Thursday, March 22, 2012

Targeted food subsidy could work in South Asia

A latest working paper (Food Price Escalation in South Asia: A Serious and Growing Concern) by Bruno Carrasco and Hiranya Mukhopadhaya of the ADB states that “a spike in the cost of food staples like rice and wheat could push tens of millions more people into extreme poverty in South Asia but food subsidies targeted at the very poorest in the region would help them cope with still-high prices”. Low income households in South Asia spend more than 50 percent of their budget on food. It also notes that while Nepal and Sri Lanka would be less affected, although a further surge in wheat prices would be especially painful for Sri Lanka, which is completely dependent on imports of the staple and has already seen prices hit historical highs in recent years.

Note that an earlier study (Global Food Price Inflation and Developing Asia) by ADB showed that a 10 percent increase in food prices will increase the number of poor people (in millions) living below US$1.25-a-day by 3.8, 0.01, 22.8, 6.7, 0.6, 3.5, and 0.2 in Bangladesh, Bhutan, rural India, urban India, Nepal, Pakistan, and Sri Lanka, respectively.

The following factors are driving poverty elasticity and may contribute to differences in elasticity indices across countries: (i) the higher inequality, the lower the price elasticity of
poverty and hence the smaller the impact on poverty ratios for any given increase in food prices (ii) the distribution of income just under the poverty line (more people just under the line, the larger the elasticity), (iii) the higher the base level of food prices, the larger the elasticity as for example a 1% change in price at $10/unit has a larger impact than 1% change in prices at $5, (iv) the level of GDP/capita with smaller elasticity for countries with higher incomes, and (v) country specifics such as the effectiveness of social security systems and other safety nets, and other cultural institutions captured by a country dummy.

Reasons for rise in food prices and inflation:

  • Mostly short-term weather shocks and costlier oil account in past few years
  • Rapid population growth
  • Changing food consumption patterns linked to higher incomes (especially in India)
  • Stagnating agricultural output

They recommend subsidizing the cost of food for the most poorest and vulnerable ones by government without putting an excessive burden on government spending. Now, that is the challenge faced by all developing countries, isn’t it? The big question is how to strike a balance between extending subsidies (temptation is always high to increase such programs for political gains) and fiscal position (more subsidies mean increase in fiscal deficit in the absence of high growth of revenues that can offset the increase in expenditure due to subsidies).

Other recommendations include boosting agriculture productivity, develop agriculture support network (infrastructure investment in irrigation and water resource management, early warning systems of flood, farm to market roads, storage facilities, and ICT for disseminating market information), getting prices right (by avoiding distortion of price signals), focusing on sustainable solution [??] (avoiding short term restrictive trade policies), effective use of monetary policy (mainly contractionary policies), and promote regional cooperation (operationalize SAARC Food Bank).

Anyway, Bangladesh has the highest weight of food on CPI. The weight of food on CPI is 42 percent in Nepal.

Food Weights in CPI (%)
Afghanistan 61
Bangladesh 58.8
Bhutan 31.7
India 46.2
Maldives 33.3
Nepal 42
Pakistan 40.3
Sri Lanka 45.5

[Here is a draft paper I wrote on high food prices and its impact on South Asia. Presentation slides here and a related article here].