As part of its advocacy efforts towards building a people-centered and sustainable recovery from the Beirut port explosion and its endeavors to promote inclusive and equitable social justice, as well as foster trust between individuals, entities, and the Lebanese government, the Lebanese Center for Policy Studies (LCPS) partnered with Transparency International (TI) and its local chapter, Transparency International Lebanon – No Corruption, to issue “The Reform Monitor.” The topics covered by the monitor are linked to the areas of reform, recovery, and reconstruction (3RF). The monitor falls within the Building Integrity and National Accountability in Lebanon (BINA’) project, which is funded by the European Union. The views expressed in the monitor do not necessarily reflect those of the donor.

What’s the issue at hand?

Lebanon's subsidy system, once praised as a vital social safety net, has become ineffective and untenable, particularly in light of the ongoing economic crisis. While the purpose of subsidizing essential goods (food, fuel, and medicine), was intended as a form of support for socio-economically vulnerable populations, they often failed to reach the targeted group while straining government budgets. In some cases, such as subsidizing fuel and wheat, for example, higher-income households have reaped most of the benefits.

This issue has always been a debatable topic in economic literature and practices. One study conducted by Arze del Granado et al. (2012) argues that fuel subsidies in developing countries are an expensive method for aiding the poor because a significant portion of the benefits go to higher-income groups—the richest quintile receives six times more in subsidies than the poorest.

The subsidy system’s lack of transparency facilitated corruption and spurred black market activity. Subsidized goods smuggling became widespread, enriching certain individuals while depriving those genuinely in need. This pervasive corruption eroded public trust and highlighted the pressing need for enhanced transparency and accountability within Lebanon’s governance structure.

The 2019 economic crisis served as a turning point. With reserves depleting and public debt escalating, the government was compelled to take action. Subsidies for certain goods, such as fuel, were gradually removed, resulting in significant price increases. However, a lack of a comprehensive reform plan and an inadequate social safety net have left many vulnerable populations struggling.

The Escalating Burden of Subsidies: A Pre-Crisis Snapshot

Before 2019, the World Bank estimated that subsidies consumed 10% of Lebanon’s GDP. This meant that for every dollar the government earned, ten cents were automatically diverted to subsidies, a figure that is many times larger than investments in critical areas like infrastructure and healthcare.

The strain on Lebanon's economy was further exacerbated by significant pressure on its foreign currency reserves. This pressure stemmed largely from the need to support the local currency and finance imports through subsidies. Lebanon's central bank had set a mandatory minimum threshold for foreign reserves at $17.5 billion (Chehayeb, K., 2021). However, maintaining this level became increasingly challenging as the country continued its costly subsidy program, which amounted to over $3.4 billion annually (LIFE, 2021).

These subsidies were essential for keeping the prices of basic goods and fuel affordable for the Lebanese population, requiring the central bank to continue to use its limited foreign currency to pay for these imports. Consequently, the outflow of foreign currency to sustain these subsidies rapidly depleted Lebanon's reserves, bringing the central bank dangerously close to breaching its reserve threshold.

Inequities and Inefficiencies in Subsidy Allocation

Beyond the immediate financial strain on Lebanon's foreign reserves, the subsidy program also created significant market distortions. By artificially lowering the cost of essential goods, such as fuel and food, the subsidies discouraged efficient market operations.

These subsidies, while providing temporary relief, failed to address the root causes of high prices. As a result, they often led to unintended consequences, such as black markets and smuggling, further destabilizing the economy. Moreover, the artificially maintained low prices masked the true cost of goods, leading to unsustainable consumption patterns. Elevated food prices, when subsidies are reduced or removed, have a direct impact on hunger and diet quality, disproportionately affecting the most vulnerable populations. This interplay between subsidies, market distortions, and economic vulnerability underscores the complex challenges Lebanon faces in managing both its economic policies and social welfare.

Take wheat, a staple food in Lebanon, for example. Subsidized wheat imports were significantly cheaper than locally produced wheat, disincentivizing local farmers and hindering domestic agricultural development. This created an overreliance on imported wheat, leaving Lebanon vulnerable to external shocks and price fluctuations. With the outbreak of the Ukraine-Russia war, two major wheat producers, disruptions in wheat exports led to a sharp increase in global wheat prices. Lebanon, heavily reliant on imported wheat, felt the impact directly, further straining its ability to provide affordable food to its citizens.

Another crucial flaw in the subsidy program was its failure to reach its intended targets effectively, with wealthier households disproportionately benefiting from subsidies. This was primarily because wealthier families tend to consume more bread and other wheat products compared to lower income families.

Similar distortions occurred in other sectors. According to the “Subsidy Reform Note” by the World Bank in 2020, the subsidy system was regressive, particularly concerning fuel subsidies, which accounted for 65% of the total subsidy cost. Notably, a significant portion of subsidized energy disproportionately benefited higher income brackets, with approximately 80% of them owning motor vehicles, compared to less than 25% among the poorest demographics. The World Bank's assessment concluded that approximately 55% of energy-related subsidies go to the wealthiest 20% of the population, underscoring the urgent need for reform.

