WPS4666 Policy ReseaRch WoRking PaPeR 4666 The Impact of Food Inflation on Urban Poverty and Its Monetary Cost: Some Back-of-the-Envelope Calculations Sébastien Dessus Santiago Herrera Rafael de Hoyos The World Bank Development Economics Vice Presidency July 2008 Policy ReseaRch WoRking PaPeR 4666 Abstract This paper uses a sample of 73 developing countries all countries, the change in the poverty deficit is mostly to estimate the change in the cost of alleviating urban due to the negative real income effect of those households poverty brought about by the recent increase in food that were poor before the price shock, while the cost prices. This cost is approximated by the change in the attributable to new households falling into poverty is poverty deficit, that is, the variation in financial resources negligible. Thus, in countries where transfer mechanisms required to eliminate poverty under perfect targeting. The with effective targeting already exist, the most cost- results show that, for most countries, the cost represents effective strategy would be to scale up such programs less than 0.1 percent of gross domestic product. However, rather than designing tools to identify the new poor. in the most severely affected, it may exceed 3 percent. In This paper--a product of the Development Economics Vice Presidency (DEC)--is part of a larger effort in the department to analyze policy-relevant topics rigorously with the best available information to support decision making. Policy Research Working Papers are also posted on the Web at http://econ.worldbank.org. The authors may be contacted at sdessus@ worldbank.org, sherrera@worldbank.org, rdehoyos@worldbank.org. The Policy Research Working Paper Series disseminates the findings of work in progress to encourage the exchange of ideas about development issues. An objective of the series is to get the findings out quickly, even if the presentations are less than fully polished. The papers carry the names of the authors and should be cited accordingly. The findings, interpretations, and conclusions expressed in this paper are entirely those of the authors. They do not necessarily represent the views of the International Bank for Reconstruction and Development/World Bank and its affiliated organizations, or those of the Executive Directors of the World Bank or the governments they represent. Produced by the Research Support Team The Impact of Food Inflation on Urban Poverty and Its Monetary Cost: Some Back-of-the- Envelope Calculations Sébastien Dessus, Santiago Herrera, Rafael de Hoyos JEL: D12, I32 Keywords: Urban Poverty, Food Prices I. Introduction The objective of this paper is to estimate the monetary cost of alleviating urban poverty changes induced by the increase in food prices since 2005 in a large sample of developing countries. The cost is approximated by the change in the "poverty deficit" (Atkinson, 1987), that is, the variation in financial resources required to lift all urban poor out of poverty under perfect targeting. In this context, the change in the urban poverty deficit can be decomposed into two additive elements: (a) the extra monetary cost (with respect to the initial situation) required to bring current poor households above the poverty line given the new set of The findings, interpretations, and conclusions are those of the authors, and do not necessarily represent the views of The World Bank or its Executive Directors. For their comments we are grateful to Shanta Devarajan, Alan Gelb, Delfin Go, Eduardo Ley, Cristina Savescu, Augusto de la Torre, and Quentin Wodon. Rebecca Lessem provided excellent research assistance. Address for correspondence: sdessus@worldbank.org, sherrera@worldbank.org and rdehoyos@worldbank.org. prices, and (b) the monetary cost required to pull out of poverty those households falling below the poverty threshold due to price increases. Thus, we take into account both the change in the depth of poverty, i.e. the increase in the poverty gap given the increase in food prices, and the additional number of urban poor. Our estimates depend on three country-specific parameters for which we have data of limited comparability: (i) the change in the domestic relative price of food, which varies across countries due to different global prices pass-through to domestic prices; (ii) the share of the total household budget allocated to food consumption by those households below the poverty line or sufficiently close to it to be considered vulnerable to price changes; and (iii), the elasticity of substitution between food and non food items for poor and vulnerable households. Given the uncertainty regarding these three parameters we consider a range of plausible values in our computations, based on information for a subset of countries. On the other hand, there exists reliable and comparable country- specific information on urban poverty and income distribution that we use to estimate the change in the poverty deficit. The results show a range of estimates of changes in the poverty deficit for each country in our sample; these back-of-the-envelope computations can be refined with additional country-specific information as it becomes available. We focus exclusively on urban poverty for various reasons. First, from the methodological viewpoint, it is critical to control for the positive income effect