The sharp1 run-up in food prices between 2006 and mid-2008 has set off a debate about how to deal with the adverse effects on low-income households, which typically devote a larger share of their budget to food. In response, policymakers across the region have adopted a variety of measures to try to mitigate the impact of rising food prices on the poor. These steps have ranged from administrative measures (e.g., price controls, export quotas) to tax and expenditure measures (e.g., lowering indirect tax rates, expanding social safety nets). These actions entail varying degrees of fiscal and efficiency costs and effectiveness in reaching those households most exposed to food price hikes.
Against this background, a recent study by IMF staff explores two related questions: (1) how large is the effect of rising food prices on household welfare and its distribution? and (2) how cost-effective are different fiscal policies to buffer the adverse social effects of food inflation? The study is based on recent household survey data for two Latin American countries—Mexico and Nicaragua—that differ in many respects to provide a useful spectrum to assess the effectiveness of fiscal policies. Based on a simple model that considers the dual role of households as consumers and producers of food, the paper uses non-parametric techniques to estimate the effect of recent domestic food price increases on real household consumption. It then simulates the distributional impact of three fiscal instruments that can be used to mitigate the burden on vulnerable households: direct transfers, food subsidies, and import tariff reductions.
The study finds that the recent rise in domestic food prices would reduce real consumption of the poorest households significantly. Urban households at the bottom of the distribution would be the most affected. Absent any policy response, the rise in food prices between end-2006 and mid-2008 would imply a reduction of real consumption for these urban households of 16 percent in Nicaragua and 3 percent in Mexico. The rural poor have been relatively more protected as they typically produce food, helping to cushion the impact of food price hikes.
However, protecting the extreme poor would not require sizable fiscal resources. The key challenge is to implement well-targeted policies that also do not introduce distortions. The paper concludes that expanding targeted transfers stands out as the most cost-effective policy to ease the burden on the poor. Other measures, such as price subsidies, are more difficult to target effectively and may entail distortions that generate long-term costs. However, an important trade-off arises in terms of coverage of vulnerable households. While subsidies or import tariff reductions ensure almost universal coverage of low-income families, the coverage of transfer programs is more limited. A priority going forward would be to expand coverage of social safety nets, particularly for vulnerable urban households.
(1) The paper is available via the Internet at: http://www.imf.org/external/pubs/ft/reo/2008/WHD/ENG/wreo1008.htm