|The reform of price subsidies may
be necessary not only to improve efficiency, but also to facilitate pro-poor
economic growth and release resources for critical social services for
the poor. At the same time, increases in prices for basic commodities
and petroleum products can be associated with real income losses for the
poor as well as political unrest in some cases. This guide provides guidance
to policymakers on how to design and implement sound price-subsidy reforms
that take into account both economic and social considerations.
This guide draws on the experience with the reform of price subsidies
in 28 countries. It discusses economic and political considerations
in price-subsidy reform and makes several recommendations concerning
the speed of reform and social protection mechanisms. Rapid reform requires
a favorable political and economic environment. In the absence of this,
reform should be implemented gradually. The social impact of reform
can be limited by establishing cost-effective and well-targeted temporary
social protection mechanisms. Governments can reduce the risk of political
disruption by distributing the initial burden of reform fairly and by
clearly explaining the cost and benefits to the public.
The authors would like to thank Stanley Fischer, Vito Tanzi, Peter
Heller, and Ke-young Chu as well as staff of various IMF departments
for helpful comments on earlier versions. Administrative support was
ably provided by Cecilia Pineda, Larry Hartwig, and Amy Deigh. David
Driscoll of the IMF’s External Relations Department edited the manuscript
and Gail Berre coordinated production of the publication.
1. The reform of price subsidies has been a key element of IMF- supported
programs in many countries. These reforms have brought prices of subsidized
items closer to their market-clearing levels and have sought to target
any remaining subsidies to the needy. Reform is typically undertaken
in the context of macroeconomic adjustment, and its major aim is to
achieve fiscal savings consistent with stabilization of prices and exchange
rates. Reform of price subsidies may also improve allocative efficiency
and promote economic growth, but can—at least in the short run—have
adverse social and political effects. These effects can be mitigated
or eliminated by establishing social safety nets and, in some cases,
by gradually phasing out subsidies.
2. This guide is intended to assist policymakers in achieving the fiscal
benefits of price-subsidy reform with minimal social disruption. To
this end, the guide draws on the experience of a wide range of countries
and lists factors that must be considered in the design of price-subsidy
reform. The countries met at least one of the following criteria: the
budgetary cost of the subsidies was significant before reform; the Fiscal
Affairs Department of the IMF provided technical assistance on reforming
price subsidies or assigned a fiscal economist to the country; or price-subsidy
reform was a major element of the IMF-supported program. The 28 countries
examined are listed in Appendix 1.
3. Section 2 of this guide presents possible reform options; Section
3 provides a checklist of considerations in the design and implementation
of price-subsidy reform; Section 4 discusses political considerations;
and Section 5 draws key lessons. The appendices describe the nature
of price subsidies, discuss different price subsidies (Appendix 2),
and illustrate how the impact of price-subsidy reform on real household
incomes could be assessed (Appendix 3).
|II. Economic Issues in the Reform of Price Subsidies
4. Subsidy reform entails price liberalization or adjusting controlled
prices of subsidized goods and services, often during macroeconomic
adjustment. The economic goals are to correct fiscal imbalances and
to improve allocative efficiency. Since the removal of subsidies may
have adverse consequences for the poor, these effects must be analyzed
and, to the extent feasible, mitigated or offset. In this context, the
principal—and interrelated—issues that arise are the speed of price-subsidy
reform and the options for protecting the real consumption of the poor.
Speed of Price-Subsidy Reform
5. There is a trade-off between rapidly cutting budget-financed subsidies
and avoiding an adverse impact on the poor. A one-time adjustment of
prices to eliminate subsidies can yield immediate budget savings and
quickly correct distortions in resource allocation. However, it can
also result in a sudden and significant drop in standards of living,
especially for low-income households. The need to compensate households
implies that fiscal savings from price-subsidy reform are usually less
than the amount spent on generalized subsidies before the reform.
6. Gradual reform is not without drawbacks. Apart from the fact that
it takes longer to reap budgetary and economic gains, progress under
gradual reform may falter, or even be reversed. A number of small price
increases may engender more public opposition to continuing reforms
than a single large increase. In addition, the continued presence during
the phase-out period of institutions needed to administer the price
subsidies contributes to the risk of a reversal of the reforms (this
was a factor in the reappearance of the bread subsidy in Jordan in 1999,
after five years of gradual reform).1
Finally, a gradual approach may fail if it is adopted to postpone politically
difficult reforms. Such failure can be avoided by publicly adopting
a detailed timetable of measures.
7. The speed of price-subsidy reform depends on a number of elements
(see Box 1). They are:
- Fiscal considerations. A high share of explicit subsidies
in spending implies a greater potential for rapid budgetary savings.
However, as noted above, the budgetary savings will be offset in part—at
least in the short run—by compensation for the poor. Elimination of
implicit subsidies, on the other hand, will not generally yield budgetary
savings, although the revenues of public-sector agencies could increase.
Consequently, the speed of reform of implicit subsidies should reflect
the availability of resources, including from external sources. One
way to generate resources for targeted compensatory programs is to
charge market prices for donor-provided commodities. This policy would
also avoid disincentives for domestic production.
- Availability of social protection instruments and administrative
capacity. Compensating the poor for the elimination of subsidies
requires not only resources, but also a system to deliver compensation
to those who need it. Price-subsidy reform can be rapid when countries
already have social protection instruments that can be adapted to
the needs of the poor during reform (see Section 3). If new social
safety net instruments need to be established, the administrative
capacity to design and implement adequate and well-targeted social
protection will affect the speed of reform. Availability of information
on the socioeconomic and demographic characteristics of the poor will
also influence the speed.
- Willingness of governments to act on a technically sound reform
package. Political considerations have an impact on whether reforms
are implemented in a timely manner. In part, they are determined by
the popularity of the government and by the level of organization
of the middle class (see Section 4 for more details). But, even under
favorable conditions, governments may opt for a slower pace of reform
in order to assess and react to unintended consequences, including
any adverse political repercussions, and adjust the timing and speed
of reforms accordingly. (As noted above, however, this runs the risk
of reform reversal.)
Box 1. Speed of Subsidy Reform: Country
An examination of 23 countries that underwent price-subsidy reform
and for which data are available (see Appendix 1) indicates that
most countries did not rapidly reform generalized subsidies. Only
two countries eliminated generalized price subsidies in one fiscal
year, while an additional six countries achieved budgetary savings
in excess of 2 percent of GDP over a two-year period (see below).
The speed of reform in the countries studied was affected by:
- Administrative capacity and availability of social protection
instruments. Many countries adopted a gradual approach to
subsidy reform so as to adapt existing social protection instruments
or to establish a social safety net (e.g., Algeria, 1992–96;
Egypt, 1980–97; Hungary, 1992–94; Indonesia, 1997–2000; Jamaica,
1984–93; Jordan, 1994–99; Sri Lanka, 1978–82; Tunisia, 1990–99;
and Ukraine, 1995–2000). In the case of Indonesia, a system
of generalized subsidies on food items and petroleum products
was introduced in 1997 as the country lacked an effective social
safety net. In late 1998, when the budgetary cost of subsidies
ballooned to 4.2 percent of GDP, the government began replacing
the generalized food subsidies with a targeted subsidy for lower-quality
rice. The reduction in the subsidy on petroleum products was
delayed because of disagreement between parliament and government
on the mechanism for delivering protection to the poor.
