The Impact of Fuel Subsidy and Infrastructure Policies to Economic Growth and Income Distribution: an Application of Indonesian Financial CGE Model

Abstract

The purpose of this paper is to analyze whether government policy to reallocate subsidy funds into infrastructure projects is favorable for the Indonesian economy in terms of GDP and income distribution. A financial CGE model is employed to simulate the impact of fiscal policy regarding fuel subsidy funds and road investment, calibrating the Indonesian Financial SAM of 2008. Other policy options have also been simulated to identify a better policy for economic growth and income inequality. This research is the first Financial CGE model of Indonesia to use Financial SAM 2008 as its database. The model in this research is a dynamic Financial CGE model with attributes of ten sectors, four households and seven economic actors, twelve labor groups and three type of assets. It is found that the policy of using additional tax to build road infrastructure generates the highest GDP increase. The policy to reduce fuel subsidies is the best policy measure regarding the distribution of income. Furthermore, if the government also has the concern to release fiscal pressure, then the shifting of fuel subsidy to infrastructure provision is applicable.