Corruption and Black Markets

The lack of accountability within Lebanon's pre-crisis subsidy system created fertile ground for corruption and black-market activities. Smuggling of subsidized goods, such as medicine and fuel, became widespread. Instead of reaching the Lebanese population at affordable prices, they were diverted and sold on the black market at significantly higher prices. According to the Lebanese Syndicate of Petrol Station Owners, more than a billion liters of fuel illegally crossed the border, estimating that revenue from this illegal trade was around USD 235 million a year.

Measures Taken

With the onset of the crisis, the government, particularly the Lebanese central bank, tried to maintain subsidies for essentials like bread, medicine, and fuel by selling dollars at a much lower exchange rate than the black market to importers. But with the economy in free fall, the government finally resorted to partially lifting subsidies. Starting in 2021, for example, subsidies were gradually removed from fuel and some food items.

Recognizing the limitations of subsidizing essential items to support vulnerable populations, proposals for cash-transfer programs began to emerge as a more effective alternative. The idea was to transition from subsidizing essential goods to providing cash assistance directly to disadvantaged communities. However, implementation was slow and riddled with challenges, leaving many without support during the subsidy reduction phase.

Why is it important?

The distortions and inefficiencies inherent in subsidizing essential goods to provide a social safety net underscore the need for extensive reforms and international assistance to stabilize the economy and shield the most vulnerable groups from the effects of hyperinflation.

Transparency and accountability are not merely theoretical ideals; they are practical necessities, particularly in a context like Lebanon's. The lack of transparency surrounding subsidy allocation and expenditure has allowed for mismanagement, corruption, and elite capture, exacerbating socioeconomic disparities and deepening public mistrust in governmental institutions.

The 3RF framework offers a blueprint for overcoming Lebanon's systemic shortcomings, emphasizing that governance reforms and transparency are crucial for overhauling its subsidy system. Implementing stringent oversight mechanisms and fostering accountability are fundamental in rebuilding trust and ensuring equitable resource allocation.

Lebanon's experience underscores the perils of neglecting transparency and accountability in economic policymaking. Integrating 3RF principles earlier could have averted many pitfalls. Embracing inclusive decision-making and data-driven policy design can steer Lebanon toward a resilient path, prioritizing the public’s needs and fostering sustainable economic recovery.

References:

Arze del Granado, F. J., Coady, D., & Gillingham, R. (2012). The Unequal Benefits of Fuel Subsidies: A Review of Evidence for Developing Countries. World Development, 40(11), 2234-2248. https://doi.org/10.1016/j.worlddev.2012.05.005

Arndt, C., Diao, X., Dorosh, P., Pauw, K., & Thurlow, J. (2023). The Ukraine war and rising commodity prices: Implications for developing countries. Global Food Security, 36, 100680.

Chehayeb, K. (2021, April 30). The weight of Lebanon's unsustainable subsidies program. Time. Retrieved from https://timep.org/2021/04/30/the-weight-of-lebanons-unsustainable-subsidies-program/

Barakat, C. (2023, March 14). Explaining the 3RF in the Wake of the Beirut Blast [online] Retrieved from: https://lcps-lebanon.org/en/publications/explaining-the-3rf-in-the-wake-of-the-beirut-blast

Dahham, J., Kremer, I., Hiligsmann, M., Hamdan, K., Nassereddine, A., Evers, S. M. A. A. E., & Rizk, R. (2022). Valuation of costs in health economics during financial and economic crises: A case study from Lebanon. Value in Health, 25(10), 1447-1455.

El-Harakeh A, Haley SJ. Improving the availability of prescription drugs in Lebanon: A critical analysis of alternative policy options. Health Res Policy Syst. 2022 Oct 8; 20(1):106. doi: 10.1186/s12961-022-00921-3. PMID: 36209085; PMCID: PMC9547632.

Lebanese Center for Policy Studies. (2023, January 11). After the end of subsidies in Lebanon: The need for an inclusive and comprehensive social protection strategy [online]. Retrieved from: https://www.lcps-lebanon.org/articles/details/2442/after-the-end-of-subsidies-in-lebanon-the-need-for-an-inclusive-and-comprehensive-social-protection-strategy

LIFE Lebanon. (2021). REFORMING THE SUBSIDIES SYSTEM IN LEBANON. Retrieved from https://lifelebanon.com/storage/policy_papers/348d1a831e32baf7a626a64db88c2c39.pdf

Dagher, Leila and Nehme, Raoul. (2021). Lebanon’s misguided government subsidies are quickly eating up its foreign reserves [Paper number 116138]. Retrieved from https://mpra.ub.uni-muenchen.de/116138/1/MPRA_paper_116138.pdf

"Shadow Trade & Smuggling." Editorial Staff, The Badil Resource Center. March 8, 2023. Retrieved from https://thebadil.com/investigations/shadow-trade-smuggling/.