In the short term, fiscal arrangements between the federal and
subnational governments can complicate the implementation of
price-subsidy reform. In the Russian Federation (1995–2000),
the federal government has established the standard for cost
recovery for housing and communal services provided by subnational
governments. However, it is up to the subnational governments
to apply this standard; they can choose to squeeze other (more
productive) programs or accumulate arrears instead.
- Lack of political support. Even when countries have
had the institutional and administrative capacity to protect
the poor, the lack of political support has stalled or reversed
reform efforts in some cases. For instance, in Ukraine, the
objective of achieving full cost-recovery of housing and communal
services is delayed, despite the availability of a well- functioning
means-tested program targeted to the poor (see Box
2). A change in government led to the reversal of reforms
in Sri Lanka (1982) and Mauritius (1995), although targeted
income-support programs in lieu of generalized price subsidies
had been established.
On the other hand, reform has been rapid where governments were
politically strong and the social consequences of reform were
largely ignored. Newly elected governments with mandates to deal
with economic crisis sharply increased prices in Peru (1990) and
Zambia (1991), effectively eliminating generalized subsidies in
one fiscal year. Other quick reformers obtained important savings
over a two-year period (Algeria, 1991–93, Egypt, 1991–94, Jordan,
1990–92, Sri Lanka, 1978–80, Yemen, 1997–99, and Zimbabwe, 1990–91).
These latter reforms were aided by a relatively small social disruption—large-scale
millers were the main losers in the elimination of the maize subsidy
in Zimbabwe (1990) and government officials were the main losers
in the elimination of the wheat subsidy in Yemen (1997–99) (Razmara
and others, 1999). Reform can also be more rapid under favorable
exogenous circumstances, such as low prices for imported staples.
Temporary Mechanisms to Protect the Poor
8. Poor households can be temporarily protected from the effects of
reforming implicit and explicit price-subsidies by:
- Providing cash compensation to all or selected consumers—perforce
including the poor—in lieu of the subsidy. This can take the form
of a separate benefit or be merged with existing social benefits (e.g.,
by increasing the minimum pension).2
Cash transfers have many advantages. They allow for consumer choice,
the cost to the budget is known with greater certainty than in the
case of generalized subsidies, and they can be targeted to the poor.
However, their real value may erode quickly during periods of high
inflation and they may be prone to corruption.
- Limiting price subsidies to a subgroup of the population—again,
including the poor. If the target group is carefully selected
and the scheme is effectively implemented, targeting can produce substantial
budgetary savings with minimal social disruption (e.g., in Jamaica
9. These temporary measures should be phased out and eventually subsumed
under existing or new social assistance programs as the economic adjustment
envisaged under economic reforms is completed. As the social impact
of price-subsidy reform dissipates over time, the imperative of providing
a coherent system of social protection for the poor overtakes the need
to provide special protection to those affected by the reform. In practice,
however, it has proven difficult to phase out temporary social safety
nets.3 To avoid this, their temporary
nature should be addressed at the outset, through public pronouncements
and, where feasible, sunset provisions. Alternatively, the cash compensation
or targeted subsidy, as well as the qualifying criteria, can be held
constant in nominal terms. In this case, the real value of the transfer
and the number of recipients will decline over time with increases in
the price level and the growth of nominal household incomes (e.g., as
happened with the food stamp program in Sri Lanka during 1979–82; Edirisinghe,
10. During reform of producer subsidies, selected small producers and
workers can be compensated for lower output prices or higher input prices
by targeted cash transfers. Producers can be given income support (e.g.,
in relation to the size of landholding in agriculture). Unemployed workers
can receive severance payments or benefits from an existing or adapted
Targeting of Compensation and Consumer-Price Subsidies
11. The primary issues in deciding how to target compensation and price
subsidies are the ability to identify the poor, the administrative capacity
to deliver assistance, and the political support for the targeting scheme
(see also Chu and Gupta, 1998a). The first two issues are discussed
below and in Section 3; the third issue is taken up in Section 4.
12. The following economic objectives should guide the design of a
- Promote efficient targeting. Targeting is subject to two
types of errors. If the targeting is too tight, some people in the
target group are excluded from the subsidy (errors of exclusion);
conversely, if the targeting is too loose, the subsidy is granted
to people for whom it is not intended (errors of inclusion). In this
context, targeting should provide adequate protection to the poor,
while minimizing leakage of benefits to the nonpoor in a cost-effective
- Emphasize economic incentives and ensure consistency with overall
fiscal and macroeconomic targets. The disincentive to work stemming
from income transfers should be recognized in the design, and the
time and cost of travel to claim benefits should not be so high that
it discourages participation by the poor (although it can be helpful
if it limits participation by the well-off).
13. The goals of efficiency and equity can best be served if the government
can limit its assistance to those truly in need. This requires the ability
to design and implement an effective means test. A means test sets an
income threshold above which benefits are phased out (see Box 2 for
its application to Ukraine). Simple means tests do not value in-kind
or seasonal income, or consider other individual adjustments. More sophisticated
tests adjust family income according to, for instance, family size or
the costs of major items such as housing and major medical expenses.
A means test should be graduated, with benefits declining as income
rises, to avoid discontinuities in labor supply.
14. Means tests have been difficult to implement in developing countries
and transition economies because of the difficulty of observing income
earned in the informal sector. A clustering of incomes around a narrow
range, implying a large change in the number of beneficiaries with a
small change in the threshold, can also add to design and administration
difficulties. In countries that are devolving responsibilities to lower
levels of government, weak administrative capacity of subnational jurisdictions
can limit the effective implementation of transfer programs.
Box 2. Ukraine: Targeting of Housing and
Communal Services Subsidy
Since May 1995, the government of Ukraine has successfully implemented
a targeted income-transfer program to cushion the impact on the
poorest segments of the population of the gradual tariff increases
to achieve full cost-recovery of housing and communal services.
The objective of this program is to limit outlays on housing and
communal services to 20 percent of total household income. Targeting
is based on total household income (total reported income of all
family members over age 16). Households have to requalify every
six months by submitting income statements for the previous three
months. The subsidy takes the form of a budget transfer to the
providers of housing and communal services which in turn accept
a discount on the amount households have to pay for these services.
In 1999, approximately 4.7 million households (25 percent of
the population) were covered at a budget cost of 0.8 percent of
GDP, down from 5.5 percent of GDP in untargeted subsidies in 1995.
In addition to providing income support, this program established
the administrative structure necessary to means test a general
15. In countries that are unable to establish an efficient means test,
the poor have to be targeted indirectly.5
Table 1 provides stylized examples of how to choose among the indirect
targeting options listed below (see also Chu and Gupta, 1998b).
- Target benefits to population groups that are likely to be poor
on the basis of socioeconomic and demographic characteristics.
These groups could include the elderly, children, or the unemployed
(categorical targeting), or those residing in specific areas within
a country (geographical targeting). Categorical and geographical targeting
are associated with relatively low administrative and economic costs
but tend to suffer from relatively large targeting inefficiencies.
