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CONSEQUENCES OF CHANGES IN SUBSIDY
POLICY IN EGYPT*
9.U>5
massachusetts
institute of
technology
50 memorial drive
Cambridge, mass. 02139
R.
S. Eckaus
M.I.T.
Amr Mohie Eld in**
Cairo University
April 30, 1980
M.I.T. Working Paper #265
CONSEQUENCES OF CHANGES IN SUBSIDY
POLICY IN EGYPT*
a(p5
*
This paper was prepared under the auspices of a joint Cairo University /MIT
research program funded by the U.S. Agency for International Development.
Neither the educational institutions nor U.S.A.I.D. bear responsibility
for the contents of this paper which is exclusively that of the authors.
**
The paper utilizes the general equilibrium model and the data prepared for
it which is described in R. S. Eckaus, F. D. McCarthy and A. Mohie Eldin,
"Multisector General Equilibrium Models for Egypt," M.I.T. Department of
Economics, Working P; per No. 233. Most of the people who contributed to
that paper have, in some degree also influenced this paper, indirectly, if
not directly.
The authors especially acknowledge the assistance and
advice of Yousef Bout ros-Ghali M.I.T., Cambridge, Mass. and Osman M. Osman,
National Institute of Planning, Cairo.
,
Summary
The size and welfare impact of the government budget allocations for
subsidies in Egypt, as in a number of other developing countries, have become a
focus of attention and controversy both internally and for international assistance
agencies.
The conventional diagnosis, which has been reinforced by recent
analyses, has been that a reduction in subsidies will reduce both the balance
of payments deficit and the price inflation whicli are characteristic problems.
There are, however, a number of different dimensions of subsidy policy and it
is shown here that the effects obtained from modifications along one of these
dimensions may be quite different from changes in other directions.
These
results are generated by the use of a general equilibrium model constructed for
the Egyptian economy.
The type of subsidy reduction whose results are most unambiguously
deflationary is an increase in
tlie
official selling price which reduces the
subsidy rate paid by the government.
If the goo. Is are rationed, i.e. if, at
both the original and the new selling price, the quantities made available are
not sufficient to satisfy the demand at that price, a change in the subsidy
rate will not reduce the quantity purchased.
But the higher price, and reduced
subsidy rate, will increase the total consumer expenditure for the rationed and
subsidized commodities and, thus, reduce the income available for expenditure
in other ways.
Reductions in private and government spending generate the
deflationary effects ascribed to the subsidy reduction.
As the levels of economic
activity fall, imports are also reduced and there is a deflationary effect on
prices.
The effects are, in a general way, the same whether or not the sub-
sidized goods are produced competitively in the domestic economy and whether
or not the subsidy is privided through direct sales to consumers or through
production subsidies to producing firms, so long as the goods are rationed.
II
The impact of these changes in worsening the nutritional status of the lower
income groups in particular has been emphasized.
Yet even a simple subsidy rate reduction will have differential effects
on the various classes and types of income recipients and consumers.
This is
due to their differential participation in and reliance upon the subsidized
goods for their consumption.
Since, in Egypt, the urban population participates
in the sijbsidy program more than do rural groups, a reduction in subsidy rates
would affect them most strongly.
Lower income groups, as can be inferred, also
would suffer more than upper income groups.
Suppose, however, that subsidies are lowered by decreasing the quantities
of goods made available in the ration shops, supplied either from imports or
from required deliveries of such goods from domestic production at an official
price.
Such a policy might also result from a straight forward desire on the
part of a government to reduce imports and government expenditures.
In this
case subsidy reduction means that fewer goods are available to consumers at
the prevailing subsidized price.
different from the foregoing.
The effects of this type of policy are quite
Expenditures which would have been made on the
subsidized goods in the ration shops spill over on to the products of the
domestic economy and, conceivably, depending on government policy, on to
uncontrolled imports from abroad.
If there is some degree of supply responsive-
ness in the domestic economy, there will be a real increase in output as a
result.
So the effect will be to stimulate the economy.
It can generally be expected,
that there will be a reduction of the foreign
trade deficit as a result of a policy of decreasing the supply of subsidized
goods to consumers.
Although the increase in domestic output generates some new
imports, that does not offset the original effect.
The government budget
deficit is also reduced by this type of policy, not only because of the reduction
Ill
in expenditures on subsidies but also because of the improvement in the levels
of overall economic activity Increases tax yields.
policy does tend to be inflationary.
The
price
effect of this
This is in part just the result of moving
up rising supply curves as costs rise with increasing production of the output
which substitutes for the loss of the subsidized goods.
reduced by more elastic supply response.
This effect would be
But the price increases are also
part of the macroeconomic adjustment necessary to raise income to bring saving
and investment into equality.
The distributional consequences of this latter type of subsidy policy
are rather different from the former.
In this case, the induced increases
in agricultural output shift income toward that sector and as well, more than
proportionately
to the lower income groups there.
The alternative approaches to subsidy reduction therefore provide a
contrast between expansion and contraction as policies for stability and growth
even when balance of payments difficulties require new adjustments.
The policies tested here were "pure" ones, either a change in subsidy
rates or in the quantities provided.
"Mixed policies which are combinations
of the two alternatives, would have mixed effects.
The general equilibrium
model solutions provide many interesting and important details as well as
general lessons, some of which have already been mentioned.
It should be noted
that the results are generally but not completely symmetric to reductions or
increases in subsidy rates or quantities.
The differences have their major
source in the relative ease of expanding or contracting domestic production.
Thus an Increase in the quantities of subsidized goods supplied from imports
IV
ceteris paribus, will tend to worsen the balance of payments deficit, increase
the government deficit and deflate the domestic economy.
It
would be mistaken to think of changes in subsidy policy as simple
economic tools.
Just as clearly it would be desirable to have a clear set of
economic priorities in making subsidy policy.
If the primary objective is a
reduction in the trade deficit, that can be accomplished In more than one way:
it
is not
necessary to deflate the economy to do it, if there is some respon-
siveness in domestic production.
Analogously, a reduction in the government
deficit might or might not be associated with attempts to reduce price inflation
via subsidy policy.
The advantages of a general equilibrium analysis of economic policy
become clearer from this particular application as the approach makes detailed
perceptions possible which otherwise could not be achieved.
If the perceptions
reveal complications not previously appreciated, that is just the beginning of
wisdom.
R. S. Eckaus
A. Mohle-Eldin
July,
1980
Consequences of Changes in Subsidy Policies in Egypt
I.
Introduction
One of the features of the Egyptian economy which is among the most
striking and also the most controversial is the role of government subsidies.
There are production subsidies and consumption subsidies which are direct
expenditures from the government budget and there are indirect subsidies created
by fixing the prices of the output of some government enterprises below their
true scarcity value.
of all three types,
There are difficulties in measuring the effective magnitudes
especially of the latter, but, in whatever manner they are
tallied, the subsidies have a significant impact on the government budget, the
balance of payments and consumer welfare.
It is not surprising that subsidy policy in Egypt is
controversial.
There is a macroeconomic debate because the subsidies, both direct and indirect,
contribute to the government deficits which are financed by central bank credit
and foreign capital.
There are arguments that these deficits are major contri-
butors to the domestic inflation.
The subsidized use of some commodities requires
imports and/or discourages exports and, thus, helps generate balance of payments
deficits.
There are microeconomic effects on the production side as the
subsidized prices may induce inefficient use of resources.
On the consumption
side, the subsidies are an important device for maintaining minimum levels of
consumption but the distribution of benefits reflects the virtual absence of
control over access to the subsidized commodities.
about
International lenders typically generate macroeconomic skepticism
to the
the subsidy progam and, domestically, there is disputation as
2.
allocation of benefits and the political consequences and social justice of any
modifications in the present system.
It is generally conceded that the riots
of 1977, which are a political landmark, were set off by a sudden, major change
in subsidy policies.
After abandoning those changes, subsidy levels have
subsequently been reduced on most commodities but subsidy policy still generates
contention.
There have already been insightful macro and microeconomic studies of the effects
of reduction in consumer subsidies and the contribution of those subsidies to
the nutritional well being of Egyptians.
be investigated.
However, a number of issues remain to
As will become clear, the existing studies, without revealing
their limitations, deal with only a small range of actual and potential policies.
Since the controversies mingle macroeconomic as well as microeconomic issues,
an analytical approach is required which can operate at both levels.
Such a
capability is one of the virtues of the general equilibrium models (GEM) which
have been developed for the Egyptian economy.
2
The models will, therefore, be
used here to study subsidy issues.
The next section contains a qualitative discussion of the subsidy system.
Section III describes the design of tests of changes in subsidy policy.
Section
IV presents the results of the application of the GEM models to obtain quantitative results in tests of changes in subsidy policy.
II.
The magnitude and distribution of subsidies.
The subsidy system in Egypt is a complex one, composed of direct production
and consumption subsidies and Indirect subsidies resulting from control of prices
of public enterprises at levels below scarcity values.
In Egypt the direct
consumer subsidies and production subsidies are created when government trade or
marketing authorities sell to consumers or producers at prices less than their
The subsidies are, therefore, measured by the difference between the
costs.
revenues gained from the sale of the subsidized goods and the costs of purchasing
them.
