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Current economic crises are forcing governments of many countries to look for ways to reduce government spending and inflation and improve the foreign exchange balance. Policies and programs that keep food prices low to consumers-consumer-oriented food subsidies-form a significant share of government expenditures in a number of developing countries and have often been the target of efforts to bring deficit spending down in attempts to deal with an unsustainable economic situation. Thus, capping or reducing food subsidies was part of about one-third of 94 adjustment programs supported by the International Monetary Fund during recent years.
Food subsidies also introduce price distortions into the economy and may result in large economic losses to food producers. Therefore, their alleviation would be expected to contribute to economic growth, which in turn would assist in effectively dealing with the economic crises.
Consumer-oriented food subsidies may be powerful policy tools for reaching certain social, economic, and political goals including transfers to certain population groups, usually urban consumers; reducing energy and nutrient deficiencies in low-income population groups; maintaining low urban nominal wages; and ensuring social and political stability. Targeted food subsidies may also be effective in protecting specific groups of poor households from deteriorations in their standard of living such as those associated with severe economic crises and macroeconomic adjustments.
Thus, although food subsidies may represent large drains of government revenue and large economic costs to farmers and to the economy as a whole, they may also be effective policy tools for reaching specific government objectives including those aimed at enhancing the health, nutrition, and general well-being of the most disadvantaged members of society. Indiscriminate use of food subsidies as a policy tool is unlikely to be the most cost-effective means to improve the welfare of the poor in the short run and may have disastrous effects on economic growth in the longer run. Conversely, if used imaginatively, they may be very effective in reaching specific and limited policy goals with little or no negative effect on economic growth and may in fact result in healthier children, more productive adults, and stronger economic growth in the longer run.
For some countries during some periods, consumer food subsidies clearly have a role to play in efforts to reach social, economic, and political objectives. However, in many cases this role has not been properly specified; failure to design or modify subsidy programs to achieve the objectives in the most cost-effective manner and failure to discontinue or replace inappropriate programs have resulted in high fiscal and economic costs and misallocations of resources and transfers as exemplified by programs in Egypt, where the annual costs during the first half of the 1980s have been US$2 billion, or around 6 percent of GNP.
Consumer food subsidies are rarely, if ever, the most efficient measure to deal with long-term structural problems in the economy. In fact, as shown by rice subsidies in Egypt that resulted in increased rice consumption, reduced production, and a change from net rice export to net import, they may contribute to such problems by distorting resource allocation in agriculture and consumption patterns. Their proper role is to compensate for the effects of inappropriate development strategies, asset distribution, institutions, and policy measures. Thus consumer food subsidies to enhance the purchasing power of the poor and to lower and stabilize food prices may not be needed in countries following a development strategy that emphasizes employment generation and productivity growth among the poor, equitable asset distribution, cost saving technological change in food production, investments in rural infrastructure, and improvements in food marketing. Institutional changes and policy measures that provide the poor with access to productive assets and skills could greatly reduce the need to enhance their incomes through food subsidies.
An important role can be played by consumer food subsidies in societies where the development strategy is biased toward capital-intensive urban development rather than employment-intensive rural development, where there is too little emphasis on expanding food production at lower unit costs and on reducing food-marketing costs, where marketing institutions are not effective in dealing with price fluctuations, or where the poor cannot maintain a minimum living standard. In situations where distortions exist in capital and product markets, including implicit and explicit subsidies and taxes on energy, transportation, and many other goods and services, food subsidies may be badly needed to compensate the poor for negative effects of regressive distortions in other sectors.
Food subsidies have resulted in large transfers from food producers or governments to consumers. For example, a subsidized food ration scheme in Sri Lanka contributed 16 percent of the incomes of the poorest decile of the population in 1978-79, while food subsidies accounted for 13 percent of the incomes of urban poor and 17 percent of the incomes of rural poor in Egypt in the early 1980s. In Bangladesh, the value of food subsidies received by the urban poor was 15-25 percent of total income, and benefits of similar magnitudes were estimated for several other countries. However, most subsidy programs are not targeted on the poor, and better-off consumers usually receive larger absolute transfers although they generally make up a smaller percentage of total incomes. As further elaborated below, targeting offers large untapped opportunities for reducing fiscal and economic costs of subsidy programs while increasing benefits to the target population.