In some countries, including Chile, Colombia, Mexico, and a number
of transition economies, categorical targeting has been further developed
by using a combination of household indicators that are correlated
with poverty but are more easily observed (proxy targeting). These
indicators may include housing characteristics and location, family
structure, occupation, education, gender of household head, and ownership
of durable goods. Using more indicators can improve targeting efficiency
and reduce program cost but will raise administrative costs.6
- Link the subsidy or cash benefit to a self-targeting work requirement.
The benefit payment can be made in-kind through, for example, food-for-work
programs (e.g., in Bangladesh, India, and Mexico). The obligations
for the recipient can also come in the form of the requirement to
send children to school (e.g., in India). Alternatively, beneficiaries
can receive wage payments for participating in public-works programs
(e.g., in Indonesia). The (monetary or in-kind) wage rate must be
sufficiently low so that only those workers who are in need are willing
to trade their time for the assistance (the wage rate should, in general,
be below the prevailing wage for unskilled labor).7
This would also allow more families to be helped. Such self-targeting
also provides an exit incentive: once the economic situation of the
participating families or individuals has improved, they will opt
out of the programs. Self-targeting also requires less information
than other targeting mechanisms. As a result, program and administrative
costs can be low. A major drawback is that coverage of the poor may
be imperfect because public works and food-for-work programs may not
be available in all areas in which the poor live and because of the
social stigma associated with such programs (e.g., in Brazil and Korea)
(Alderman and Lindert, 1998). Moreover, such programs cannot target
the working poor or those who are unable to work (e.g., the disabled,
elderly, and mothers with young children).
Table: Stylized Options
|Socioeconomic and Demographic Characteristics of
Existing Social Protection Instruments
Available Targeting Options
|Rural landless workers and small-olders who are net
purchasers of food; workers in the urban informal sector.
||Information on the poor is lacking; weak governance
and administrative capacity.
||Nonexistent or limited.
||Food-for-work and public works programs; commodity
targeting; food transfer programs that build on existing efforts
by nongovernmental organizations (NGOs); guaranteed minumum amount
for all, equivalent to amount consumed by the poor using coupons.
| Pensioners living alone; large families headed by
single mothers; disabled.
||Weak governance and administrative capacity.
||Well-functioning social protection programs, including
pensions, unemployment insurance, and family allowances.
||Means-tested cash compensation; categorically targeted
cash compensation and subsidies; public works programs; guaranteed
minimum amount for all, equivalent to amount consumed by the poor
| Rural and urban informal sector workers and long-term
||Information on the poor is lacking; weak governance
and administrative capacity.
||Pensions with limited coverage of formal sector workers
and limited social assistance programs.
||Commodity targeting, as well as guaranteed minimum
amount, for all, equivalent to amount consumed by the poor using
coupons; public works programs.
|Urban unemployed and low-skill formal sector workers;
||Information on the poor is lacking; governance and
administrative capacity is somewhat weak, but there is experience
with targeted social protection schemes.
||Pensions for public sector workers.
||Commodity targeting; limiting subsidies to amount
consumed by the poor using coupons; public works programs.
Note: In all cases, the subsidy to be reformed is assumed
to be a generalized subsidy for basic food staples. The targeting options
are meant to provide an indication of what may be appropriate under
different circumstances. The choice would crucially depend on prevailing
conditions, such as the incidence of corruption and available financing.
- Self-target through subsidization of lower-quality items.
Commodity targeting limits price subsidies to items that are viewed
as necessities for low-income families, but consumed in very low quantities—or
not at all—by other groups (e.g., “inferior” items in the sense that
the quantities consumed, and thus the subsidies, go down as household
income rises). It is self-targeting in that benefits are available
to all, but the program is specifically designed so that only the
poor elect to participate. Brown sugar, coarser varieties of rice
and wheat, and generic medicines are attractive options for commodity
targeting.8 The choice of packaging
can also enhance the efficacy of self-targeting. Commodity targeting
suffers from the same problems as other self- targeting schemes (imperfect
coverage of the poor and, in some cases, lack of political support).
Further, if the targeted commodity is consumed by the nonpoor, leakage
of benefits will occur. In practice, at least one-third of the commodity-targeted
subsidy can be expected to benefit the nonpoor (Alderman and Lindert,
- Limit a generalized subsidy to or below the amount consumed by the
poor. A uniform benefit to all households at a low level equivalent
to the consumption of the poor protects those below the poverty line
and is likely to attract more political support than a scheme targeted
just to the poor. On the other hand, by covering the nonpoor, the
targeting is imperfect and the budgetary costs are raised. However,
improvements can be made through the choice of delivery mechanism
(e.g., the provision of food subsidies via health clinics in Jamaica—see
Box 3). This kind of targeting has been used in
various rationing schemes for administrative ease, including direct
quantity rationing (e.g., the provision by the government to the consumer
of a fixed quantity of the subsidized item at zero or below-market
cost, as in India), cash transfers (at a value equal to or below the
loss to poor households from price-subsidy reform as in Mauritius),
and the issuance of coupons as in Sri Lanka. This principle also underlies
the establishment of two-tier tariffs for electricity and water. In
this case, households pay a lower tariff up to a certain level of
Box 3. Successful Price-Subsidy Reforms
A successful price-subsidy reform should achieve significant
budgetary or quasi-fiscal savings within a relatively short period
of time, while avoiding social and political disruptions.
- Tunisia realized substantial budgetary savings from
increased targeting of its generalized system of food-price
subsidies, reducing spending from 2.8 percent of GDP in 1990
to 1.0 percent in 1999. Reform was gradual and involved repeated
price adjustments, sensitizing the population to the need for
reform, introducing compensatory measures (e.g., higher social
assistance benefits, minimum wage adjustments, and increased
student aid), and limiting subsidies to items perceived to be
of lower quality (e.g., subsidized milk, bread, and wheat flour
were packaged unattractively).
- Jamaica implemented a food stamp program in 1984 to
provide staples to pregnant and lactating women, young children,
the poor, the elderly, and the handicapped, in lieu of a generalized
food-price subsidy. The cost to the budget fell from about 6
percent of GDP in the late 1970s to around 0.1 percent since
1993. Moreover, the innovative delivery mechanisms (such as
the distribution of benefits through the health care system)
allowed for a substantial increase in targeting efficiency.
In 1998 the real value of the food stamps was only 73 percent
of its value in 1990, and the program covered only a small share
of the low-income consumption basket.
- Targeting in Hungary during the early 1990s relied
on social assistance offices to target housing allowances to
poor households, while raising housing rents to market levels
and eliminating interest subsidies.
- The price-subsidy reforms in Jordan and Ukraine
were successful in that they achieved reductions in government
outlays while providing protection to vulnerable groups. Sustainability
of the reform has been a problem in Jordan, however, while progress
in Ukraine toward achieving full-cost recovery for communal
and housing costs has been slow.