In principle Indirect subsidies generated by public sector enterprise
selling at prices bolow costs could be measured in an analogous manner but that
has not been attempted. The Social Accounting Matrix (SAM) in Table
1
prepared for
1976 provides a partial illustration of the variety of these subsidies and
indicates some magnitudes for that year.
sector are shown in line 30, columns
sectors,
//5,
1
The direct production subsidies to each
through 12 of the SAM.
In only two
the food processing industries, and #6, the textiles industry, are
these subsidies at all large in absolute terms but in these sectors they amount
to slightly less than 12 per cent and 10 per cent, respectively, of the value of
gross output.
In the other sectors, the direct production subsidies are, typically,
less than two per cent of the value of gross output.
Direct subsidies to consumers
The difference between the costs of provision of subsidized commodities to
consumers and the revenues from their sales does not measure the contribution
to welfare of the subsidy program yet it provides some perspective on the effects
of the direct subsidy program.
According to the SAM the costs of the purchases
by the government for direct subsidies, indicated in the Government Trade and
Government Trade Import rows for the Household sector were 79 and 216 million
Egyptian pounds respectively in 1976.
Since subsidies to the Household sector
amounted to 168 million pounds, the revenue from sales to the Household sector by
government supply authorities was 127 million pounds (Ei 295 - Et 168).
127/295 indicates that the sales price was 43% of the
subsidized commodities.
ccist
The ratio of
of providing the
It may be noted that this cost includes not only the
purchase price paid by the government authorities but also the distribution costs.
Thus, on the average, direct subsidies to consumers lowered the cost of buying the
subsidized group of commodities by 57 per cent.
Table
2
provides additional
insight as to the significance of the direct subsidies to consumers.
Lines (1)
and (2) give summary descriptions of the income distribution data in the SAM.
Line
(3)
indicates the direct subsidies paid per person in the various income
brackets and line (4) shows the subsidies as a percentage of income for each
person in each income bracket.
It should be noted that the direct subsidies
were allocated among income groups in proportion to their expenditures on each
commodity.
It is strikingly clear from Table 2 that both income and subsidies
were
concentrated in urban areas with 66 per ceat of income and 81 per cent of
subsidies being received in this part of the economy.
Thus, subsidies per
person and as a share of income were much higher in urban than in rural areas.
Yet, it is also true that taxes and net transfers from the private sector to
government, the latter consisting of the net payments into the social welfare
system, were also substantially higher in urban than in rural areas as demonstrated
in lines (5) and (6) of Table 2.
There is some progressiveness in the tax system as shown in line (6) of
Table 2 by the larger percentages of higher incomes which 'were taxed away in
both urban and rural areas.
But the progression in the tax system alone was
Table 1
SOCIAL ACCOUNTI NG MAiniX
FOR EGYPT 1976 *
(MILLIONS
(
tEl
ri-121
.
Nx
2.
1.
SECTORS
RECEIVING
\^
3.
„
_lO
O-O
ui
N^
DELIVERING
SECTORS
\^
<o
&
7.
1.67613
37.25629
3.
4.
Olh«v Agriculture
54.58346
282 05030
Food ProcnSing
T«xul« (nduKry
OO^tt IndusIliM
10.
11.
Housing
12. OltY« Strvicjt
Toul InouO
5.91269
9 92237
2.13755
329303
002107
39 82283
133642
O
ec
Z
o
2
0.05167
021883
3507248
1.05422
0.38918
1.53937
73 09539
00O4S9
5.95715
34 46799
1.86421
14IJ0160
3.77228
960896
1.41447
31059280
1J0919
134634
1.11537
o
I
X
75
160
16
3
0.27845
392
72
14 3
16 4
2.17375
00846
9321643
290
1232
324.5
0.22 304
0.26195
0.02569
5305054
373
512
799
9.00 784
8.51700
0.16177
7089040
292
1100
9.24410
5 66571
1445822
8081433
37
599
355
254
31 34770
40
6.31325
10
488 83130
968
057402
0.20957
0.40542
021384
002967
0S4438
2.08350
68208
2.16599
0.21176
2.10867
003204
001009
1647459
0J31148
0.00192
1.00935
0.65231
0.40390
079597
0.41906
0J5143
71460
067209
31 34575
33 86751
12JSS50
2638286
11-12
o
y-
061798
30fi6.T10
382
in
1796
99110
2.42426
132.4586
157
35 3&494
87
G1
G2
G3
22.
23
24.
00697
2
13139
8
867
3486
DO
in
25.
26.
27.
28
29.
30.
31.
32
33
34
35.
36
37
3a
39
40
41.
<
Z
.o
Z
-S3 Si
Ouj
852
11.03780
201
21.
li
'^<
^^
s°
416
1.77580
10J6930 1353957
li
17 61671
12.06315
487
20
o
0.61618
3 41 795
719
19.
_l
22
0.S7014
11
18.
-J
2.7
200618
29
17.
16.
238
3.91501
408
15.
10 18230
0.13579
130
in
IT UJ
O
l-O
1.17015
7
14.
1.3611
3059438
2.90146
z
in
12.73104
I1J89 70
O
<s
Its
2.91491
164.4493
<
<
0.16335
13.57468
13.
lU
gy
Si
in
Oo
12.
h- h-
1-
9.35259
9. Conttruction
Oud« OJ & Ptodu<n^
Tramoort & Comm,
0.47003
0.40303
Ind.
UJ
t-
<
46.6722
11.
z
O
o
in
111
10
*9
1796283
NonSup^c Food
Conon
5.
8
9
2
t
2
2.
6.
o
O
SlipU Food
13.
6.
Jgat;
z
l-O
in O
2"-
1.
».
6.
IE
UJ
-1
7.
4.
Ill
>uj£
o a:
in
O
o
S5
l-O
K
Ul
22 6
7.1
4.5
1866
110.7
114.0
65 8
53 3
0.4
1.6
0.6
J
7J
4 3
140.4
234 6
100 6
70 8
1146
50
26
26
38J2
30 9
25.7
327
27
109
109
268
89
89
75
14
710
60
95
17
28
4
100
55
in
1-
5.3
1-
-q
u
16
16
455
1
1268
10
10
1522
3
46
49
885
360
40
400
1392
599
836
1
609
122
3118
1198
13C3
•-Wo.£o-oo2"|--£
17
49
53
1
275
1
97 2
11
55
1
5
5
2
16
1
60 J
45.1
23.3
19.6
18.4
9.4
IIJ
4.7
28
69
35
537
4S.4
170J
7.8
6J
4.7
265
100
132
167
39.4
553
4.4
3.9
83
128
4
2150
2083
223.2
152.7
78.1
83 4
76.3
802
1013
12
1571
265
772J
565.4
310 9
235
16
464
99
1014 6
65
56
1\S
300
f994 4
<a:
IC
13 5
95 6
7817
-it-
i=
>o
2 o<
O on:
>
343
599
49
149
172
172
171
171
681
857
100
1
577
142
268.5
3926
176
122
1085
113
(
14.
VALUE ADDED
15
U.
317
806
202
438
164
330
669
254
324
454
134
2049
6041
6647
1
16
U
0.0
0.0
0.0
40566
94 863
86.783
36.260
0.928
52.356
34076
631.429
30%
0.0
0.0
0X1
45 179
89 8 70
89 106
35 473
28.425
61.263
40 122
646964
64 255
92.267
98.106
98267
45 648
79 381
50 801
6^3 607
00
00
00
00
00
Middle
Too 10%
0.0
0.0
R LiF~«i 60%
135.140
289 890
17. U.
18
Low«ie0%
0.0
90J12
00
180 2»4
19.
R Middli 30%
87 207
240066
58 509
128.291
20
H Top 10%
79 652
225 044
S3 179
129415
21.
HOUSEHOLD
VALUE ADDED
22.
Go.
0.0
00
00
0.0
0.0
Oi)
00
0.0
0.0
0.0
0J>
0.0
00
00
65
1
1043
1126
930
1305
1
2542
i
721
1
00
i
0.0
1
89 9
0.0
302
755
202
438
150
277
274
170
75
193
125
1962
4923
15
61
-
-
14
S3
295
84
249
261
9
87
1118
20.46
535
16.12
503
310
310
5233
i
&P>jb
VALUE ADDED
296
1414
1
23. Go».
24
Coo*enuonAl
1
47?
Go.. Tr>d<
25
lmp<yu
25. Go.. Tradi
12
37
10
7
22
4
8
25
391
94
I
552
j
Imporu
26- Otfief
27
28.
TOTAL IMPORTS
Imp. Tarilh
.29
IND TAXES
30
Sutot.diMl-l
31.
19
1
-12
59
14
15
23
6
-10
-10
-8
9
425
47
435
Tun
r2a-x
34
Pri.. Sj.lf\9i
32. Oir.
35. Gov.
i
15.2
7.6
19.9
11.4
4.7
79
507
45.2
31.9
44.1
29.4
14.7
216
155
304
893
11.6
19.5
18.7
125*
768
Foreign Finance
40.
TOTAL SAVINGS
41
GHOSSPHOO
tfi
POPULATION
768
20
340
37.9
39J
31.1
19.3
150
7.5
-15
-12
-346
-63.8
-48 4
-23 6
-12 9
-9.8
-9 5
78.7
94.3
123.0
-
-
296
296
100
223
6.2
337
70.7
3.7
15.1
25 6
1S5
378
.-96.8
-982
202.8
69.9
143.5
1728
394
66
42
166
12
100
205
65
-86
35
15
-182
-3
-8
26
30
55
13
1208
391
341
1
60
326
_
91
391
1172
391
1940
91
ISO
.
