Political regime, institutional capacity, and inefficient policy: Evidence from gasoline subsidies

Why do some governments subsidize gasoline consumption, despite its very high economic and environmental costs? We answer this question by examining how a state's political regime and level of institutional capacity jointly determine its level of fossil fuel price distortion. We find that, without sufficient institutional capacity, democratic regimes do not necessarily provide less fuel subsidies, as those governments are unable to pursue other more efficient welfare policies. Using data on monthly domestic gasoline prices from 2003 to 2015, we demonstrate that democratic governments with high institutional capacity are less likely to control domestic gasoline prices. Democratic institutions and strong institutional capacity jointly mitigate the effect of the benchmark oil price increases on the domestic price. These results suggest that the combination of motive (democratic accountability) and means (institutional capacity) can help countries avoid inefficient subsidy policies.