16. The choice among targeting options depends on the ability and willingness
of governments to target subsidies and cash transfers. In cases where
the country lacks both the administrative capacity to target price subsidies
and social protection instruments that can be quickly adapted to compensate
the poor, self-targeting mechanisms or provision of a limited subsidy
to all are likely to be the only available options for compensating
the poor, at least in the short run. Box 3 lists selected examples of
countries where price-subsidy reform has been successful.
|III. Checklist of Economic Considerations in Price-Subsidy
17. Based on the above discussion, policymakers should do the following
to the extent information is available:10
18. Assess the nature of existing subsidies—their objectives, beneficiaries,
administrative mechanisms, and costs. The analysis of current subsidies
should be the starting point and should include an assessment of their
economic rationale and efficiency in achieving their objectives. Special
attention should be given to identifying the extent of implicit subsidies,
which in contrast to explicit subsidies, cannot be easily gleaned from
the budget. In the case of producer subsidies, design considerations
are different. The goal of producer subsidy policy is to protect incomes
of producers and support employment. In such cases, as noted in Appendix
2, output prices are set above market-clearing levels. Compensatory
measures should then be targeted at smaller, less wealthy, producers
and those rendered unemployed by reforms.
19. Assess the socioeconomic and demographic characteristics of
the population affected by higher consumer prices, particularly the
poor. The poor may be clustered in certain socioeconomic groups
or regions. For instance, in Europe and Central Asia, single mothers,
families with many children, pensioners living alone, and workers with
little or outdated education are very often poor (Grootaert and Braithwaite,
1998); much of the poverty in Africa, on the other hand, is concentrated
in rural areas (Demery, 1999). Such information is typically available
from the World Bank’s Poverty Assessments and household surveys. The
poverty line is crucial for assessing the characteristics of the poor.
In the design of social safety nets, the usual practice has been to
use country-specific poverty lines, rather than international poverty
lines defined in terms of daily consumption measured in U.S. dollars
in purchasing-power-parity terms.
20. Assess the gains from price-subsidy reform. These would
include improved resource allocation (e.g., improved availability of
price- controlled items), resource savings that could finance critical
public services, or reduce the deficit or taxes, and the beneficial
impact on real incomes of some households (see below).
21. Examine the short-term impact of increasing prices of consumer
items on real household incomes, particularly the incomes of the poor.
Both the direct and indirect effects of changes in the price of subsidized
items must be considered by following these steps:11
- Assess the direct impact of a reduction in subsidies on real
household incomes. A pragmatic approach to estimating this impact
is provided in Appendix 3. Such estimation requires information on
the share of subsidized spending in total household expenditure. These
data can usually be obtained from household surveys, but are often
available only with a substantial lag or with less detail than desired
for these purposes (see Deaton, 1997). For example, in Poland in 1993,
an increase in household tariffs for heating, electricity, and natural
gas to market levels (an increase of about 80 percent) would have
resulted in an immediate 5.9 percent fall in real income of the households
in the bottom 20 percent of the income distribution (Freund and Wallich,
1997). In Indonesia, in the aftermath of the 1997–98 financial crisis,
food price increases had an immediate and significant impact on the
level of real consumption of low-income households. This was attributable
to the high share of food (over 70 percent) in total expenditures
of low-income households and the high increase (over 75 percent) in
food prices during 1998 (Gupta and others, 1999).
Not all poor households lose from price-subsidy reform. For example,
households that produce more food than they consume may gain from
the liberalization of food prices. Those employed in the traded-goods
sector may also benefit from the elimination of implicit exchange
- If possible, assess second-round effects. Increases in subsidized
commodity prices may trigger price increases in other items, such
as locally produced foods (e.g., in Jordan, elimination of the wheat
subsidy in 1996 prompted producers of poultry and dairy products to
raise their prices sharply; see Footnote 1). Reducing the subsidies
on energy products will increase the production cost of a broad range
of items. Although such effects on the production cost of nonsubsidized
items are typically difficult to assess ex ante, an initial, tentative
estimate can be made by using the input share of subsidized items
in the production of other major goods and services consumed by households.
Data on such input shares can be obtained from social accounting matrices
(e.g., see Thorbecke, 1998).
- The impact of price-subsidy reform on real household income (particularly
of the poor) should be monitored. With the support of the World
Bank, units have been established in a few countries to continuously
monitor social outcomes during the implementation of reforms (e.g.,
the Social Monitoring and Early Response Unit in Indonesia, in 1998).
22. Examine the macroeconomic stance. Typically, price-subsidy
reform is undertaken at a time of fiscal consolidation to help achieve
macroeconomic stability. The scope of the compensation scheme and the
speed and extent of the reform must be consistent with these overall
policy targets. Macroeconomic policy should also take into account the
impact of price-subsidy reform. The reduction of consumer-price subsidies
will be reflected in a one-time increase in prices. Monetary and fiscal
policies should prevent these price adjustments from triggering a period
of sustained higher inflation through, for example, a price-wage spiral.
23. Examine the capacity to use, on a temporary basis, existing
social protection instruments to compensate the poor. These instruments
may include formal social security arrangements, including social insurance
(such as public pensions and unemployment insurance), family allowances,
and social assistance. In cases where speed is of the essence, the administrative
structure of existing social security programs can, in principle, be
used to transfer benefits quickly to those poor individuals and households
affected by the price-subsidy reform. It will be important, though,
to ensure that such use of existing social security programs is temporary
and that any additional cost is funded separately. Since these instruments—particularly
social insurance programs—do not have poverty reduction as their principal
aim, they may need to be adapted, a process that has often encountered
political resistance, especially in transition economies. Finally, although
some countries—particularly many transition economies—have a variety
of such instruments, others— notably in Africa—may lack them.
24. Assess the interaction with other elements of the adjustment
program. The adverse impact of price-subsidy reform can be exacerbated
by other adjustment measures (e.g., an exchange rate devaluation and
civil service reform). Specific measures, though not designed to compensate
for price-subsidy reform, may help to ameliorate its adverse impact
on certain population groups (e.g., the provision of severance pay to
assist those laid off from civil service and public enterprises). On
the other hand, in a number of transition economies, enterprises provide
in-kind subsidies to their workers (e.g., for housing, day care, school,
health care, sports, and food) (Hu, 1998). Enterprise reform can deprive
households of such in-kind benefits, and this fact should be reflected
in the design of safety nets.
25. Assess governance and administrative capacity. In many countries,
weak governance and administrative capacity hamper the targeting and
delivery of benefits. Weak governance can divert and waste resources
allocated for price subsidies. Weak administrative capacity reflects
the lack of cost-effective mechanisms to channel income transfers or
targeted price subsidies to the designated population groups, and can
be rooted in such factors as insufficient information on the poor and
lack of equipment. Even where administrative capacity exists, targeting
and delivery can be difficult. Determining eligibility on the basis
of income may lead to mistargeting benefits if the administrative capacity
is weak. Furthermore, incomes change over time and frequent updates
of income data are costly (Van de Walle, 1998). For example, the cost
of administering a means-tested rice-subsidy program in India’s Andhra
Pradesh state in 1996 was Rs 1.75 for every rupee reaching the poor,
and another Rs 3.6 were lost in leakage to the nonpoor (Radhakrishna
and others, 1997).
26. Take account of available financing. The reform of explicit
subsidies is usually undertaken to achieve, inter alia, budgetary savings.