477
490
-168
146
368
394
1414
1414
-393
-393
-389
-389
654
654
654
1680
Stocki
455
1268
235
464
1522
885
1392
636
609
677
142
(Mill)
3118
11303
!l043
12.798
lncom« 9iv»t
O3O02
Population 9-ia.n
Ptr CjpiiJ
1012
94
435
,
37. Go.. Tf*d* Otfjal
OiftO70
1324
21
61
47
656
Pub. S^vifuji
39
119
51
36. Go.. Con*. Daficit
38
119
178
66
Go.. Tfvulcit
13
202
469
721
1305
8.399
3341
2.133
10 139
0.3757
.0 4099
O'ssa
Income
81.497
lncofT>« p«. E*/n«r
*Source:
1126
250 79
Eckaus, R. S., McCarthy, F. D. and Mohie Eldin, A.
(1979)
175.965
563 10
635
503
6069
3042
1690
2859
0.442
611
SN
1967 80
71.112
227 56
105 544
297.633
337 74
952 43
394
1414
-393
-339
6233
1414
1324
1012
176
1110
1940
477
490
-
296
378
1567
113
1680
TABLE
2
Income Shares, Direct Subsidies, Net Direct Subsidies, Taxes and Transfers
by Income Class in 1976*
Lowest
60%
(1.0) Distribution
of total
Urban
Middle
30%
10%
Lowest
60%
Upper
Rural
Middle
30%
Upper
10%
19.93
21.52
24.94
13.78
10.22
9.61
30.02
32.41
37.57
40.98
30.42
28.60
+4.99
+7.56
+11.06
+1.27
+1.93
+5.62
household
income (%)
(2.0) Distribution
of sectoral
household
income (%)
by sector
(3.0)
Subsidies
per capita
(4.0) Subsidies
per tE of
0.06
0.04
0.02
0.02
0.02
0.02
-9.59
-26.12
-105.39
2.26
5.94
19.59
-0.12
-0.15
-0.17
-0.03
-0.06
-0.07
-4.61
-18.57
-94.33
-1.00
-4.00
-13.96
-0.06
-0.11
-0.15
-0.01
-0.04
-0.05
income
(5.0)
Taxes and
Transfers
per capita
(6.0) Taxes per
tE of
income
(7.0) Net Subsidies
Taxes and
Transfers
per capita
(8.0) Net Subsidies
Taxes and
Transfers
per tE of
income
*Plus signs indicate net subsidy; minus signs indicate net taxes.
6.
slight; the per capita income in the top urban income bracket
per capita income in the lowest urban income bracket.
was 5.7 times the
Yet the share of taxes on
income paid by the top income bracket, at 17 per cent, was only about 40
])er
cent
more than the 12 per cent average tax on income in the lowest urban income bracket,
The situation was generally the same in rural areas.
Interestingly, most of the
progression in both urban and rural areas was between the lowest and the middle
income brackets with only a slight degree of progression from middle to upper
Income brackets.
The effect of direct subsidies in changing the impact of the fiscal system
is shown in lines (7) and (8),
The larger subsidies, per capita, received by
the middle and upper income groups^ as compared to the lowest income group^had
the effect of making a larger absolute reduction in the burden of the fiscal
system for the former groups.
But, since subsidies are a falling proportion of
Income as income rises, the direct subsidy program increased markedly the net
progressiveness of the fiscal system.
On balance the net effect of the
direct subsidy and tax system together was to place a heavier burden on urban
dwellers than on persons in rural areas.
There are indications that the character of the subsidy system has changed
somewhat.
Table 3, reproduced from a paper by Professor Lance Taylor, shows the
changing composition of the budgetary allocations for commodities supplied under
3
the direct subsidy system.
Wheat, wheat flour, and maize have always and still
do account for the major part of direct subsidies.
The reductions in
government expenditures on these commodities was due entirely to the drop in
world prices.
As shown elsewhere by Taylor, the physical quantities purchased
and distributed have increased continuously from 1973 to 1978.
The most striking
change in the composition of subsidized goods supplied directly to consumers has
been in the increasing provision of frozen meat.
Although there is no doubt
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that all
Income classes benefit from this last addition to the subsidy program,
middle and upper income groups benefit most because the lower income groups
cannot afford to take advantage of the subsidized supply
to the same extent.
One
There are several immediate implications of these simple comparisons.
is that any across-the-board reduction in subsidies would have had a greater impact
on the lower rather than on the upper income groups because the subsidies
larger proportion of the incomes of the low income groups.
are a
An across-the-board
reduction would also have reduced the purchases by the lower income groups of the
"luxury" food items because they would need to increase their expenditures on
bread, flour and legumes in order to maintain consumption levels of these basic
components of their diets.
Thus, if existing progressiveness of the fiscal
system in 1976 were not to be lost by changes in the subsidy program, the changes must
be designed to also reduce the participation in the program by the upper income
groups or increase the benefits going to low income groups or there must be
compensating tax changes.
Since there is no means or "income" test for access
to the subsidy program, and since, presumably, such a test is not administratively
feasible, there are only a few ways in which the subsidy program can be modified
to maintain progressiveness in the overall fiscal system if subsidies are reduced.
For example, restriction of the amounts of meat and fish provided through the
subsidy program to the relatively low levels at which consumption occurs in the
lower income groups would maintain this component of the diet of these groups
but reduce the subsidization of the upper income groups.
Some microeconomic effects of reducing the subsidy program have been
analyzed previously by Taylor who concluded that, even with compensating
macroeconomic policies, the elimination might reduce food consumption among
the poor by 100-200 calories per day.
Without compensating policies, the
reduction in caloric consumption would be much more severe.'^ On the
other hand,
the maintenance for a number of years of fixed prices for major
subsidized
commodities has lowered their relative prices substantially in the face of
gen.-ral inflation.
There can be little doubt that this has promoted some
undesirable substitution and wastage of these commodities although it is
difficult if not impossible to know how significant that is.
The stories about
feeding subsidized bread to chicken and livestock cannot be added
up to a
quantitative estimate.
Production subsidies
An inspection of the SAM indicates that of the LE 514 million in total
subsidies in 1976, LE 346 million were production subsidies rather than subsidies
which were paid more or less directly to consumers through sales in the ration
shops.
Only the production subsidies have an explicit effect on market prices
as distinct from the controlled prices of directly subsidized commodities.
Determination of these effects requires a detailed analysis but some rough
orders of magnitude can be inferred from the SAM.
Table
4
indicates the ratios
in per cent, of subsidies to the value of gross production in 1976.
Production
subsidies were concentrated in the agricultural, food processing and textile
sectors.
The four agricultural sectors accounted for 11.6 per cent of total
production subsidies; food processing alone received 52.6 per cent, mainly for
baking bread; and the textile sector received 24.9 per cent.
Altogether these
sectors received 89.1 per cent of total subsidies, which was 6.3 per cent of
the total value of the output of these sectors plus the value of government
trade imports which also supplied the subsidized commodities.
This average is
somewhat misleading, however, as the subsidies were concentrated on a relatively
few items, which are the most important components of the sectors' sales.
TABLE
4
Share of Subsidies in Prices of Producing Sectors (per cent)
in 1976
Sector
1
Staple food
2.6
2
Non-staple food
0.8
3
Cotton
A. 3
4
Other agriculture
1.7
5
Food processing industries
6
Textile industry
9.7
7
Other industry
0.2
8
Construction
9
Crude oil and products
1.3
10
Transport and communication
2.6
11
Housing
12
Other services
12.0
-
0.4
10.
Th'i
SAM does not indicate the distribution of the consumption benefits
of the indirect subsidies.
A separate calculation^ essentially using the same
method employed to distribute the benefits of the direct subsidies^ has been
done with the results shown in Table
5.
11-
Line (1.0) presents the estimates of production subsidies for consumption
distributed across income classes and line (1.1) indicates the percentage shares
of the total received by each income class.
The production subsidies art larger
than the direct subsidies for all rural income groups but this is true orly for
the upper ten per cent of urban income recipients.
For purposes of compjirison
the total direct subsidies and their distribution across income classes are
reproduced from Table
2.
It can be seen that rural groups receive a larger
share of production subsidies than urban groups although this result may, to
some extent, reflect the method of allocating the subsidies rather than the
reality.
In particular, subsidies to the food processing industry as are
other production subsidies are allocated according to expenditures on its
products.
But most of the subsidies to this industry actually go to bread
bakeries to which access is more limited in rural than urban areas.
On the other
hand rural groups benefit in the same way as urban groups in most of the other
production subsidies.
The effect of the differences in the distribution of the
benefits of production subsidies is to make the total subsidy system more redistrlbutive than the direct subsidies alone.
When production subsidies are added to the net direct subsidies, taxes and
transfers as shown in Table
2
the effect is to reduce the net burden on all
groups in absolute terms and to substantially increase the progressiveness In
the system.
This reinforces the argument made above that subsidies generate
most of the progressiveness in the Egyptian subsidy, tax and transfer system.
Thus, any change which Is contemplated in the system must take into account not
only the overall budget effects but the equity implications as well.
