TO SUBSIDISE OR TO TRANSFER?

A CGE ANALYSIS OF ALTERNATIVE POLICIES TO TACKLE CHRONIC FOOD INSECURITY IN ETHIOPIA

Seneshaw Tamru, Gerawork Bizuneh,

A. Stefano Caria

Ethiopia is Chronically Food Insecure

Persistent availability problem 1960-2001: per capita food availability always

significantly below per capita requirement (Demeke et al, 2004)

Increasing number of people with insecure access Number of estimated food transfer beneficiaries

trending upwards (Demeke et al, 2004)

Numerous utilization issues Acute watery diarrhoea (AWD), malnutrition, child

wasting and stunting prevalent

Tackling Access and Availability: To Subsidise or to Transfer?

Increase ag productivity through input (Fertilizer) subsidy Lower cost of inputs benefits farmers Higher production: availability Lower prices for consumers: access

Food transfers based on local procurement Higher prices benefit farmers Stimulate more production: availability Transfers used to address access

3 Caveats

Is fertilizer subsidy the most efficient policy to boost ag productivity? Optimal use, complementary policies, environmental

concerns If better ag policies exist, then our results are a low-

bound estimate of the effects of ag productivity growth

Focus on chronic food insecurity Fert subsidy not adequate to respond to fast-onset

disasters

Focus on access and availability, not utilization

Why Interest in Transfers, Local Procurement and Subsidies?

Transfers effective in raising food consumption, but incomplete “additionality” (Dorosh & Del Ninno, 2002)

Local procurement is solution to price disincentive effects of food aid imports (Barrett C. B., 2006)

Fertilizer subsidies have proved effective in the past: Malawi experience: higher application rates and yields

(Gilbert et al, 2009) Role in Green Revolution in Asia (Demeke, 2004)

In Ethiopia, given declining soil fertility and land availability constraints, food production growth has to happen at the intensive margin (increasing land productivity) But high cost of inputs

The Ethiopian Fertilizer Market Before 1993: Govt Monopoly, 15% subsidy in

93 93-00: significant private sector participation

1995: 30% subsidy 1996: 20% subsidy

February 1997: Subsidy Removed Marked fall in fertilizer application rates

2000-present Regional Holdings first and later Cooperative Unions dominate the market

Structure of the presentation Description of Simulations Results & Sensitivity Analysis Conclusions

The Simulations

Fertilizer Subsidy, Transfers from Local Procurement… and both

FERT: 50% decrease in fertilizer price through a subsidy on imported

fertilizer No change in food aid wheat imports

FERTL: 50% decrease in fertilizer price as in FERT Some food aid wheat imports replaced by local procurement

LOCAL: No subsidy on fertilizer No change in food aid wheat imports Increase in wheat transfers to rural poor through local

procurement same level of local procurement as in FERTL

Simulating a fertilizer subsidy

Introduce a negative tariff to reduce fertilizer price𝑃𝑀𝑓𝑒𝑟𝑡 = 𝑝𝑤𝑚𝑓𝑒𝑟𝑡 ∗൫1+ 𝑡𝑚𝑓𝑒𝑟𝑡൯∗𝐸𝑋𝑅+ 𝑇𝑟 𝐶𝑜𝑠𝑡𝑠

Subsidy on fertilizer calibrated so as to get a 50% reduction in price

…and the right demand and productivity response

Comparing 5 years averages before and after the 97 subsidy removal, we .. Adjust input output coefficient to obtain a

realistic demand response:𝑄𝐼𝑁𝑇𝑐,𝑎 = 𝑖𝑐𝑎𝑐,𝑎 ∗𝑄𝐼𝑁𝑇𝐴𝑎 Adjust productivity parameter to obtain a

realistic productivity response Assume ½ of difference in yield due to

fertilizer & no productivity change for non-traded agriculture𝑄𝑉𝐴𝑎 = 𝛼𝑎𝑣𝑎 ∗ቌ 𝛿𝑓,𝑎𝑣𝑎 ∗𝑄𝐹𝑓,𝑎−𝜌𝑎𝑣𝑎