Depending on the size of required fiscal adjustment, part of those savings
can be used for targeted programs. On occasion, access to foreign funds
and commodity assistance may provide additional resources for compensatory
27. Assess the impact on the environment. Price-subsidy reform
is usually, but not always, beneficial for the environment (Gupta, Miranda,
and Parry, 1995). Input subsidies for pesticides, fertilizers, and irrigation
can be harmful for the environment. They also provide incentives for
land clearance, which can lead to soil erosion. Subsidies for energy
may contribute to global warming, acid rain, and respiratory and other
health problems. On the other hand, subsidies for kerosene have been
defended because they tend to benefit the poor and they can reduce reliance
on firewood and protect forests.12
However, the most efficient way to internalize environmental costs and
benefits is to penalize behavior that harms the environment, as with
a carbon tax, rather than subsidize alternatives to this harmful behavior.
|IV. Political Considerations
28. When reform targets benefits to truly needy families, less needy
families will suffer. The latter families may be part of politically
powerful groups. If governments perceive the risk of political fallout—including
apprehension about violent protest—as too large, they may be deterred
from implementing reforms. In some countries—Ecuador in 1998–99, for
instance—the government’s popularity was eroded in the wake of the implementation
29. As noted above, political considerations influence the speed of
reform. These considerations include (see also Box 1):
- Popularity of the government. It is easier for a popular
government to implement difficult policy reforms. For example, the
election of a new government with strong public support can provide
an opportunity for rapid reform. Furthermore, an economic crisis may
temporarily engender greater support for actions that would be otherwise
unpopular. For example, in Peru, President Fujimori continued to enjoy
approval ratings of 64 percent in 1992 and 69 percent in mid-1993
despite sharp reductions in price subsidies without accompanying compensatory
measures. Graham (1994) attributes this to the extreme economic shock
that preceded reforms and to the on-going civil strife.
In some instances, a reduction in the international price of imported
subsidized items has provided a window of opportunity for governments
to implement reforms (e.g., Yemen in 1998). When such opportunities
arise, a government intent on reform should act quickly. Indeed, implementing
reforms rapidly may even bring political benefits. Evidence from transition
economies suggests that incumbent radical-reform governments have
done well in elections, whereas incumbent slow-reform governments
have been defeated (Ĺslund, Boone, and Johnson, 1996). In the same
vein, evidence from the Russian Federation suggests that in regions
that have implemented radical reforms, support for reformist parties
is stronger (Warner, 1997). Governments that lack political and economic
credibility may face insurmountable obstacles in the implementation
of price-subsidy reform (e.g., Indonesia in 1998 before the change
- The level of political organization of the middle class.
In many cases, protests against price-subsidy reforms are fueled,
and sometimes led, by the urban middle class (civil servants, teachers,
university students, and affiliated labor organizations). These groups
may protest because they would lose the benefit from existing, poorly
targeted subsidies without a compensating reduction in their tax burden
(Hausmann, 1998, and Nelson and others, 1994). In Venezuela, in the
early 1990s, for instance, the lukewarm political support of the middle
class for a cash-transfer and food-stamp program targeted through
the basic education and primary health care system sharply contrasted
with this group’s opposition to realigning public-sector prices with
their true economic cost. Over time, subsidies can become entrenched
as entitlements for current and future generations, which intensifies
resistance against reform (Samuelson, 1995).
30. In general, violent reactions to price-subsidy reform are the exception
rather than the norm, and often are not triggered by the reform alone
(Box 4). Subsidy reductions that have touched off
civil unrest are those for staple foods, such as bread (Egypt, Jordan,
and Morocco), maize (Zambia and Zimbabwe), and petroleum products (Ecuador,
Indonesia, Nigeria, and Venezuela).
31. To assess the political risks associated with price-subsidy reform,
policymakers should, to the extent feasible:
- Identify the winners and losers from price-subsidy and other
economic reforms.13 One way to
establish winners and losers is to examine the benefits of existing
subsidies for different income classes (see, for example, Chu, Davoodi,
and Gupta, 2000). Furthermore, the characteristics of the winners
and losers need to be identified. For example, urban dwellers tend
to be hit the hardest by food price increases, while rural consumers
are less affected because they grow more of their own food. Some ethnic
groups can be poorer than others; opposition against price-subsidy
reform was strong among the poor indigenous population in Ecuador
Box 4. Subsidy Reform and Civil Unrest
The following examples illustrate the risk of political disruption
where rapid reform was attempted without credible social protection
mechanisms and governments were unpopular:
In Jordan, in April 1989, an attempt to raise fuel prices
resulted in riots that brought down the unpopular prime minister.
In August 1996, Jordanians again took to the streets in response
to a 200 percent increase in the price of bread and associated
price increases for other items (see Footnote 1 in main text).
Observers noted that the unrest was also rooted in the absence
of economic opportunities (GDP per capita fell by 2.5 percent
in 1996) and dissatisfaction with the lack of public participation
in decision making.
In Zimbabwe, in 1998, riots erupted in the wake of a currency
devaluation when the poor and the middle class faced higher prices
for a wide range of items. Higher-income groups were perceived
to be benefiting through large wage adjustments amid accusations
of widespread and growing corruption. In early 1999, the government
pegged the Zimbabwean dollar at a fixed rate against the U.S.
In Zambia, in 1990, the government faced public protest
and a coup attempt when it announced an increase in the price
of maize meal without an explanation. The subsequent government,
after great efforts to explain its reform program to the public,
freed the price of maize, resulting in its quadrupling, virtually
without public protest (Graham, 1994).
Indonesians took to the streets in May 1998 to protest
energy price increases proposed by the Suharto regime. In March
2000, there were renewed protests against a proposed hike in fuel
prices and the price increase has been postponed until a compensatory
scheme for the poor households can be put in place. The current
government, elected in 1999, has been actively campaigning to
explain why subsidy cuts are needed to support economic recovery
and to finance the expansion of social programs.
In Ecuador, in September 1998, the government increased
prices of cooking gas, gasoline, and diesel. To compensate poor
households, the government introduced a cash-transfer program
targeted to poor women with dependent children, senior citizens,
and the disabled. Despite the success in reaching 1.3 million
beneficiaries (50 percent of households), the government changed
its position on the price increases after street protests in July
1999. Subsidies for fuels reemerged in 1999 as import costs increased
and the exchange rate continued to depreciate.
In Nigeria, in June 2000, the government increased the
price of gasoline by 50 percent. This price increase followed
an effective doubling of civil service wages and a major adjustment
of the minimum wage in May. However, in reaction to protests by
organized labor and students in the major cities, the government
agreed to a reduced price increase of 10 percent, while apologizing
for not consulting various stakeholders more widely. Observers
have linked the protests to an IMF-supported program and the absence
of social safety nets in an environment of widespread poverty.
- Assess the magnitude of the losses. This will likely provide
an indication of the intensity with which those who lose will oppose
price- subsidy reform.
- Assess the political strength of the winners and losers.