12
TABLE
5
Distribution of Production Subsidies, Direct Consumption Subsidies
Taxes and Transfers Among Income Classes in 1976*
Lowest
60%
Urban
Middle
30%
Upper
Lowest
Rural
Middle
Upper
10%
60%
30%
10%
16.8
12.6
(1.0) Production
52.0
48.1
26.7
35.0
(1.1) Distribution
27.2%
25.2%
13.9%
18.3%
8.8%
6.6%
(2.0) Direct
63.8
48.4
23.6
129.9
9.8
9.5
38.0%
28.8%
14.0%
5.8%
5.7%
96.5
50.3
32 3%
.
26.9%
14.0%
8.7%
7.4%
6.2%
4.1
7.5
12.5
3.5
3.3
7.4
Subsidies £E
Subsidies ^E
(2.1) Distribution
7.7%
Total
191.2
168.0
(3.0) Total
Subsidies
to Consumers
(3.1) Distribution
{
115.9
.
31.2
26.7
22.1
(A.O) Production
Subsidies
Per Capita
(5.0) Production
Subsidies
Per tE.
Income
.05
.04
.02
,51
-11.07
-81.83
-.07
-.13
.05
,03
.03
(6.0) Total
Subsidies,
Taxes &
Transfers
Per Capita
2.5
-.7
-6.56
(7.0) Total
Subsidies,
Tax^s ,
Transfers
Per KE
Income
£c
-.01
*Minus signs indicate net taxes.
.04
-.01
-.02
359.2
13.
Indirect subsidies resulting from public enterprise pricing policies
As noted earlier, there are indirect subsidies which result from the sale
of output of public enterprises at prices below their scarcity values.
There
are obvious examples in the petrolevnn, electricity and housing sectors in which
dual price systems exist with substantial sales at a price less than a market
price and, in some cases below costs.
For example, since petroleum and its
products are internationally traded commodities and foreign exchange is scarce,
the internal scarcity value of a barrel of crude oil or a gallon of gasoline is
equal to the value of the foreign exchange which could be earned from its sale.
In fact, however, the domestic price of oil products is one-third or less of
the international price.
Electrical power is not an internationally traded
commodity but, to the extent that costs are unduly low because fuel is underpriced, unit costs and prices based on them are also too low.
is also provided at rental rates far
Public housing
below any free market rental.
subsidies on petroleum and electricity are available to all buyers.
The hidden
The subsidy
involved in public housing is restricted to just those fortunate enough to obtain
an apartment in a public project.
The SAM, in itself, cannot identify such indirect subsidies as it adjusts
market prices only in those cases in which direct subsidies appear.
The under-
pricing of goods and services which occurs when public enterprises or authorities
forego charging scarcity prices and, as a result, make smaller profits than
otherwise, or take losses, is not shown in the SAM explicitly.
It is reflected
in a lower amount of government and public enterprise value added than would
otherwise be the case.
14,
III.
The microeconomlc theory and the design of tests of changes in
subsidy polic y
A.
Adjustments in direct subsidies to consumers
General equilibrium models are necessary for the analysis of subsidy policy
as the effects of a change in one sector
will reverberate in other sectors as
substitution takes place in res]>onse to relative prices or availabilities, when
Changes in real incomes will also generate reactions in
goods are rationed.
other sectors.
One of the consistent macroeconomic results of previous analyses
of price subsidies using such models is that a reduction in subsidy levels may
5
This result, obtained both for direct and indirect
depress an economy.
subsidies is, in some respects, counterintuitive, and appears to contradict
earlier results obtained using simpler models of the effects of food aid in
6
developing countries.
Thus it
Ls
desirable to make more explicit the accounting
and the theory of the policy tests to be made.
The apparent simple rationale for the previous results, obtained through
the complex calculations of the models, is that a reduction in direct subsidies,
is,
in effect, a decrease in disposable income of consumers and in government
expenditures.
The decreases in consumption and government demands depress
overall levels of economic activity.
A reduction in indirect subsidies, i.e.
those going to producing firms, increases prices and also reduces real consumption
with effects which flow through the rest of the economy.
There is no doubt that
both the calculated results and the rationalizations of them are correct for the
particular manner in which the tests were made.
As will be shown, however, the
conditions which generate the results are rather special.
Ill
contrast to the rationale above, it is well recognized that the provision
to a developing country of food grains, which compete with domestic production,
will lower both prices and domestic production and have a generally depressing
effect on an economy.
of stiniulating total
This can be
ol
fsct only by n conscious government policy
denwnd ao that hotli the uubaicW/.vd Hup|)ly the the prt'-exlstlng
domestic supply are absorbed.
15.
This type of "foreign aid" is, in terms of its markec effects, roughly
equivalent to the provision of consumer goods at subsidized prices as
practiced by the Egyptian government.
A reversal of the process, i.e.
a
reduction in the supply of goods, as explored in the previous test, would
have a reverse effect.
By this reasoning, a reduction in direct subsidies
would stimulate rather than depress the economy.
Both of the above arguments can be true only if they do not apply
to the same conditions and, on inspection, that turns out to be the case.
The tests which have previously been done with the GEM models on the effects
of subsidy reduction change only the total value of subsidies and make no
adjustment in quantities supplied.
Yet, the latter adjustment was an integral
part of the second story described above.
Two different kinds of policy
packages are being compared and give two different results, which should
surprise no one.
Subsidy policy can rely on price or quantity Instruments or a
combination.
For example, one of the motivations for subsidy reduction is
to decrease government spending and the associated government deficits.
That might be achieved under certain conditions simply by Increasing somewhat
the price at which subsidized goods are sold.
That may or may not affect
the quantities provided under subsidy, depending on the policy directives
and, especially, on whether the goods continue to be rationed.
A different type of policy is the reduction of the quantity of goods
provided under subsidy.
The objective, sometimes pursued under the pressure
of international lending agencies, may be the reduction of Imports to
alleviate a balance of payments deficit and/or government budget deficit.
Or there may be a domestically generated Intent to reduce dependence on
foreign assistance to which the Imports of subsidized goods contribute.
Whether prices or quantities are adjusted, it has been clear for some time
that the omission of real changes in supply as part of food supply policy
may omit much of what is interesting and important.
16.
One feature of the accounting In the Social Accounting Matrix, which
Is an essential part of the GEM structure,
of the supply aspects of subsidy policy.
they were non-competitive.
lends itself to the omission
All imports are treated as if
That means that exogenous changes in the
quantity of imports such as may be induced by subsidy policy changes will
not operate within the model either to augment or displace the demand for
If such changes are to take place,
domestic production.
they must be
imp sed on the system.
Still another aspect of the accounting In the GEM might be misleading
as to the effects of subsidies on consumer expenditure and deserves
clarification.
In calculating the disposable Income of consumers which
can be spent on domestically produced goods, the direct subsidies on
consumer goods are added as if they were positive transfer payments which
supplement disposable income.
The expenditures by government on subsidized
goods are subtracted, to take_into account the fact that the
amounts available for domestic expenditure on unsubsidized goods must
exclude the spending on subsidized goods.
For each income class the
relevant part of the term which def ^.nes total consumer expenditure on non-
subsidized goods is defined as:
(Earned income - taxes - transfers to government - savings - direct subsidies
- government expenditures on subsidized goods)
Direct subsidies are the difference between the amounts paid by consumers
and the amounts paid by the government in buying the goods for distribution
to consumers.
The expression for subsidies and government expenditures
when restated in algebraic terms which distinguish prices and quantities is:
-(PQ
-PQ
)-(PQ)
g^S
S^S
g 8
17-
= the price paid by consumers for the subsidized goods;
where: P
= the price paid by government in buying
P
^
Q
s
the.
subsidized goods
for distribution
= the quantity of subsidized goods,
Government traded goods purchased both domestically and abroad have been
aggregated for purposes of this simple demonstration.
The term in the first parenthesis is negative as payments by consumers
for subsidized goods are less than the payments by government.
Thus,
with a minus sign in front of the first parenthesis, making the whole term
positive^ subsidies appear to become a transfer payment to consumers.
The
term in the second parenthesis is, again, simply the government expenditures
on subsidized goods.
It can be seen that the algebraic expression reduces to
-P Q
.
Thus,
the net effect of adjusting consumer incomes by adding subsidies and sub-
tracting government expenditures on subsidized goods by the government,
though somewhat hidden, is only to subtract all consumer expenditures on
subsidized goods.
Subsidies are not really treated as if they were a
positive transfer payment to consumers, although on first glance it may
appear so.
Rather, subsidized purchases are subtracted from total consumer
spending, as if consumers made their decisions on such purchases prior to
and without regard to other types of expenditures.
The foregoing discussion suggests that there are issues which deserve
clarification and, thus, the potential usefulness of a modest amount of
microeconomic theory in order to make explicit the reasoning involved in
the accounting and to carefully design tests of the effects of subsidy
policy changes.
The theory to be used is conventional supply and demand,
"partial" equilibrium analysis, thus no attempt will be made to capture
sectoral interdependence.
While that might be attempted in a simple model.
18.
it is cumbersome even in a simple model as
have to be taken into account.
the effects of rationinK
The partial equilibrium approach will, in
any case, suggest the issues which will be resolved in
the general equilibrium
model computations which will be reported.
Figure
1
represents what is, perhaps, the simplest case:
a foreign
supply of goods for which there is no domestic
production, such as tea and
coffee.
The supply schedule is perfectly elastic at price P
since Egypt
is a "small country" whose demand has no significant
effect on world
prices.
The government supply authority purchases the commodity
at P
and sells it to consumers at P^, with a subsidy of P^ P^ on each unit.
