Balancing Act: Helping Households Cope with Rising Energy Prices in Europe and Central Asia

As the effects of ongoing global financial fragility continue to affect economies across the Europe and Central Asia (ECA) region, policy makers remain vigilant in their pursuit of economic measures that can reduce spending. With subsidies for household energy accounting for as much as 2 percent of Gross Domestic Product (GDP) around the region, this is a key area for fiscal reform. However, with both poor and middle class households particularly vulnerable to increases in energy prices – spending as much as 5 percent of their income on electricity and 2 percent on gas – reform in this area must focus on minimizing the social impacts.

A new report by the World Bank is helping policy makers in the region address these reforms. This report, Balancing Act: Cutting Subsidies while Protecting Affordability, offers strategic advice and concrete recommendations to countries on how they can reduce – and eventually eliminate – energy subsidies without increasing the economic burden faced by poor and middle-class households.

“The report highlights how higher energy prices are going to significantly impact both the poor and the middle class,” says Caterina Ruggeri Laderchi, Senior Economist at the World Bank and co-author of the report, “this is not a matter of cutting down on luxuries, but rather a question of covering basic heating needs. As such, the report looks at ways governments can expand social assistance strategies targeted at the poor while simultaneously investing in energy efficiency.”

While on the surface these energy subsidies can seem like effective means of social assistance – making it possible to satisfy a basic need – the report illuminates many of the inefficiencies of this system and offers solutions to the subsidy problems, based on improved social assistance programs and the implementation of energy efficiency measures.The report also highlights ways to ensure that these reductions do not harm those households most vulnerable to energy price shocks.

Evidence has shown that households often cope with increases in energy prices by cutting down on other types of basic consumption, such as food or health spending. However, by supplementing these price hikes with improvements in social assistance programs – especially those that target the poorest and most vulnerable – while simultaneously investing in energy efficiency, countries around the region can save as much as 1 percent of Gross Domestic Product without burdening poor households.

An important step in this process is the consolidation of social assistance programs through the introduction of an integrated system of measures that provide support to the poorer groups while also offering incentives for all households to manage their energy consumption more effectively. According to the report, this system should be anchored by three main pillars:

• continuing reforms to ensure that social assistance programs are more effective at reaching the poorest;
• integrating demand management policies in the strategy to help households deal with tariff shocks;
• ensuring a smooth transition while these measures are put in place.

A second piece to this puzzle is improved energy efficiency. Although the report shows that tariff adjustments are possible, they are likely to be a burden if not accompanied by improvements in energy efficiency. The Europe and Central Asia region is the most energy intensive region in the world, making improvements in energy efficiency an economic and environmental imperative. Although the region accounts for just 12 percent of global carbon dioxide emissions, given its output levels and production structures, these emissions are double what they could be.  Artificially low energy prices, resulting from subsidies, can provide perverse incentives for overconsumption. When households are not paying the true cost of energy, they have fewer incentives to save or invest in energy – leading to significant increases in carbon emissions.

“Energy efficiency measures are an essential part of the agenda advocated by this report,” says Ruggeri Laderchi, “these investments help all households manage their energy demand.”

Although concerns persist over energy affordability in the wake of higher tariffs, the last decade has shown that relatively rapid increases in energy efficiency are possible and that these advances can help households adapt to higher energy prices. While energy efficiency measures often entail large up-front costs, these investments can permanently decrease the demand for energy in a household. A number of energy efficiency initiatives have helped households throughout the region manage their energy consumption – programs which can be scaled-up and extended to all countries in the region.

Policy makers in the region, fearing the negative impacts these reforms can have on vulnerable segments of society, are understandably reticent to introduce measures that will ultimately eliminate subsidies for energy. By following the recommendations in this report, however, countries may just be able to reduce spending in their energy sectors, improve the livelihoods of the poor, and reduce harmful greenhouse gas emissions – a triple win that can benefit all.