32. Even if price-subsidy reform is associated with considerable risk
of political disruption, certain policies can ameliorate those risks:
- Embed the subsidy reductions in a reform program that engenders
broad support and yields widespread benefits—the stakeholder approach
(Graham, 1998). By providing compensatory measures to the poor,
the government can gain the support of an important constituency for
implementing and sustaining price-subsidy reform. In the short term,
resistance from the middle class may be overcome by providing them
with temporary compensation (De Donder and Hindriks, 1998; and Gelbach
and Pritchett, forthcoming). In such cases, an appropriate option
for targeting may be to limit generalized subsidies to the amount
consumed by the poor.
The stakeholder approach implies that governments should avoid reforms
that impose an unfair burden on a narrow group of vulnerable socioeconomic
or ethnic categories. Public intolerance for price-subsidy reform
can be exacerbated by widespread discontent with initial living standards—for
instance, in case of a high incidence of poverty, particularly among
certain population groups and in some regions.
In the longer term, sustained support for reforms needs to be crafted
through consultative processes (see, for example, Nelson and others,
1994). In this context, consultations with civil society for the drafting
of a poverty reduction strategy paper should help to alleviate public
concerns. It is desirable that the program of economic reform is “owned”
by the government and is not perceived to be designed by others. Greater
transparency of the budget and enhanced accountability of public spending
would also promote support for price-subsidy reform.
Decisions to target compensating measures to the nonpoor on the
basis of political considerations are extremely difficult to make
and should be approached with great caution. The fiscal cost of
providing income transfers to the nonpoor may be considerable, and
there is a risk of eliciting claims from other groups for similar
transfers. For international financial institutions, including income
transfers in one program and not in others also raises the question
of fairness of country treatment. The ultimate goal of successful
reform is to target assistance to the truly needy only.
- Encourage the authorities to organize mass information campaigns.
In successful reforms, governments were able to communicate effectively
to the population the drawbacks of the prereform situation and the
advantages of pressing ahead with the package of reform measures.
There are two basic options for such communication:
- Present the cost of subsidies in concrete terms. In Egypt,
for example, the budgetary burden of subsidies was illustrated
by comparing outlays with the revenues from the Suez Canal. In
Tunisia, the cost of subsidies was cast in terms of those of other
public services, such as provision of hospitals (Razmara and others,
- Explain to the public how the reform package affects real
household incomes. In Zambia in 1991, for example, the government
emphasized the people’s historical willingness to pay high black
market prices for maize in times of shortages and the improved
availability of this staple after reforms. In Peru in 1991, the
presentation of the reform package on television by a popular
member of government successfully promoted the view that the government’s
proposal presented a viable option for addressing the severe economic
crisis (Graham, 1994). In Venezuela, on the other hand, the government’s
efforts to explain its reforms were timid and suffered from the
inability of public officials and agencies to communicate their
actions clearly and credibly (Naim, 1993).
If targeted subsidies are introduced, the public should be informed
about eligibility criteria and the steps they need to follow
to obtain benefits. In Jamaica, procedures for obtaining food stamps
were explained through a media campaign involving radio, television,
posting of handbills, public address systems, and a series of newspaper
inserts. Similarly, in Ecuador in 1998, the rapid introduction of
a cash compensation program in lieu of generalized subsidies for cooking
gas was aided by a comprehensive publicity campaign.
|V. Key Lessons
- Large budgetary savings from price-subsidy reform are difficult
to achieve in the short run. Most countries have adopted a gradual
- When reform is gradual, the government can reduce the likelihood
of policy reversal and inadequate progress by adopting and making
public a detailed timetable of reform measures.
- Rapid reform is feasible only when governments are politically
strong and the social disruption from reform is assessed
to be small. Reform can also be more rapid under favorable exogenous
circumstances, such as low prices for imported staples.
34. Social protection mechanisms
- Mechanisms for protecting the poor should be established
before the reform of generalized price subsidies is initiated
and prices of subsidized items change.
- Compensation schemes that protect households from real income losses
should be temporary, to be replaced with permanent social policy
- Using income for targeting benefits in developing countries
and transition economies is often not a practical option in the short
term. Targeting benefits to households with specific characteristics
can be relatively efficient in certain cases.
- The choice among targeting options can be severely constrained by
lack of data on the poor and by weak governance and admin-
istrative capacity. Self-targeting may remain the only feasible
- A generalized subsidy limited to, or below, the amount consumed
by the poor protects both the poor households as well as politically
vocal groups, while generating budgetary savings.
35. Political disruption
- The risk of political disruption is highest when rapid
reform is attempted without credible social protection mechanisms,
and the government is unpopular.
- Governments should be encouraged to adopt the stakeholder approach
to reform, thus avoiding an undue burden on any single group,
and initiate mass information campaigns for explaining to the
public the benefits of price-subsidy reform and the working of social
|Appendix 1: List of Examined Countries14
North Africa and Middle East:
Jordan (1990–92 and 1994–99)*
Europe and Central Asia:
Russian Federation (1994–99)*
Rep. Bolivariana de Venezuela (1989–91)*
South and East Asia and Pacific:
Sri Lanka (1978–82)*
Appendix 2: The Nature of Price Subsidies
36. A price subsidy reduces the consumer price of a good or service
below what it would be in the absence of the subsidy (consumer subsidy)
or increases the price received by a producer above its market level
(producer subsidy). In practice, consumer subsidies are often implemented
with price controls, resulting in shortages of the subsidized item.
Producer subsidies, on the other hand, are often administered through
producer support prices. When support prices are set too high, there
is an oversupply of the subsidized item.
37. Explicit price subsidies are recorded in the government budget
as expenditures, although not necessarily under the category “subsidies.”15
Explicit subsidies can take many forms. In the case of a consumer subsidy,
a public agency can make direct payments to producers to compensate
them for charging lower prices for their output. Alternatively, the
government can directly provide goods and services free of charge or
at below-market prices through a public distribution system.
38. Implicit price subsidies are not easily identifiable in the government
budget, but can show up as (1) losses of the banking system (e.g., owing
to below-market interest rates or directed credits); (2) losses of state-owned
enterprises, owing to setting prices below cost recovery levels; (3)
differential tariffs for various consumers (e.g., by charging industrial
users a higher tariff for electricity and water); (4) tax expenditures
(e.g., tax exemptions, concessions, and deferrals); (5) below-market
procurement prices, which act as a tax on producers and a subsidy for
consumers; (6) equity participation in state-owned enterprises without
an expectation of a market return or net lending to them at preferential
interest rates; (7) regulations that alter market prices or restrict
market access (regulatory subsidies); and (8) distribution of donor-provided
commodities at below-market prices. All these subsidies affect the government
budget, although some (tax expenditures, equity participation, and net
lending) more directly than others.
39. A price-subsidy policy can be helpful in pursuing social and economic
goals. Price subsidies can be designed to correct market imperfections.
For example, the provision of basic education and childhood immunizations
free of charge or at reduced tariffs can promote broad-based human and
economic development. Subsidies can also be used to address domestic
market imperfections in domestic factor and product markets of traded
goods. In that case, a subsidy policy is preferable to imposing tariffs
(Bhagwati and Ramaswami, 1963). Other price subsidies, such as for basic
commodities, can provide food security and improve the well-being of
the lowest-income individuals and households in a society. Transitory
subsidies may be the only means of cushioning against sharp losses of
purchasing power (e.g., following the CFA franc zone exchange reform,
and in the wake of the 1997 financial crisis in Indonesia).