Food subsidy programs in several countries have also positively affected household food security and nutrition. Programs that make fixed rations available at predetermined prices, such as food ration schemes in Egypt, India, Sri Lanka (up to the late 1970s), and Bangladesh, have been particularly effective in ensuring access by households-especially urban ones-to staples. Food consumption among low-income consumers has increased as a result of food subsidies. For example increases of 15-18 percent in energy consumption were estimated for Kerala, India, and urban areas of Bangladesh. Estimates of nutrition effects are scarce, but food subsidies were estimated to reduce the prevalence of underweight children in Kerala, India, and the Philippines.
The long-run benefits have been less than the income transfer embodied in the subsides, because wages tend to adjust to changing food prices. This is particularly pronounced in cases where minimum wage laws or labor unions are able to maintain at least a certain degree of indexing between prices and wages. The implication is that government savings from reduced food subsidies would be partly offset by increasing public-sector wages. This offset occurred in Sri Lanka and would be likely to occur in Bangladesh, Egypt, and probably most other countries. In some countries, food subsidies are viewed as partial wages to public-sector employees, including military personnel, and may be designed with this in mind.
In cases where the subsidy cost is borne by donors of foreign food aid, government savings from reducing or removing explicit food subsidies may be less than expected. In fact, some food subsidy programs based on foreign food aid have resulted in net gains to governments, thus providing a source of government revenue that would disappear if both food aid and subsidies were discontinued.
Benefits to recipients may also be less than the value of the transfer when explict subsidies are financed in such a way as to result in higher rates of inflation and therefore higher prices for other commodities competing for the budget of poor households. For example, it was found that a 10 percent increase in government expenditures on food subsidies in Egypt would result in a 5 percent increase in the rate of inflation on the assumption that the expenditures were financed through expanded money supply.
Costs to government may be high, particularly in the case of explicit, untargeted subsidies. During the first half of the 1980s, Egypt spent about US$2 billion annually for food subsidies, or 16-18 percent of total government expenditures. Similarly, during the mid-1970s, 15 percent of government expenditures in Sri Lanka went to food subsidies. However, in most countries government costs fell during the 1980s, primarily because of falling real prices of food procured by governments in the international market rather than explicit action to curtail subsidies. There are exceptions such as Sri Lanka and Mexico, where explicit and large reductions in food subsidy programs were made. Thus, the nominal costs of the Sri Lankan programs have been kept constant since the late 1970s, resulting in large reductions in real costs from about 12 percent to less than 3 percent of government expenditures. In Mexico, large price subsidies on several foods including maize were drastically cut in 1986-87 as part of a structural adjustment program.
Alternative programs for short-run goals
In the short run, food subsidies are but one of many ways in which governments may increase the purchasing power of the poor and compensate for losses in real incomes caused by economic recessions or adjustments, or by an inappropriate development strategy. Cash transfers as well as food transfers are among the alternatives. Cash transfers not linked to food tend to be less palatable politically than transfers linked to food, such as food stamps, targeted food-price subsidies, and food-supplementation schemes.
There are other arguments favoring food transfers. Political resistance to programs directly aimed at a reduction in starvation and malnutrition is likely to be much less than political resistance to cash transfers. Cash transfer programs are also very difficult to implement, and the cost of the necessary control measures to avoid fraud and excessive leakage to non-target groups is usually high. Self-targeting, which may be possible if food subsidies are aimed at less-desired foods, is not possible with cash transfers. Also, food may be available from foreign aid at a cost to governments considerably below its market value, thus making food-related transfer less expensive. In some cases, such food aid can be monetized by the recipient governments, while in many others, donor restrictions prohibit monetization.