𝑓𝜖𝐹 ቍ

1 𝜌𝑎𝑣𝑎ൗ�

Simulating a Wheat Transfer

Transfer money from government to households

𝑌𝐼𝑖 = 𝑌𝐼𝐹𝑖,𝑓𝑓𝜖𝐹 + 𝑇𝑅𝐼𝐼𝑖𝑖′𝑖′𝜖𝐼𝑁𝑆𝐷𝑁𝐺′ + 𝑡𝑟𝑛𝑠𝑓𝑟𝑖𝑔𝑜𝑣 ∗𝐶𝑃𝐼തതതതത+ 𝑡𝑟𝑛𝑠𝑓𝑟𝑖𝑟𝑜𝑤 ∗𝐸𝑋𝑅

Force households to consume out of cash transfer as if they had received wheat

Calibrate gamma in order to achieve a 0.25 MPC for an in-kind wheat transfer𝑃𝑄𝑐 ∗𝑄𝐻𝑐,ℎ = 𝑃𝑄𝑐 ∗𝛾𝑐,ℎ𝑚 + 𝛽𝑐,ℎ𝑚 ∗ሺ𝐸𝐻ℎ − 𝑠𝑢𝑏𝑠𝑖𝑠𝑡𝑒𝑛𝑐𝑒 𝑒𝑥𝑝𝑒𝑛𝑑𝑖𝑡𝑢𝑟𝑒ሻ

Simulating Local Procurement We fix wheat imports (mainly food aid and price

inelastic high quality wheat) & hence change model: Add one exogenous variable Make QMwheat and QDwheat highly substituable (sigma

8) Add one endogenous variable: Implicit Tariff

Imports of wheat in 2005 were 1.638 For LOCAL, imports at 1.638: all additional wheat

purchases from local markets For FERTL, imports go down: 1.061 of food aid

previously imported is now sourced locally

The implicit Tariff

𝐼𝑚𝑝𝑙𝑖𝑐𝑖𝑡 𝑇𝑎𝑟𝑖𝑓𝑓= ሺ𝐼𝑃𝑃′ − 𝐼𝑃𝑃ሻ∗𝑄𝑀′

Partial Eq Cost of the subsidy and a transfer of the same cost

pwm - World price 0.729tm- Subsidy 0.707EXR1- Exchange rate post-subsidy 1.019QM1- Fertilizer demand post-subsidy 2.230Total cost of subsidy 1.171

𝑝𝑤𝑚𝑓𝑒𝑟𝑡 ∗𝑡𝑚𝑓𝑒𝑟𝑡 ∗𝐸𝑋𝑅∗𝑄𝑀𝑓𝑒𝑟𝑡

The Partial Eq cost of the subsidy to the government is:

The subsidy will cost 1.171 billion birr. 1.061 billion birr of wheat can be transferred for the same cost:Total cost of wheat transfer 1.171

Total logistic costs 0.110Total amount transferred (value) 1.061

Closure

Factors closures… Labour is not fully employed and is mobile across

sectors Land is fixed and mobile Capital is fixed and activity specific

Marginal propensity to save is fixed; investment adjusts

Tax rate fixed, government savings adjusts Foreign savings fixed, exchange rate is flexible

DPI is numeraire (CPI flexible)

Results and Sensitivity Analysis

FERT: fert sub, no change in food aid imports

Productivity shock, lower cost of fert and higher application Higher domestic production and lower prices for 3 cereals Higher HHs consumption, also for rural poor FERT increases overall import demand: ex rate depreciates,

exports increase

Teff Wheat Maize Ntraded ExportProductivity shock 2.4 2.8 4.3 0.0 1.3Composite price -5.26 -5.73 -6.38 -0.41 -1.17Domestic Production 6.95 10.59 7.40 2.38 2.98HH consumption 8.25 9.37 8.17 2.97 3.72Rural poor consumption 8.33 9.25 8.02 2.83 3.62

Absorption 1.6 3.1HH consumption all goods 2.8 1.1Investment -2.4 0.8Real exchange rate

% Change from base- Ag commodities

% Change from base- Macro variablesExportsImports

FERTL: fert sub, some aid imports replaced by local procurement

Similar to FERT: production, price and consumption effects Local procurement induces larger domestic production

response for wheat and lower price reduction HH consumption on all goods rises compared to FERT Total import demand slightly reduced: small appreciation of

real ex rate

Teff Wheat Maize Ntraded ExportProductivity shock 2.4 2.8 4.3 0.0 1.3Composite price -5.12 -2.78 -6.23 -0.18 -0.39Domestic Production 7.38 36.33 7.90 2.71 2.52HH consumption 9.70 7.31 9.16 3.98 4.23Rural poor consumption 8.72 6.62 8.66 3.38 3.57

Absorption 2 -0.1HH consumption all goods 3.3 -0.2Investment -2 -0.2Real exchange rate