40. In practice, price subsidies have also been motivated by other
goals, including providing subsidies to nonpoor special interest groups
(e.g., in 1999, only 21 percent of kerosene subsidies reached the poorest
30 percent of households in Indonesia).
41. Even when price subsidies achieve their intended objectives, their
economic and social benefits have to be weighed against their costs:
- Explicit and implicit price subsidies burden the government budget
and can aggravate the country’s fiscal position. Government spending
on subsidies averaged 1.6 percent of GDP in a group of 65 advanced,
developing, and transition economies in the mid-1990s.16
Such spending was relatively high in industrial countries (1.8 percent
of GDP), especially in the European Union. On the other hand, in developing
countries, spending on subsidies averaged 0.9 percent of GDP, and
in transition economies, 2.3 percent of GDP.17
- Price subsidies reduce allocative efficiency by distorting relative
prices. Consumer price subsidies often are associated with overconsumption
or underprovision of the subsidized item, and producer subsidies with
excess production. The welfare cost of such price distortions (i.e.,
the excess burden of price subsidies) increases faster than the rate
of subsidization. In addition, price subsidies have been associated
with smuggling (e.g., subsidized wheat and wheat flour in Yemen and
subsidized petroleum products in Nigeria have all been smuggled out
of these countries) and waste (e.g., subsidized bread was used as
animal feed in Belarus, Jordan, Ukraine, and the Russian Federation,
and wheat flour was used to mark soccer fields in Peru). In some cases,
subsidizing of inappropriate commodities has led the poor to consume
a less nutritious diet (e.g., in the Dominican Republic, the poor’s
intake of calories and protein fell when they substituted less nutritious
subsidized chicken for rice, beans, and oil plantains). In the European
Union, estimates for 1978–95 suggest a net income loss of between
0.3 percent and 2.7 percent of GDP from the Common Agricultural Policy.
The inefficiency of this policy is also reflected in its high cost;
in 1980, the budgetary cost of transferring $1 to a farmer was, on
average, close to $2 (Rosenblatt and others, 1988).
- The methods used to finance subsidies—higher taxation or
higher deficit financing—further worsen resource misallocations.
- The capture of benefits of subsidies by middle- and upper-income
households raises issues of equity and fairness. Moreover, price
controls—used frequently to implement price subsidies—often result
in black markets that limit the access of the poor to scarce items.
- Subsidies for certain activities—agriculture, energy consumption,
and timber exploitation—can contribute to environmental degradation.
For example, subsidies for certain activities, including cattle raising,
under the Polamazonia Program in Brazil in the 1970s adversely impacted
the environment in the Amazon (Davis, 1977).
|Appendix 3: Examining the Short-Term Impact of Reducing Price Subsidies on Real
Household Incomes: An Illustration
42. This appendix provides two competing pragmatic approaches to estimating
the impact of price-subsidy reform on households in the short term.
- Estimate the loss of real household income as the arithmetic mean
of the relative price change, using the shares of the consumption
items in household expenditures as weights. This amounts to the following:
where RL denotes the impact on real household income in percent,
wi is the share of item in household expenditures, Pi(1) is the new
(in most cases, higher) price of item i, and Pi(0) the price before
the reform of price subsidies. This estimate of the loss of real household
income can be illustrated with an example. Suppose the price of subsidized
rice rises by 50 percent, and that the weight of rice in the expenditures
of poor households averages 30 percent, and that of nonpoor households,
10 percent.18 Using the above equation,
the average impact on the real income of poor households can then
be estimated at 15 percent. For nonpoor households, the corresponding
loss in real income is smaller—5 percent, on average.
This estimate provides an upper boundary on the increase in living
costs. If households respond to changes in relative prices by shifting
away from the item for which the price has increased, the actual loss
will be smaller. The loss will be close to the above estimate if the
subsidized item is a basic commodity for which no ready substitutes
are available. If there is a perfect substitute, households will react
to even a small change in the price of the subsidized item by shifting
completely out of that item and into the substitute, suffering no
loss in real income. The procedure below recognizes the likelihood
of a consumer response.
- Alternatively, estimate the real loss of household income as the
geometric mean of the relative price change, using the shares of the
consumption items in household expenditures as weights. This can be
calculated as follows:
Using the same example as before, the estimated loss of poor households
from a rise in the price of rice by 50 percent can be calculated at
13 percent, and for nonpoor households, 4 percent. These estimates
reflect the case when households are responsive—but not infinitely
so—to changes in relative prices.19
43. Which estimate of real-income loss is more appropriate? The above
approaches provide a reasonable range within which the correct answer
is likely to fall. Which point in this range is most relevant for estimating
the desirable level of compensation for price-subsidy reform depends
on many factors, including whether the subsidized item is a basic commodity
and some substitution possibilities exist. To be more precise, which
estimate is more accurate depends on the size of the income effect of
the price change versus the substitution effect. What is reassuring,
however, is that the difference between the two estimates is typically
small for poor households. In the above example, the estimates differ
by only two percentage points.
|Index Guide to Concepts and Issues20
Administrative capacity, 7, 14, 16, 23, 25, Box 1, and Table 1.
Available financing, 7 and 26.
Benefit incidence and equity, 19–20, 28, 31–32, 35, and 40.
Cash transfers, 8–11, 15–16, 29, and Boxes 3–4.
Delivery mechanism, 15, and Box 3.
Exogenous factors, 29, 33, and Box 1.
Efficiency of compensation mechanisms, 12–13 and 34.
Fiscal savings, 1–2, 5–7, 26, 33, and Boxes 1–3.
Mass information campaigns, 32, and 35.
Middle class and other nonpoor groups, 7, 28–29, and 32.
Political disruption, 28–32, and Box 4.
Political support for price-subsidy reform, 6–7, 28–32, and Boxes
1 and 4.
Price-subsidy reform in the longer term, 9, 32, and 34.
Rationale for price-subsidy reform, 1, 4, 18, 20, and 41.
Reversal of price-subsidy reform, 6–7, 33, and Box 1.
Social impact and disruption, 2, 4–5, 20–21, and Boxes 1 and 3.
Social safety nets and social compensation instruments, 5, 7–10, 15–16,
23, 25–26, 32, 34, Boxes 1–4, and Table 1.
Speed of price-subsidy reform, 5–7, 33, and Box 1.
Stakeholder approach, 32, 35, and Box 4.
Subsidies by type,
Consumer, 8, 22, 36–37, and 41.
Explicit, 7, 18, 26, 37, and 41.
Food, 9, 15, 29–32, 39, Boxes 1 and 3, and Table 1.
Implicit, 7, 18, 38, and 41.
In-kind, 15 and 24.
Petroleum product, 30, 32, 41, and Boxes 1 and 4.
Producer, 10, 18, 36–37, and 41.
Subsidies and environment, 27 and 41.
Targeting, 8, 10–16, 25, 28, 34, Boxes 2–3, and Table 1.
Targeting by type,
Indirect targeting, 15, 34, and Table 1.