If the amount
Q^ demanded at F^
were purchased and resold to consumers,
no non-price rationing would be necessary.
If only Qj^< Q^ were purchased
and resold, then Q^ would have to be rationed by cards,
queues or some
other device.
In this case,
there is an excess demand, D^, which would
result In imports of
Q^ at price P^ unless the government exercised
quantitative controls over such imports.
In the case represented by Figure 1, if there is rationing such as
at Q„
,
it is possible to change
administered prices between P- and zero
without any corresponding changes in quantities purchased and sold by
government authorities if only direct - or partial equilibrium - effects
are taken into account.
At selling prices above P
there would be no
subsidy and there would have to be quantitative controls over imports to
maintain the government price as non-government imports would have a
lower price.
Changes in the selling price of the subsidized commodity when it is
subject to rationing do not involve any quantity changes in
demand.
If the price is subsidized but the commodity
Ls
imports or
not rationed,
then changes in subsidy price levels which leave consumers on their demand
schedules will imply corresponding changes in quantities purchased by
consumers and, therefore, changes in import levels.
19.
Fiquf-e
%
<?R
QlQa
!_
Qejantity
20.
In the context of the GEM model a subsidy policy change which is
solely a change in the price of rationed goods can be tested by changing
the direct subsidy entries for each class of consumers
to be worked out in the model's solution.
with the consequences
A subsidy policy change
which involved quantity changes with or without price changes would
require additional exogenous adjustments in the data before tests could
be made.
Not only would the entries in the value of subsidies to each
consumer class have to be altered but the total value of the imports
of the subsidized goods would have to be adjusted to reflect the import
quantity change.
If goods were rationed,
the excess demand function would
have to shift as a result of a change in the rationed amounts.
If there
were no rationing, the quantities implicit in the entries in the government
trade import and the rows would also have to change to reflect movement to
a different point on the demand schedules.
In this as in the following partial equilibrium analyses it can be
surmised that a change in expenditures on a subsidized commodity which
takes a noticeable fraction of total expenditure will have indirect
consequences through the effects on income available for other types of
consumption.
However, in order for those indirect effects to take place
there must be some responsiveness of domestic production to shifts in
demand and prices.
That assumption will underlie all the later tests to
be done with the GEM models which are "general equilibrium" tests.
The next case is that of a change in the subsidized price of a commodity
which is also purchased abroad by the government supply authority but for which
there is as well a domestic supply.
This describes the supply conditions
for frozen chicken and meat which are good if not perfect substitutes for
domestic chicken and meat.
Again there are differences between the situation
in which the subsidized supply fully satisfies demand at the subsidized
21..
In Figure
price and the situation in which it must be rationed.
and
Q.
S
D
2
are the domestic demand and supply schedules respectively.
P^
and
are the price and quantity levels which would prevail in a competitive
Suppose, however, that Q„ of
market without any other source of supply.
the good is provided at the price P„ by government supply authorities.
the amount which would be demanded at P^, there
Since Q„ is less than Q„
,
must be rationing of Q
among consumers.
In this case, as in the previous
case there is an unsatisfied, or excess, demand, above the rationed quantity.
That is Dg which is D
supply
S
- Q
.
The interaction of D
with the private
generates a private, non-subsidized price p, at which Q, is
4
demanded and supplied.
exist
4
Thus a rationed supply and subsidized price co-
with an unrationed supply and unsubsidized price.
seen that at prices below P
the quantity Q
It
can be
would be purchased by
consumers from government sources before they turned to private sources.
But at a government price above P., but less than P,
,
private sources would
he preferred for that part of consumer demand which could be satisfied
at a price less than the subsidized price.
22.
Fi<^ure.
%Q
I^R
<?1
2.
^t
CPo/xyyi-.t^
23.
It should be noted that there is an implicit assumption in this type
of conventional anaysis of subsidized supply that all types of potential
consumers exercise equal access to the rationed supply.
That may not be the
case, because middle and upper Income groups may prefer to pay a somewhat
higher price rather than to stand in queues or because these people are
not is.sued ration cards.
If this condition prevails, then the demand
which is left "unsatisfied" by the supply of rationed goods cannot be
determined by subtracting the rationed supply Q
D, to obtain the "excess demand", D^.
1
E
from the total demand
In this case the demands of the
particular income or social groups which are satisfied by the supply of
the rationed commodity would have to be identified and subtracted from
the total demand in order to determine the excess demand.
If enough of the goods were provided under subsidy via imports so
that demand were fully satisfied, e.g. if at P^ the amount Q» was supplied
then, of course, rationing would not be necessary and there would be no
place for domestic supply.
In this circumstance any change in the price
of a subsidized commodity must be accompanied by a quantity change in a
Since the supply is from imports by government authorities,
test of policy.
the Import adjustment would have to be imposed exogenously in the use of
the GEM model for testing the policy by adjustments in the government
trade import row.
Even if the quantity supplied under subsidy did not
fully satisfy demand, then any change in the subsidy price above P^,
the;
level at which the domestic supply plus the subsidized supply would just
clear an uncontrolled market, would require a change in imjiorts.
The adjustment
is necessary in this, as compared to the previous case, because there is a
competing domestic source of supply which will take a larger share of the
market if the subsidized price is raised, even for a fixed supply, above
P..
It
would also be necessary to adjust the excess demand function.
24.
since that is calibrated on the assumption that all the subsidized supply
will be taken.
If it is not,
because its price, though subsidized, is
nonetheless below the price at which additional domestic supply would be
provided to substitute domestic for subsidized foreign goods, the substituticnmust be recognized by shifting the excess demand function.
Turning next to change Jn policy which involves a change in quantity
alone, or along with a change
in the price at which the subsidized j^oods
are sold, more extensive changes in the data inputs to the GEM model would
be required to analyze this case.
The entries in both the subsidy rows and
the government trade import rows must be adjusted to reflect changes in
the quantity supplied as well as in prices,
if those occur.
And as in the
last example, the constant term in the private demand functions must also
be adjusted to reflect the shift in the excess demand functions.
Another type of Egyptian direct subsidy program has been one in which
all - or a substantial part - of the goods provided to consumers with a
subsidy were purchased domestically by the government supply authority.
Those domestic "purchases" have been both compulsory deliveries at an
imposed price.
purchases.
Figure
3
illustrates a subsidy program based on domestic
P^ and Q^ are the price and quantity which would prevail if there
were no government intrusions in a competitive market.
Suppose, however, that
the government requires that Q^ be delivered to its supply authority at a price
7^,
The goods are then resold to consumers through a ration program at a price P_.
The subsidy per unit is P
- P
There is both an excess demand, D
= D -
not satisfied by consumer purchases through the rationing scheme, and an
excess supply,
s^^
= S -
Q^^,
which is available from producers once they
have satisfied the compulsory delivery requirements.
The price which
clears the market which exists outside the compulsory delivery system
and rationed and subsidized consumer sales is P
being bought and sold.
with a quantity of Q
,
25.
Changes in either the compulsory delivery price or the price at
which rationed sales are made or
both with no changes in the quantity
transacted will change the net earnings of sellers and the consumer
surplus of buyers and, of course, the receipts of sellers or the expenditures
of buyers,
respectively, or both.
Tests of changes in this type of policy
require a different set of adjustments than the previous tests in which
the purchase prices of the government supply authority are fixed by the
foreign market price.
good P
First, if only the selling price of the subsidized
is changed and the good continues to be rationed, then only the
direct subsidy entries need be changed as quantities purchased and sold
remain unaffected.
Second, if the compulsory delivery price is changed,
but the quantity purchased and its selling price is not, then two adjustments
must be made.
The value of government trade purchases and the amount of
the subsidy must both be changed to reflect the new compulsory delivery
price and the new effective subsidy rate to consumers.
Third, if there
is a change in the amount of compulsory deliveries and, thus,
in the amounts
offered for sale even without a change in prices, then again both the
value of government trade purchases and subsidies must be adjusted.
However, in this latter case it is also necessary to shift the excess
demand functions of consumers since the amounts they are provided under
subsidy change and, therefore, the demand which they exert in the marketplace also change.
Finally, there may be combinations of all the above
policy changes which, in turn, will require for their investigation
combinations of the adjustments described above.
In all the analysis above it has been assumed that if there were,
in the aggregate, rationing for a particular commodity, i.e. quantities
supplied were less than quantities demanded at the subsidized price,
tlien
26.
Fi'(^u.rc
Fn<^^
3
''
^t4.a ttTi'ty
27.
it would prevail for each income class.
Of course, this need not be the
A subsidized price which rations upper income groups might clear
case.
the market for lower income groups.
at the ration shops,
There might be, subsequent to pur( base
"re-contracting" among buyers so that lower incom-i
groups sold some of their subsidized purchases to higher income groups.
That would eliminate the rationing among the groups by means of an
"unofficial" price which cleared the market but there would still be
rationing of the subsidized quantities for some groups at the official
price.
If tests are to be made of changes in subsidy policies in which
rationing does not prevail among all income classes,
thei>,
those classes
for which it does not prevail must be treated differently from the classes
for which it does.
28.
B.
Adjustments in production subsidies
As noted earlier, production subsidies, i.e. those which are paid to
producers, are quantitatively more important than the subsidies on goods
sold directly to consumers by government authorities; the 1976 SAM indicates
that the former were twice as large as the latter.
subsidies
Of the total
the largest part is for wheat purchased by bakeries
production
for
breadj which was more than 50 per cent of these subsidies in 19 76 and more
than one-third of total subsidies.