In an attempt to reduce leakages to nontarget households and to focus more sharply on improved nutrition, some countries have opted for food supplements or direct feeding of individuals deficient in calories and protein, usually children and pregnant and lactating women. Such programs may ensure that leakages to nontargeted households are small. However, intra-household leakages will occur through reductions in the allocation of food to target individuals, and households may reduce food acquisition from other sources.
If nutritional improvement is the sole goal of a food subsidy program, it is likely to be most cost-effective if combined with a primary health-care program, which may include growth monitoring, nutrition education, vaccinations, and various preventive and curative health measures. Malnutrition is likely to be caused by a set of factors, only some of which will be affected by a food subsidy per se. Since the effect of changing one factor-for example, purchasing power- depends on changing other factors-for example, infectious diseases or anorexia, or low budget allocation to food due to poor nutrition knowledge-a combined program is likely to be more cost-effective than a food subsidy program per se. Such an approach may also be pursued to identify target households through, for example, growth monitoring at the health center or in the community.
An integrated approach implies a risk of overloading the primary health care system. Therefore, it is important that sufficient additions be made to the resources available to the system. Private retailers rather than the primary health care system should be charged with distribution of the subsidized food. This may be accomplished by distributing food stamps to target households at health centers.
Improving program design and implementation
Modifications of existing programs may improve their performance. But pursuing rationing or price stabilization goals efficiently may require programs that are different from those needed to ensure efficient income transfers. This is because efficient income transfers must be based on targeting, while ensuring access to a ration at a fixed prices by all households is not a function of targeting. Similarly, if the goal is to improve nutrition rather than to transfer income, the most cost-effective program design may be different. Improved nutrition may be most effectively pursued through a program that continues income transfers and primary health care.
Many existing programs and policies have changed over time, from public distribution schemes aimed at assuring households access to certain rations of basic staples at fixed prices to food-linked income-transfer programs. In some cases, the transition has been by default rather than through a change in policy goals and has been caused by an inability to increase the prices of food rations at the same rate as the price increased in the open market-as in Egypt, where nominal prices for staple foods remained constant over a number of years. The result has often been cost-ineffective programs.
Household targeting is a key element in achieving income-transfer or nutrition goals at reduced costs. Modifications in food subsidy programs toward targeting would be likely to reduce fiscal and economic costs, but they would also result in economic losses for nontarget households and therefore incur political opposition. The design and implementation of programs to reach target households and to exclude nontarget households are difficult. The difficulties are due to political and logistical factors as well as to insufficient information. Nontarget households will oppose successful targeting, in some cases to the point of threatening political and social stability.
There is a point beyond which increases in administrative costs, including the cost of identification of target households, exceed the savings from further reducing leakage of benefits to nontarget households. As a program becomes more narrowly targeted, the risk of excluding target households increases. A program narrowly targeted on the poor is likely to have little political support and, if implemented, may have a short life, as exemplified by the Colombian food stamp program, which was discontinued after four years in spite of its high cost-effectiveness, simply because it was not seen as being important by the new government.
Ideally, household targeting would be based on incomes of households adjusted for size and composition. However, reliable estimates of household incomes are not usually available; obtaining and periodically updating such estimates would be extremely expensive in most developing countries and often impossible. Households may move in and out of poverty or may need support only during certain periods, so flexibility as well as an exit criterion may be needed. Nevertheless, income and assets may be used to exclude the highest income group.
Many other targeting mechanisms have been tried, some with success and others not. These include targeting by geographical area, by nutritional or employment status of household members, by subsidization of inferior commodities or qualities, and by time of year according to seasonal fluctuations that severely limit the acquisition of sufficient food. The most appropriate choice among the various targeting approaches depends on the particular circumstances within which subsidies are introduced. As a general rule, targeting approaches that do not contradict household behavior-for example, subsidies on less preferred foods-are most likely to be successful. Lack of success in targeting or high costs of targeting often reflect the desire and ability of nontarget households to circumvent targeting efforts. Removing this desire would cut targeting costs.
In some cases, targeting may stigmatize certain population groups. This may be unacceptable in societies where social and political instability would result, particularly if the target group belongs to a distinct ethnic group.
