APPENDIX II Some Empirical Evidence on Price and Subsidy Policy

International Monetary Fund
Published Date:
September 1986
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Empirical information concerning the direct effect of price and subsidy policy on income distribution is scarce and of questionable quality. In addition, existing studies do not cover a sufficient range of countries to provide an adequate basis for generalization. The conclusions of the few studies available, however, indicate that for large, general subsidy programs the hardship imposed in the short run by eliminating subsidies to the poor cannot be ignored. They also indicate that such programs are inefficient and ineffective mechanisms for redistributing incomes.

A practical problem is the practice in many countries confronting budgetary constraints to reduce subsidy outlays by adopting the expediency of excluding the poor, further exacerbating the adverse distributional implications of these programs. As a consequence, subsidy programs are often inconsistent with their stated objective of helping the poor. In one member country spending approximately 2 percent of GDP on consumer subsidies, for example, a Fund technical assistance study based largely on household survey data found that even a relatively open-ended subsidy scheme with no mechanisms to selectively exclude the poor nevertheless resulted in relatively perverse distributional effects. As such open-ended food subsidy schemes are typical of those attracting Fund attention, precisely because of the budgetary exposure they engender, the major results are worth reviewing here. In urban areas, it was found that less than 10 percent of the benefits of food subsidies accrued to the poorest 20 percent of the population, while 46 percent of the subsidy went to the richest 27 percent of the urban dwellers. Looking more directly at nutritional status, and taking the figure of 1,800 calories a day as representing the limit of serious undernutrition, one finds that in the rural areas only 15 percent of the budgetary cost of subsidies is transferred to those under this limit; in the urban areas the corresponding figure is 25 percent. Despite this poor targeting, however, data indicate that food subsidies provide an income transfer equivalent to up to 6 percent of per capita household expenditure for the poorest urban dwellers.

In a second member country for which data is available (Tarrant (1982)), food subsidies are allocated through ration shops that distribute foodgrains below free market prices. Rural people, which make up 90 percent of the population, receive less than 20 percent of the available food ration, and even this proportion is reported to be reduced in the event of shortages. More than 60 percent of the recipients are government employees, and the privilege of a ration card is reportedly used to hold down government wages and salaries.

A recent study in another member country, which spends approximately 7 percent of GDP on food subsidies, finds a substantially less skewed distribution of benefits, no doubt owing to the broader coverage (and higher cost) of the system.59 The amount of income transferred equaled 17 percent of the income of the poorest rural expenditure quartile and 16 percent of the income of the poorest urban expenditure quartile. The amount of income transferred for the richest rural and urban quartiles was 4 percent and 3 percent, respectively. The distribution of subsidy benefits in absolute terms appears to be much less regressive than in the first country mentioned.

The distributional effect of subsidy programs can be substantially improved. For example, another member country decreased the budgetary cost of food subsidies from 6 percent to 3 percent of GDP, at the same time increasing the per capita transfer to the poorest classes by more than 30 percent through the introduction of a food coupon system that targeted food subsidies to the lower-income classes (Mateus (1983)).

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