The analysis of production subsidies and the effects of policy
changes are complicated by
thci
regulations and controls which are associated
with them and conditions of joint production.
In addition, the price-
quantity adjustments of the CEM models are not of the type conventionally
envisaged.
schedule.
On the demand side, there is a more or less standard demand
The differences are on the supply side. Suppose there were an upward
shift in the demand schedule, as the result, say, of an increase in one
of the parameters.
At existing prices, that would generate an increase
in quantity demanded, an increase in sectoral outputs and inputs,
an increase in value added.
including
The manner in which this value added is
produced and, therefore, the price of the value added will depend on the
production function and the resource constraints.
Thus the price associated
with the new level of production will not, in general, be equal to the
original price.
A process of iteration will then take place to adjust
price and quantities to be consistent with the newly located demand
schedule and the resource constraints and production functions.
This
iteration process is not the one which is envisaged in the conventional "story"
abouL competitive entrepreneurs responding to prices, but the typical result
nonetheless is tc generate an upward sloping supply schedule.
Now, however,
29.
the final result will be a shift in the positions of the supply and demand
schedules as well as reflecting shifts along the schedules.
That is, the
GEM model iterations are general equilibrium adjustments rather than partial
equilibrium adjustments of the supply-demand geometry.
always be kept in mind that the Egyptian markets which are
It must
analyzed are not, in fact, fully competitive, as they are represented in
the GEM and are required for the use of conventional supply-demand analysis.
While there seems to be no reason to believe that private bakeries in
Egypt have monopoly power, there are other non-competitive elements in
bread markets.
These include the government bakeries,
which are not
subject to the same competitive pressures as private bakeries.
Prices
and qualities of most types of bread are fixed and, in some circumstances,
government authorities may intervene to require supplies to the market.
A special complicating factor in the subsidized supply of wheat to bakeries
is the ability of the latter to upgrade the wheat quality so that it can
be used in producing bread of higher quality and higher marginal returns.
With these cautions in mind, the conventional diagrams can be used to
indicate the parameter adjustments associated with changes in production
subsidy policies.
Suppose there were a specific production subsidy of a constant
atnount on each unit of output
in a particular sector.
familiar case can be portrayed by Figure
curve would be
S
4.
This analytically
The unsubsidized supply
and the subsidized supply curve would be S„.
At the
I
initial equilibrium price and quantity, P„ and Q„,
per unit is P^- P^.
the amount of the subsidy
The total amount of the subsidy is (P^ - P.)
•
If there should be an increase in the amount of the subsidy from
1
P]^
f
-
'^2
ti
^° ^1 " ^3 ^^^^ would shift the supply curve to S-.
The new
Q2-
30.
equilibrium price and quantity would be P
would be
(P'j
-
P^)
•
and Q
.
The new total subsidy
Q^.
As is well known, the difference between the initial price ?£ and
the new price P
-^
would be less than the increase in the subsidy, indicating
a division of the benefi><s between consumers and producers.
The proportions
of that division would, in turn, depend on the demand elasticity.
Tests of changes in direct production subsidy rates require first
an adjustment of the subsidy rate itself.
That subsidy rate is the total
amount of production subsidy in the box for the particular sector divided
by the gross output of the sector, assuming that subsidies are paid on
gruss output and not just on the amount sold to consumers as distinct
from sales for other purposes.
Production subsidies in Egypt are provided for bread production by
selling the wheat to bakers at prices which are below market prices.
In
recent years, the subsidized wheat inputs have been entirely imported.
The provision of a siiecific subsidy based on input rather than on output
raises no analytical problem as long as there is a fixed relation between
the input and output and there is only one source for the input.
Neither
condition holds in Egypt, although it is possible, without doing too much
violence to reality, to assume the former relation exists.
As noted
above, the quality of flour sold to bakers can be upgraded by them by
sifting it, so that it becomes suitable for the production of higher
quality bread and bakery products.
The incentive to exploit this possibility
arises because the prices of the various qualities of bread are controlled
so that the profit rates vary and, according to the conventional wisdom,
the rate is negative on the lowest qualities of bread.
Thus, even though
there are some weight losses involved in upgrading the flour, it appears
31.
to pay to carry that out.
However, it will be assumed here that the
government has enough instruments of direct control to insure that the
output of the various qualities of bread correspond to the output
composition desired by the supply authorities.
Thus the fixed relation
between inputs and outputs can be assumed.
The second issue, the existence of more than one source for the
subsidized input, is important because there is no scope in the GEM
models for substitution among intermediate inputs.
determined by fixed coefficients.
Their proportions are
That applies to the mix between
domestically produced and imported inputs as well because all imports are
treated as if they were noncompetitive.
Kxere is, however, domestic production of wheat which is undoubtedly
affected by domestic prices which are, in turn, influenced by the suppl;"
of imported wheat.
Some part of the domestic supply may even be available at
prices below even the subsidized prices of the imports.
Thus, if the
s
ibsidy
rate should change, the proportion of the total supply which comes from
domestic sources would also change.
Figure 5
presents
an analysis of
this latter situation.
S
is the
domestic supply schedule, without any subsidy and D, the demand schedule,
^m
^^ ^^^ foreign price at which Egypt can import.
P^
is the price which
would prevail if there were no imports and/or subsidies and Q
quantity transacted in this case.
with a subsidy of P
- p
P„ is the controlled price of the wheat
being provided on each unit of Q
the demand schedule D, the amount demanded
would be Q„.
is the
imports.
Given
at the controlled price, ?2^
The sum of domestic and foreign supply at the price P„ is Ql
which is less than the amount demanded so there must be some non-price
rationing mechanism.
If the controlled price rises to P- in conjunction
32.
with
a
reduction of the subsidy to ^^ ~ ^oj
then the quantity demanded
and offered from domestic and foreign sources is Q
.
Tlie
important
point in this case is that the mix between domestic production and
imports will change.
If the changes in subsidy policy push the bread
market to a point like P„ and Q„, then, in effect, the domestic and
foreign input coefficients must change in the SAM to reflect the new
The wheat input coefficient into the bread industry, which
conditions.
in the SAM is the delivery from staple agriculture to the food processing
industry, would have to be adjusted as would the coefficient indicating
imports to the food processing industryIt is,
perhaps, also obvious that similar changes would have to be
made if the quantity of imports made available under the subsidy program
were changed.
The import coefficient and the domestic input-output
would both require adjustment.
C.
Adjustments in indirect subsidies.
It
will be recalled that "indirect" subsidies were identified as
those resulting from deliberate underpricing of output by government
enterprises with the objective of lowering prices to producers or
consumers.
They may or may not be a source of accounting losses to the
enterprises but not all accounting losses can be attributed to underpricing for the purpose of subsidization.
Thus, neither the existence
nor the amounts of such subsidies are easy to ascertain.
There are
some clear cases, however, notably the underpricing of petroleum and
its products.
The underpricing of electricity is partly due to the
underpricing of petroleum, a major input for the thermal generation of
electric power.
But it is also possible that there electricity is
underpriced simply out of a desire to subsidize certain classes of users.
33.
Figure
A
may be used to represent this type of subsidy.
The
effective supply schedule is shifted downward by the amount of the
subsidy, with a change in the market price and the quantity consumed.
It should be noticed in this case that there is no rationing of the
sales of tho comraodlty.
Any change In subsidy levels will, therefore,
be associated with changes in the volume of transactions.
There is no obvious place for changes in subsidies of this type
Ln the Social
Accounting Matrix, xhe value added by labor in government enter-
prise is included with the value added in private firms in the social
accounting matrix and value added of public enterprises Includes only
that attributable to capital and other primary factors.
To the
extent goods produced by government enterprise are underpriced, value
added is understated.
While simply changing value added in government
enterprise might seem to be the most straight forward means of adjusting
subsidy levels, this type of change would generate an increase in demand
for the primary factors which produce value added.
la fact, presumably
the value added not collected is simply a rent foregone by the enterprise
and changes in this rent to not require changes in input requirements.
There are at least two ways of testing for changes in implications
of subsidy policies of this type.
One means is simply to increase the
amount of value added by the change which is envisaged in the subsidy.
That
would call for a greater use of primary factors in the production of the
value added, however, with corresponding changes in the returns to the
factors in limited supply.
This type of adjustment in effect rejects the
argument that the earnings foregone through subsidy are a rent.
Another
device is to change indirect taxes on the sector by the amount of the
subsidy.
That would not require any more factor inputs and would resu]
in the change in government revenues which would actually be associated
3A.
iigMrg i
Frit.
Qi (^nQz
Oc<^m7>t^
35.
FioLcre.
<^M
^
^'A<
<5s^a
Guant'ifj
36.
with a change in prices of goods subsidized by underpricing the output of
government enterprise.
In both cases the change in quantities demanded
would occur endogenously as a response to price changes.
As noted earlier, the partial equilibrium analysis which has been
presented omits the indirect effects of changes in subsidies.
These
indirect effects are, in fact, difficult to trace, as suggested by the
limited degree of development of the theoretical literature on the
subject.
Thus a computable general equilibrium model is an excellent
device for testing the economy-wide implications of changes in subsidy
policies.
The simple partial equilibrium analysis above only indicates
the parameters which must be altered to carry out the tests.
Yet the
simple theory also indicates that the tests must be carefully designed
because the structure of th€ models does not quite reproduce the conventional competitive market structure which is the reference point.
