccororaton@pidsnet.pids.gov.ph
jliguton@pidsnet.pids.gov.ph
The Policy Notes series is available online at
http://www.pids.gov.ph
through the price system, and the observed impact was
that of being favorable in terms of welfare, income distri-
bution and effect on the budget, which is currently the
biggest concern of the government.
Meanwhile, what our paper did not do was to ana-
lyze what would have happened had the government re-
imposed quantitative restrictions. Economic theory, how-
ever, will tell that this would have led to a higher welfare
cost.
In short, the results of our simulation exercises re-
veal that among the various scenarios that we consid-
ered, the one calling for a temporary reduction in the
current 3 percent tariff rate on oil products may be the
most direct way of partially minimizing the adverse im-
pact on the overall economy and people's welfare of the
oil price increases.
And the "windfall profit" earlier mentioned for the
government in terms of the increased earnings from the
tariffs5 imposed on the oil importations are large enough
that even if the government considers this reduction in
tariffs on oil products, the government earnings from such
source will still be positive. With a lower tariff rate on oil
products, the country's level of oil imports might not drop
as drastically as it had when the world price of oil in-
creased. And because the level of oil supply in terms of
imports will not suffer that much, the domestic price of
oil products would not perhaps go up as much as it did
and will. The chain reaction of this mechanism is such
that the adverse consequential effects on the general
price levels, incomes, employment and people's overall
welfare will thus not be that much either.
Conclusion
To be clear, our paper, as we have said, did not
analyze the consequences of a reimposition of regula-
tion through quantitative restrictions as called for by the
————————
5A tariff, as we know, is a tax applied on an ad valorem basis or at
a certain percentage on the total value of an import.
proposed establishment of a national oil exchange. Suf-
fice it to say, though, that the lesson to be noted from
the results of our simulation exercises is that lesser regu-
lation such as a reduction in the tariff rates leads to a
higher welfare level. Conversely, a more direct govern-
ment involvement, either through the price system or dis-
tribution like the proposed oil exchange, means lower
welfare and higher societal costs.
The oil sector has already gone through a series of
reforms, including the elimination of the Oil Price Stabili-
zation Fund (OPSF) which gave the government its big-
gest headache in the early 1990s. The reimposition of
this or a similar type of regulation would certainly thus
be highly unproductive at the moment. It would also give
wrong signals to investors who do not have a positive
outlook on the Philippine economy at present because of
unfavorable events, both manmade and natural in na-
ture.  4 4
"...Among various scenarios that were
considered, the one calling for a temporary
reduction in the current 3 percent tariff rate
on oil products may be the most direct way
of partially minimizing the adverse impact
on the overall economy and people's welfare
of the oil price increases."

Oil Price Increase: Can Something be Done to Minimize its Adverse Effects?

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Oil Price Increase: Can Something be Done to Minimize its Adverse Effects?

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