% Change from base- Ag commodities

% Change from base- Macro variablesExportsImports

LOCAL: additional wheat transfers from local procurement

Minor increase in prices of all cereals, due to income and consumption effects of transfer

Increase in domestic production of wheat, large increase in rural poor consumption of wheat due to transfer

Small macro effects on real exchange rate

Teff Wheat Maize Ntraded ExportProductivity shock 0 0 0 0 0Composite price 0.19 0.42 0.19 0.22 0.56Domestic Production 0.82 6.67 1.03 0.69 0.40HH consumption 0.88 5.16 1.05 0.89 0.62Rural poor consumption 4.16 20.67 3.45 3.92 3.6

Absorption 0.2 -0.7HH consumption all goods 1 -0.2Investment -2.8 -0.1Real exchange rate

% Change from base- Ag commodities

% Change from base- Macro variablesExportsImports

Availability of Food: Cereal Production & Supply

Subsidies (FERT + FERTL) cause production and supply gains for all cereals Local procurement

(FERTL) increases domestic production of wheat further

… but slightly lowers overall supply given cap on imports

Food transfers (LOCAL) affect production and supply of wheat only

Teff Wheat Maize0

10

20

30

40

% Change in Domestic Production

FERT FERTL LOCAL

Purchasing Power: Income Effects

Fertilizer subsidy (FERT) raises income of all HHs Local procurement

(FERTL) increases income gains of the rural poor, through higher returns to land and labor

Wheat transfer (LOCAL) delivers highest income gains for rural poor Small-no gains for

other HH

Rural Poor Urban Poor0.001.002.003.004.005.006.00

HH Income: % Change From Baseline

FERT FERTL LOCAL

Access to Food: Cereal Consumption of the Rural Poor

Fert subsidies (FERT and FERTL) increase consumption of all cereals Price and income effects

contribute to access Food transfers (LOCAL)

increase wheat consumption only Transfers and small

income effect increase access

Higher cereal prices tend to lower access

Teff Wheat Maize0

5

10

15

20

25

% Change in Rural Poor Consumption

FERT FERTL LOCAL

Cereal Consumption of the Rural Poor is sensitive to changes in assumptions

Change in aggregate food consumption depends on: Productivity gains from

fertilizer use MPC out of in-kind transfer

Under conservative assumptions, LOCAL achieves a higher aggregate consumption than FERTL

Realistic estimates are 2/3p & 0.25<MPC<0.5 No clear ranking

0.0%6.0%

12.0%18.0%

6.2% 7.1%

15.6%

6.6% 9.0%

% Change in Rural Poor Consumption of 3 Cereals

+ ntag

Effects of wheat transfer on non-recipient HHs

Wheat consumption of all other household groups decreases with additional food transfers (LOCAL) Effect of higher prices dominates income effects

Mis-targeted rural poor will not receive the transfer but pay higher cereal prices Effects are negligible

teff 0.15%wheat -0.01%maize 0.11%

Mis-targeted Rural Poor Wheat Cons Change

General Equilibrium Effects

Same partial eq cost for all simulations, but in general eq revenue and expenditure (ie govt net revenue) change

Fertilizer subsidy (FERT + FERTL) income effect has positive effect on govt tax revenue, hence PE Costs > D.net revenue

In LOCAL PE Costs < D.net revenue, WHY? reduction in investment resulting from reduction in net revenue

Subsidy with local procurement most cost-effective at delivering GDP growth

Govt Savings D.net revenue PE Costs % GDP Change D.GDP/ GE CostBASE 5.37FERT 4.35 -1.02 -1.171 2.02 2.4FERTL 4.29 -1.07 -1.171 2.58 2.9LOCAL 4.13 -1.24 -1.171 0.31 0.3

Costs Benefits

Conclusions

Subsidy with Local Procurement has a strong Food Security Response

Fertilizer subsidy with local procurement (FERTL) delivers: The best domestic production and supply (availability)

response for all cereals Large household consumption (access) response for all

cereals Smaller loss in government net revenue

Locally procured transfers (LOCAL)… Generate little general supply response compared to fertilizer

subsidy Large consumption response (access), especially wheat Harm food consumption of other groups; mis-targeted food

consumption is unaffected

Agricultural Productivity effective in tackling Chronic Food Insecurity

Fertilizer subsidy works through agricultural productivity reponse

Virtuous cycle of increased production, increased incomes, lower prices, higher food consumption

Best when coupled with local procurement

Calibration: what are actual productivity gains from additional fertilizer use? What is a realistic MPC for in-kind transfers? If low productivity & high MPC transfers to be

preferred for improving access of rural poor