37.
IV.
Tests of the consequences of subsidy adjustments
The previous discussion has outlined alternative subsidy policy
adjustments and analyzed their qualitative implications.
While the partial
equilibrium effects of the subsidy policy changes could be identified,
the general equilibrium effects can not be determined without a general
equilibrium model.
In this section the GEM III model will be used to
provide quantitative illustrations of the consequences of particular types
Q
of subsidy policy adjustments.
The tests described below are only a beginning, because the objective
here is not to propose or design policy or to provide a complete basis for
designing policy.
Rather, the purpose is to illustrate the effects of
alternative approaches to subsidy policy and their consequences and, by so
doing, to provide the ingredients for thinking carefully about subsidies.
The analysis will proceed through a series of quantitative tests of
the policies which have been previously analyzed in a qualitative and
"partial equilibrium" manner with the conventional tools of microeconomic
supply and demand schedules.
will be contrasted.
Finally, the results of the various tests
In each of the tests the sources of the subsidized
goods and tht use of price or quantity changes will be distinguished.
It
will typically be assumed that those subsidized goods provided directly
to consumers are rationed.
The data used are all for 1976 and were prepared for the 1976 Social
Accounting Matrix.
This means that the tests conducted are "as if" tests,
i.e., as if those conditions prevail which are represented in the 1976
SAM.
There are, even so, many qualifications which must be attached to
the results.
The SAM reflects a number of approximations as does the GEM
38*
model used to test the subsid/ policies.
In particular it should be noted
that the particular numerical results are sensitive to both the specific
values of the consumer demand elasticities employed, for which the estimates
can be regarded now only as rough approximations, and to the sectoral
production functions, whose parameters are even more approximative.
In
addition the factor supply constraints in the various sectors are chosen
to isolate those regarded as most restrictive, having in mind the need to
limit the number of these constraints in order to maintain the feasibility
of solutions.
In calculating the amounts of the subsidies for the various
categories of goods, the distribution costs of all subsidized goods have
been allocated in the proporuions of the purchase costs of individual
commodities to total purchase costs.
Therefore, although there is an
apparent precision in the solutions, the quantitative results should be
regarded with some skepticism except insofar as they indicate qualitative
patterns.
In particular it would be mistaken to accept numerical results
based on 1976 data as indicative of the quantitative implications of current
policies.
39.
Test 1
Change in direct subsidies to consumers by a change in pri ce of imported
commodities, for which there is no domestic production, with rationing
prevailing.
The goods wliich fall into this category are the non-staple foods:
edible oils, fats (animal), tea and coffee with the following accounting
in thousands of
"
-iE:
Share of distribution costs
Totals
Purchases
Sales
138,783
92,255
Profit/Loss
-46,528
- 7,786
7,786
146,569
-54,314
92,255
The share of total distribution costs of iE 42,707 is calculated at
(138,783/803,913 - 42,707)« (42, 707) where 803,913 are the total cost of
purchases of subsidized goods.
In the test carried out it will be assumed that subsidies are reduced
to 10% of the value of purchases by an increase in the selling price
oi
the
rationed commodities:
New situation
Purchases
Sales
146,569
131,912
Profit /Loss
-14,657
The subsidy reductions are spread across the various income classes in their
proportions of total consumption of non-staple food.
This is the type of test which has been done previously with general
equilibrium models and for which the general nature of the results are
well-known.
comparisons.
The test is repeated here only to provide a basis for
40.
The results of this test are shown in Tables 1As can be seen in
the tables,
1
through 1-
5
the results are generally deflationary,
as predicted from the qualitative analysis above and consistent with the
pre^'ious analysis which has been done of changes in subsidy policy.
u
Output and prices fall in every sector with the relative changes reflecting
the different demand elasticities, production parameters, and factor supply
conditions as well as all the other structural conditions of the SAM and
the GEM.
The fact that the deflationary effects are so thoroughgoing supports
the rationale of the results.
The reduction in subsidies is a reduction
in real personal income, and given the nature of the tax system, an increase
in government saving.
With investment, government consumption and export
components of final demand remaining unchanged, the only possible result
is general deflation.
The macroeconomic adjustment requires a decrease in
personal income and saving to maintain the total saving- investment equality.
The impact of the deflation can also be seen in the reductions in
real factor demands which take place and, perhaps most dramatically, in
the changes in household consumption of the various income classes.
Without
commitment to the exact magnitudes because of the many uncertainties in
the data, it appears likely that the general patterns shown are correct.
The lower income classes suffer more than the upper income classes and
the rural income groups more than urban income groups because of differences
in sources of their income.
While the deflationary effects of the subsidy reduction might be
unintended, the foreign trade balance and government budgetary effects
are the ones which are usually sought by advocates of reductions in
41.
consumer subsidies.
There is a slight reduction in exports, which is a
price effect, a larger reduction in imports and a more than
reduction in the trade deficit.
6
per cent
There is also an even more substantial
Increase in government savings, 35 per cent.
The average price reduction
faced by each income class, reflecting its particular composition of
expenditures is shown in Table 1-
4
•
The differences are small.
There are some income distributional consequences of the changes in
subsidies as might be expected, but they are relatively small.
Table 1-
shows the income distribution of disposable income and total expenditure
before and after the change in subsidy policy.
In general, the relative
positions of the lowest income classes in both urban and rural areas
decline slightly.
The relative position of the middle and upper income
classes in urban areas improves slightly and the position of the middle
and upper income classes in rural areas deteriorates slightly.
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42.
Test
2
Change in direct subsidies by a change in quantity provided of imported
goods, for which there is no domestic production, with rationing prevailing.
These are also the non-staple goods:
edible oils, fats (animal),
tea and coffee with the following values in thousands of Efiyptian pounds:
Purchases
Sales
138,783
92,255
Share of distribution costs
Profit/Loss
-46,528
- 7,786
7,786
92,255
146,569
-54,314
The share of total distribution costs attributable to these commodities
is estimated as in Test 1.
In the test carried out it will b3 assumed that these subsidies are
completely eliminated by stopping the imports of the quantities
had been provided:
which
This means:
(1) Direct subsidies to consumers are reduced by tE 54 million with
the reductions spread across consumers in proportions of non-staple food
in each income class;
(2) Government trade imports are reduced by tE 146 million, with the
reductions spread across income classes in the same as above;
(3) Consumer demand functions adjusted by increasing the constant
term for each income class by amounts in (2)
This is done under the
assumption that there would be a shift to domestically produced non-staple
goods by the amount that expenditure is reduced on imported subsidized
goods.
.
The rationale for this adjustment is that when the estimation of the
original consumer demand functions was done, they had to be adjusted to take
into account the amounts made available at subsidized prices under rationing.
That is, the original demand equation corresponds to D
in Figure 1 or 2.
Eliminating the subsidized and rationed supply moves consumers to their
basic total demand curve,
D.
43.
Tables 2of
I
1
to 2- 5
present the results of this test.
The effects
his type of change are quite different from the previous one.
There is a
shilt from consumption of imports to domestic consumption which stimulates
domestic economy.
As can be seen in Table 2- 1
output rises in every
sector as a result of the increased demand for the output of the non-staple
goods sector which has multiplier effects on the rest of the economy.
The largest changes are in the agricultural sectors reflecting
the location
of the initial increases in demand and the estimated demand elasticities.
Prices also rise most in the agricultural sectors as a result of the
induced effect on land prices which increases costs of value added and,
therefore of total production.
The changes in household incomes reflect the
different dc-grees of
participation of each income class in the value added in the various
sectors.
The elimination of the subsidies decreases the relative shares
of incomes of the urban income classes as could be expected from the
concentration of output and income increases in rural areas.
There is a
slightly larger shift in the position of the lowest income group in rural
areas than in the shares of the upper two income classes.
However, it
should be emphasized that the consumption levels of all income classes
rise.
Some of the overall effects are those typically desired by advocates
of subsidy reduction.
Imports fall, indicating that the direct effect of
the reduction in subsidized imports is greater than the induced increase
in imports resulting from the improvement in domestic incomes.
Although
induced government expenditures increase slightly, the decrease in expenditures on subsidized imports is larger so that total expenditures fall.
On
the other hand, there is an increase in revenues due to higher domestic
levels of activity.
The net result is a substantial increase in government
spending as shown in Table 2-
5.
Contrary to conventional objectives of
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44.
reducing subsidies, the increases in prices are quite general.
The policy of reducing the quantities of subsidized imports has the
expected effects of stimulating domestic activity and prices.
However,
perhaps somewhat unexpectedly, that is not associated with an increase in
the balance of payments deficit, but rather the opposite, and, as well an
improvement in the government budget position as well.
It must be emphasized, however,
that all of these effects depend on
the indigenous availability of resources to meet the increase in demand
for domestic production,
i.e.
If that were not the case,
on a significant elasticity of domestic supply.
the price increases would have been much greater.
By assumption, the goods are not produced domestically.
with-domestic-production
aggregation however.
The non-competitive -
nature of the imports is lost in the sectoral
So it must be assumed that there are other domestically
produced goods which are close substitutes.
The argument is implicit in
many subsidy programs that the domestic resource situation
is
quite tight.
In this case the provision of imported goods at subsidized prices helps to
hold down prices.
effect.
Reducing that foreign supply has a general stimulating
Supply elasticities may be low for various reasons, including
institutional rigidities and resource constraints.