Governments may consider targeting subsidy costs as an alternative to targeting subsidy benefits. The generation of revenues to cover subsidy costs through excise taxes on luxury goods and services is one example of such an approach; progressive income taxes is another. However, it is not clear that targeting costs is easier than targeting benefits.
Although costs of explicit subsidies are borne by government, costs of implicit food subsidies are usually targeted on producers. Efforts to maintain consumer subsidies through artificially low producer prices may entail high economic costs, but selective procurement need not. Government procurement of food at prices below free-market prices need not reduce incomes to the producer sector if the lower prices are passed on to low-income consumers in the form of a highly targeted food-price subsidy and if the procured quantity is a small part of the production of a particular farmer. This is so because the scheme will result in an overall demand increase and in compensation to producers through higher prices for the quantity sold in the free market.
If such procurement is limited to large producers, small ones would benefit from the price increases without having to contribute to the cost of the subsidies. In the absence of changes in foreign trade of the commodity, the net result would be a transfer from high-income (nontarget) consumers to low income (target) consumers and small producers. Whether large producers would lose or gain would depend on the price response among consumers and producers. Studies of the Indian procurement scheme for food grains indicate that producers as well as low income consumers may gain, at least in the short run, and that significant improvement in income distribution may be obtained with only small losses in economic efficiency if the subsidy scheme is effectively targeted on the poor rather than mostly on urban consumers, as is currently the case.
Private-sector distribution of subsidized food can be very cost-effective, often more so than public distribution. Food stamps that may be redeemed in private stores, as exemplified by programs in Sri Lanka and Mexico, are an obvious example. Even when the subsidy is embodied in a lower price for a certain commodity ration, a separate public-distribution network is unlikely to operate at a lower cost or a lower degree of corruption and program abuse. Distribution through primary health care posts and similar public sector agencies seems to be particularly inefficient and inappropriate. Private distribution of subsidized food has been successfully used in a number of countries, including the Philippines and Egypt, at a relatively low cost. But household food-security goals may not be fully achieved through private distribution in countries without strong competitive markets or where the risk of political or social instability is high.
In most countries, investing in marketing infrastructure and activities to improve competition among marketing agents appears to be a more efficient strategy than maintaining a public-sector food distribution network. Promoting small-scale private sector retailing, improving transportation, and investing in other private-sector marketing activities are particularly promising because, in addition to being cost-effective and reducing concentration of food marketing in the hands of a few, such a strategy will accelerate entrepreneurship and income generation among the poor.
Improvements in the efficiency of food production through technological change, improved rural infrastructure, and expanded input use, as well as improved marketing efficiency, offer great opportunities for reduced consumer prices without adverse effects on producers and without large government outlays. Enhanced capacity of the poor to generate sufficient incomes to meet nutritional requirements and other demands provides the long-term means to meet welfare goals. Consumer food subsidies or alternative transfer programs should be viewed as temporary but important means to ensure that the poor can acquire sufficient food for nutritional requirements while such capacity is being created. To be cost-effective, it is essential that the programs be targeted.
Opportunities for using food subsidies to create self-sustained income-generating capacity among the poor have not been fully exploited and should be pursued. Such opportunities include the formation of human capital through improved health, nutrition, and education, as well as the use of subsidized food to facilitate development of small-scale enterprises and other self-help activities by the large portion of the poor who are self-employed. Public-works schemes offer promise in this regard. Access to food subsidies along with credit and technical assistance during the initial phase of new private-sector activities may greatly facilitate and expand small-scale entrepreneurship, increase incomes among the poor, and reduce the need for food subsidies in the future. Food subsidies may also be effectively used to support community efforts to create the infrastructure needed for local economic development. Ideally, the poor would gain first from participating through public-works programs that generate infrastructure and, subsequently, through increased employment and opportunities for small-scale entrepreneurship made possible by the infrastructure.
The most important lesson learned from recent research and policy experience is that consumer food subsidies can be a powerful and cost-effective policy tool to reach certain social, economic, and political goals, or they can be harmful to growth and equity. As with so many other policy tools, the question is not whether consumer food subsidies are good or bad but when and how they are applied.
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