Food Price Hikes: Equitable and Efficient Subsidies

Posted by Christian Schiller

On June 3 to 5, 2008, a United Nations sponsored conference on world food security took place in Rome Italy. A large number of world leaders were there, including my boss, the Managing Director of the IMF, Dominique Strauss-Khan. He warned that high food prices are a serious humanitarian concern as well as a source of macroeconomic instability affecting, among others, government budgets everywhere in the world. The MD told delegates that the Fund has already doubled financial assistance to four low-income countries affected by food and fuel price hikes and is discussing additional support with another 11 countries.

Not unusually, countries faced with the problem of rising food prices are tempted to resort to price controls or other forms of general price-subsidies. International experience however suggests that general price-subsidies are neither efficient nor equitable and undesirable. How policymakers should go about designing and implement equitable and efficient social protection mechanisms instead of unfair and expensive general price-subsidies is not an easy task. A sound approach to follow was outlined a few years ago in a small booklet with the title “Equity and Efficiency in the Reform of Price-Subsidies” published by a team of IMF economists. The guidance note for policymakers draws on the experience with the reform of price-subsidies in 28 countries. While the guide was written with the view of advising policymakers on how to replace a general price-subsidy (that typically results in a price increase) with a well-targeted and more efficient social protection mechanism, the problem that policymakers have to address today in the face of food price hikes are similar. In both cases the price of consumer items rises and policymakers are under the pressure to find solutions for sheltering the poor from the adverse consequences of rising prices. The guide suggested a 9-step approach for the reform of price subsidies:

Assess the nature of existing subsidies, their objectives, beneficiaries, administrative mechanisms, and costs.
Assess the socioeconomic, and demographic characteristics of the population affected by higher consumer prices, particularly the poor.
Assess the gains from price-subsidy reform. These would include improved resource allocation, resource savings that could finance critical public services, or reduce the deficit or taxes, and the beneficial impact on real incomes of some households.
Examine the short-term impact of increasing prices of consumer items on real household incomes, particularly the incomes of the poor. Both direct and second-round effects of changes in the price of subsidized items must be considered.
Examine the macroeconomic stance. Macroeconomic policy should also take into account the impact of the price-subsidy reform.
Examine the capacity to use, on a temporary basis, existing social protection instruments to compensate the poor. These instruments may include public work programs, family allowances and social assistance. Unfortunately, although many countries have a variety of such instruments, others—notably in Africa—may lack them. (The Managing Director, in his remarks presented in Rome, referred in this regard to food for work and conditional cash transfer to the poorest programs in Brazil and Mexico. Other effective short-term measures are reducing or eliminating tariffs on key food items (as done by more than 40 countries), temporary subsidies on the one or two products most vital for the poor, and expanding the school feeding programs that exist in many countries.)
Assess the interaction with other elements of the adjustment program. The adverse affect of the price-subsidy reform can be exacerbated by other adjustment measures, such as exchange rate adjustment or civil service reform.
Assess governance and administrative capacity. In many countries, weak governance and administrative capacity hamper the targeting and delivery of benefits and waste resources.
Take account of available financing and assess the impact on the environment.