Means testing, 13–15, 25, 34, Box 2, and Table 1.
Self-targeting, 15, 34, and Table 1.
Vouchers and food stamps, 15, 32, Box 3, and Table 1.
Winners and losers of price-subsidy reform, 29, 32, and Box 4.
1Before 1994, generalized subsidies
in Jordan covered many food items at an average cost to the budget of
2.2 percent of GDP. These subsidies took two forms: (1) coupons distributed
to all households for buying rice, sugar, and milk; and (2) wheat price
controls, which provided an implicit subsidy for bread. In 1995, the
government also began issuing coupons for bread, but the price of bread
remained extremely low, leading to wasteful consumption (bread was used
for animal feed) and smuggling. In 1996, the price of wheat was increased
and the government replaced coupons with a cash transfer for bread.
This also led to an increase in prices of other foods like poultry and
dairy products, which provoked food riots. In 1999, the fall in international
wheat prices offered the opportunity to align the domestic price with
its international level and integrate cash transfers into the targeted
social assistance programs administered by the National Aid Fund. But
the authorities set the domestic price of bread somewhat below its production
cost, and a small subsidy reappeared. The domestic price of wheat continues
to be controlled, and the bread subsidies may rise if wheat import prices
2In some instances, the government awarded
wage increases at the time of price liberalization. This policy is tantamount
to a cash compensation targeted to workers in the public sector and
recipients of social security benefits.
3Korea has been successful in phasing
out safety nets after the effects of the 1998 financial crisis dissipated.
4Based on a sample of 24 targeted-subsidy
and cash-transfer programs in 11 countries in Latin America, Grosh (1994)
finds that the administrative cost as a share of total program cost
ranges from 3 percent to 10 percent for self-targeted programs, against
4 percent to 16 percent for geographically targeted programs, and !/2
percent to 29 percent for programs that assess eligibility individually
for each participant. These wide differences in administrative cost
are not reflected in the targeting efficiency; for all programs for
which data were available, the share of benefits accruing to the poorest
40 percent was within or near the 70 percent to 75 percent range. This
result can be attributed to the small share of screening cost of participants
in the overall administrative cost of subsidy programs and disparity
in the availability of existing mechanisms to channel benefits. Another
reason might be that the administrative costs do not vary significantly
with the level of the benefits; administration of a scheme that pays
beneficiaries very little will thus tend to absorb a large share of
the total program cost, independent of the targeting mechanism (see
Foster, Goméz-Lobo, and Halpern, 2000).
5See also Van de Walle (1998). Several
studies have shown that the targeting of social safety nets tends to
become more efficient over time; see Hammer, Nabi, and Cercone (1995)
and Lanjouw and Ravallion (1999).
6Targeted food supplements and nutrition
interventions for women and children, including school feeding programs,
are a special case of such targeting. The drawbacks of these programs
are imperfect coverage of the poor and high administrative costs. On
the other hand, they are not associated with labor market disincentive
effects, and are subject to minimal leakage.
7In Zambia, where cash-for-work road
construction projects offered a relatively high wage rate, some beneficiaries
subcontracted their jobs to others at a lower wage.
8The principal factors that underlie
self-targeting in the broader sense are the opportunity cost of time
used for obtaining benefits in work programs, the attractiveness of
products to the poor, and social stigma.
9In practice, the design of price-subsidy
reforms will be the outcome of a collaborative process involving the
country authorities, the IMF, the World Bank, and other stakeholders,
particularly if such reforms are part of a poverty reduction strategy
10If full information from existing
sources is lacking, substantial resources would be required to take
into account all relevant considerations set forth in the guide.
11For a number of countries, World
Bank staff carries out analyses of the impact of price subsidies in
the context of the Poverty Assessments and Public Expenditure Reviews.
12However, Pitt (1985) found that kerosene
subsidies in Indonesia disproportionally benefited the nonpoor and that
the elasticity of substitution between firewood and kerosene was very
13Hausmann (1994) argues that entitlements,
such as subsidies, imply a negative-sum game leading to a highly inefficient
but stable political (Nash) equilibrium. Moving to a better, Pareto-efficient
equilibrium, requires a package of policies that yields benefits over
the medium term for all groups. Ravallion and Lokshin (2000) examine
support for government redistribution in the Russian Federation in 1996.
They find that support for redistribution not only depends on whether
the population is poor or well-off, but also on whether it expects to
suffer an income loss or gain.
14An asterisk indicates that data on
public spending on price subsidies before and after reform are available
for the country.
15Subsidies paid to consumers, as opposed
to producers, are typically classified as transfers in the public sector
accounts. Subsidies that are administered by extrabudgetary funds (such
as agricultural subsidies in a number of countries) are sometimes not
consolidated with the budget.
16Data on subsidies are from the United
Nation’s System of National Accounts (SNA), which defines subsidies
as current unrequited government payments to enterprises on the basis
of their production, sales, or imports. Thus, the SNA data on subsidies
exclude payments to consumers, such as food stamps, which are recorded
under transfers, as well as implicit subsidies. The IMF’s Government
Finance Statistics (GFS) uses a similar definition of subsidies as the
SNA; however, for most countries, the GFS does not report separately
on subsidy payments but instead lumps these outlays together with government
17Clements, Rodríguez, and Schwartz
(1998) find that a large government, a large external current account
deficit, and a relatively large manufacturing sector are associated
with a higher level of explicit subsidies.
18Data on household expenditures can
be obtained from household surveys.
19The estimate reflects households
who respond to price changes in such a way that the shares of spending
on different consumption items in their total expenditures remains constant.
This behavior is consistent with preferences that can be described by
(a monotonic transformation of) a Cobb Douglas function, which has unitary
compensated own-price and cross-price elasticities. Preferences of this
type also underlie calculation of the Consumer Price Index in a number
of countries, including many components of the CPI for the United States.
20The numbers refer to paragraphs,
text boxes, and tables.
Alderman, Harold, and Kathy Lindert, 1998, “The Potential and Limitations
of Self-Targeted Food Subsidies,” The World Bank Research Observer,
Vol. 13 (August), pp. 213–29.
Ĺslund, Anders, Peter Boone, and Simon Johnson, 1996, “How to Stabilize:
Lessons from Post-Communist Countries,” Brookings Papers on Economic
Activity, No. 1 (Washington: Brookings Institution), pp. 217–91.
Bhagwati, Jagdish, and V.K. Ramaswami, 1963, “Domestic Distortions,
Tariffs and the Theory of Optimum Subsidy,” The Journal of Political
Economy, Vol. 71 (February), pp. 44–50.
Chu, Ke-young, and others, 1995, Unproductive Public Expenditures:
A Pragmatic Approach to Policy Analysis, IMF Pamphlet Series No.
48 (Washington: International Monetary Fund).
Chu, Ke-young, and Sanjeev Gupta, 1998a, “Economic Reforms, Social
Safety Nets, and the Budget in Transition Economies,” in Social Safety
Nets: Issues and Recent Experiences, ed. by Ke-young Chu and Sanjeev
Gupta (Washington: International Monetary Fund).
———, 1998b, “Social Safety Nets in Economic Reform,” in Social Safety
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