that food inflation has on the households which derive their income from agriculture-related activities. Unlike rural households, urban ones only derive a small --if any-- share of their income from agricultural activities. Hence, the assumption that food inflation will only affect the price of their consumption basket, leaving their income unchanged, is not unrealistic. In contrast, rural households derive a substantial part of their income from agricultural activities, and estimation of the net impact of food inflation on rural poverty would require detailed and country specific data which we do not have on a large and comparable basis.1 Hence, the focus on the urban poor does not mean that rural poverty is not of concern, but rather, it is an unfortunate consequence of the lack of valuable information. Second, from the policy perspective, it is justifiable to distinguish urban from rural areas, in particular when it is advised to resort on targeted transfer programs to mitigate poverty (World Bank, 2008). Indeed, these programs are, by nature, located in specific places (food-for-work programs, schools to send children) or destined to localizable agents. As such, it is possible to assess the adequacy of current and envisaged transfers in cities in response to the increase in poverty. Third, the inflation information captured by CPIs reflects price changes taking place in the cities rather than in rural areas. Finally, focusing on urban areas--where a welfare loss will unambiguously occur as a consequence of higher food prices--allows us to identify countries at risk of potential social unrest. 1 Not only the net buyer/seller position of rural households vis-à-vis each commodity needs to be known (such data are not always available in households surveys; and many developing countries simply do not have sufficiently recent surveys), but also the cost and factors' market structures to estimate who would benefit the most from food price spikes: farmers, land owners, intermediaries, etc. There are alternative approaches to estimate the impact of the price shock on the poor. Compared with recent papers on the same subject (Ivanic and Martin, 2008, Wodon et al. 2008), the present paper differs on several grounds. First, we use household survey data for 73 countries2 covering 88 percent of the population living in developing countries in 2005; second, in addition to measuring the impact of food price changes on the headcount poverty rate, we differentiate between the cost attributable to the "new poor" versus that one of the existing poor before the price increases; and third, our approach focuses only on urban households, ignoring income effects for food-producing households. Similarly to Ivanic and Martin, 2008 and Wodon et al. 2008, the present study focuses on the short- term micro-economic impacts, ignoring second-round or multiplier effects which could occur in the longer run.3 Despite the methodological caveats and data limitations, this paper is a useful first step to identify countries facing the highest risk level of severe disruption in their fight against urban poverty as a result of the food price shock. The note also gauges the order of magnitude of a ceiling for the cost of these interventions, understood as aiming to offset the impact of food price spikes on urban poverty at US$1 or US$2 a day.4 II. Methodology and Stylized Facts A. Methodology Define yh as the per capita household income of household "h" and z as the minimum income required to purchase a basket of goods that satisfies a required level of consumption (the poverty line), most of which of food. If q individuals fall below z, the total monetary cost of providing those individuals with the required consumption level is defined as: (y ) q (1) PD = (z - yi ) 1 < y2K< yq z i=1 The increase in food prices will raise the monetary cost of affording the same basket of goods. Assuming that incomes remain constant (consistently with our focus on consumption effects), the change in the poverty deficit (PD) due to an increase in the poverty line can be defined as follows: 2Since the household survey data for China is not available, the computations for this country relied on the PovCal parameterization of the Lorenz curve. 3Ivanic and Martin (2008) also account for changes in unskilled wages rates so as to capture higher factor remuneration in agriculture. According to the authors, citing Ravallion (1990), such a wage response could take several years. Passa Orio and Wodon (2008) estimate the longer term impact of specific commodity price spikes on the price of other commodities through a social accounting matrix multiplier effect approach, and suggest that indirect effects are much more pronounced for oil than food. Dessus (2008), using a computable general equilibrium model, assesses the impact of imported inflation on domestic prices accounting for behavioral effects and substitution effects in the short, medium and long run in Tanzania. 4This paper consistently uses poverty lines and GDP expressed in purchasing power parities derived from the ICP 1993, as new poverty lines derived from the ICP 2005 have not yet been disclosed. (z ) (z ) q q q (2) PD = - yi - (z - yi)+ - yi i=1 i=1 i=q Old Poor New poor where z and q represent the post-price increase extreme poverty line and headcount, respectively; hence y1