Even if true overall,
it would be reasonable to expect shifts in agricultural production toward
the commodities whose relative price has increased most because of the
elimination of the subsidized supply.
45.
Test
;i
Change in direct subsidies by change in price of imported goods which are
rationed, for which there is also a domestic supply, but lor which there
are no non-government imports.
The domestic supply does not Involve
compulsory deliveries.
These commodities are frozen meat, frozen chicken, and sugar with
the following accounting in thousands of
fcE:
Purchases
Sales
Profit/Loss
71,496
77,137
+ 5,641
Share of distribution costs
+
4,011
77,137
75,507
1,630
By the simple definition of subsidies as a situation of losses by the
Egyptian
supply authority, there are no subsidies on this group of
commodities, entirely because of the profits made in selling frozen meat.
Presumably^, although this is the case,
the selling prices are still below
market prices for domestically produced meat.
would not be sold.
Otherwise the imported meat
Without knowing the relative prices of domestic and
foreign meat, it is impossible to stipulate precisely by how much the selling
price of the imported meat could rise without losing its price advantage and
no longer be subject to rationing.
However, it will be assumed that selling
prices can rise by 50% without violating this condition.
increased to
fcE
116 million;
So sales are
profits go up by the amount of BE 39 to
Therefore, in this test subsidies are reduced by
fcE
fcE
40.
39.
As in Test 1 in which prices are increased, in this case also, the
effect is to depress the economy and for the same reasons.
shown in Tables 3-
1 to
3- 5
.
The results are
The fact that there is a domestic supply of
the commodities has no distinctive effect on the outcome for two reasons.
In the first test, the non-competitive nature of the subsidized imports was
46.
hidden by the high degree of aggregation in any case.
And, secondly, the
goods are still assumed to be rationed because, in spite of the reduction
in subsidy and increase in the official price, that price is still lower
than the domestic, unconstrained market price.
The rationale of the changes is the same as for Test
drop in real income and in government expenditure.
1:
there
Is
a
Consumption falls, in
part resulting from the decline in real income associated with the increase
in prices but mainly as a result of the macroeconomic adjustment.
With
investment and exports exogenously determined and government saving larger
as a result of the decline in government expenditures,
private income must
decline in order to reduce private saving and thus, achieve the necessary
saving - investment condition.
Thus, as desired by some proponents of decreases in subsidies, the
trade balance improves and the government deficit is reduced.
In this case
prices actually fall slightly, suggesting that it would be realistic to
expect at least an associated reduction in inflationary pressures.
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Change in direct subsidies by change in quantity of imported goods, which
are rationed, for which there is also a domestic supply, but for which
there are no non-government imports.
If these commodities are frozen meat,
cliicken and sugar, any reduction
in quantities provided would reduce the small profit apparently made on
this group of commodities, specifically on imported meat.
This is a case,
however, in which the definition of a subsidy rate as the difference
between purchasing and selling price is particularly misleading as the
domestic cost and price of imported meat, at least, is substantially above
the import price.
Assuming that the provision of these commodities under subsidy is
eliminated, government
trade imports are reduced by
are actually increased by
"tE
3
fcE
76 million.
Subsidies
million (=2 X 1.6) since profits of that amount are
eliminated from the total supply authority accounts.
in the non-staple food private demand
is increased by
The constant term
fcE
76 million.
The various amounts are distributed across income
groups in
the proportions of their consumption of non-staple goods.
48
This is also a case in which the elimination of imported goods which
are provided under subsidy will stimulate the domestic economy as it responds
to the transferance of demand to internal sources of supply.
It is again
assumed that the domestic economy has capacity which will permit it to
expand in response to the new stimulus.
Since the commodities are, in
fact, produced domestically, the test is less artificial than Test 2 in
which it was assumed that there was a shift to domestic substitutes for
goods not produced within Egypt.
The results of this test are shown in Tables 4-1 through 4-
5
.
The
largest increase in output is in the non-staple food sector, to which
demand formerly satisfied by imports is directly transferred.
However,
there are induced demands which run through the economy resulting from the
increased output and income in the non-staple food sector.
is a 3.5 per cent increase in output.
Overall, there
Prices rise in all sectors as money
incomes rise to achieve macroeconomic equilibrium.
That is consistent
with a rise in the prices of land, labor and capital under increased
pressure to produce additional output.
As is usual, of course, the
particular pattern of product and factor price increases reflects the
constraints which are imposed with respect to the availability of factors
to the particular sectors.
Under the assumptions for this test the distribution of income shifts
toward the rural sectors.
The largest increases in the relative shares
go to the lowest rural income class.
This is true both for disposable
income, which includes the effect of subsidies, and for total private,
non-subsidized expenditure.
The declines in relative shares of the urijan
income groups are slightly greater for the lower than for the highest
income groups.
These changes are borne out by the corresponding decreases
in private household consumption which occur in the two lowest urban
A9
Income classes as compared to the increases in consumption among all the
rural income classes.
The foreign trade balance improves somewhat and the government budget
deficit declines substantially, both the direct results of the reduction
in
The effective increase
overnment expenditures on imported commodities.
in the general price level for all income groups is
5
to
6
per cent.
These changes are quite different from those induced by changes in
the prices of subsidized commodities but are, on reflection, not surprising.
As pointed out above, it is well known that the subsidized import of
commodities which compete whith a domestic sector will tend to depress
that sector.
Only if there are off-setting measures such as general
investment progr.mis will these depressing effects be offset.
In the tests
which are run there are no offsetting effects so the impact of the change
in subsidy policy is fully revealed.
It should also be noted that the
generally stimulating effects of this policy are not necessarily desirable
as they do contribute to price inflation, even under the factor supply
conditions assumed.
In effect this solution provides a "general equilibrium" analysis of
an issue raised some time ago with respect to the effects on domestic
agriculture of the supply to developing countries of food aid under
conditions of "differential distribution."
is
The particular case examined
the withdrawal of that food aid, but the results can be interpreted
in the reverse order.
It may also be inferred that the macroeconomic
effects could be offset only by a conscious government policy of stimulating
the economy.
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50.
Test
5
Change in production subsidy rates for imported goods, which are rationed,
for which there is also a domestic supply.
The test will apply to wheat, flour and maize imports supplied to
the food processing industry.
The values in thousands of Egyptian pounds are:
Profit/Loss
Purchases
Sales
274,711
149,449
-125,262
Flour
75,355
52,574
- 22,781
Maize
49,640
26,566
- 23,074
399,706
228,589
-171,117
Meat
Share of
distribution costs
Totals
- 22,425
22,425
422,131
228,589
- 193,542
The present subsidy rate, i.e. the proportion of the purchase price
paid by the government is
1 -
If this rate is cut in half,
228,589 =
422,131
to .2293,
1 - .5415 =
the value of sales to consumers
would be 325,360 and the subsidies would be 96,771.
be reduced to LE 97 million.
.4585.
So subsidies vrlll
51-
The results of this test are shovm in Tables 5-1 through 5-
5
.
They
are generally similar to those for Test 1, which consisted of a reduction
in the direct subsidy rates on imported goods for which there was no competing
domestic supply.
In this case there is a domestic supply, but there is
no recourse to it.
That is because the structure of the model does not
permit the endogenous substitution of domestically produced goods for
imports and no exogenous adjustment is made.
The rationale is that the
imported goods are sold at prices much less than the domestic supply price
even after the increase in subsidy rates.
As a result, the production
subsidy reduction raises prices and, thus is, again, like a decrease in
real income.
There is a decrease in private savings but a much more than
offsetting increase in government savings.
The consequences are a decline
in effective demand for the output of all the sectors ranging from about
0.7 to slightly over
3
per cent.
There are price declines in all but the
food processing sector which are at a maximum about 3.5 per cent.
The distributional consequences of the changes embodied in this test
are,
likewise, virtually identical to those of Test
1,
with the outstanding
feature of virtually no changes of any magnitude.
Corresponding to the declines in income, there are reductions in
household consumption across all income classes and producing sectors.
The price changes for the consumption baskets of the various income groups
are almost negligible.
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52.
Test 6
Change in quantities of imported goods provided as production subsidies
for which there is also a domestic supply.
This test will also apply to wheat, flour and maize.
It will also
be assumed that the quantities supplied under subsidy are reduced in this
test in order to decrease government expenditures on imported goods.
The
reduction in quantities will be assumed to be one-half for all three goods
but the subsidy rate will be assumed to stay the same.
In this case government trade imports to sector 5 are reduced by
-fcE
211 million to
180 million and subsidies by 98 million to
fcE
fcE
84 million.
Since lesser amounts of subsidized wheat, flour and maize are provided from
imports, per unit of total output, more must be provided, per unit of output,
Therefore, the domestic deliveries from sector 1,
from domestic production.
staple food, to sector
5,
food processing, must rise by
fcE
211.
The effects of this adjustment are quite substantial, as seen in
Tables 6-1 through 6-
5
.
The imposed shift from imports to domestic
supply elicits a 50 per cent increase in output in the staple food sector
at the consequence of a 21 per cent increases in price.
The other sectoral
adjustments reflect the conflicting influences of induced income effects
and price effects.
In some sectors the net effect on output is negative;
in other sectors it is positive.
The largest of these induced output
effects is 4 per cent, in the "other agriculture" sector.
food output actually falls.
Non-staple
It should be kept in mind as always that
the
results depend on the assumptions as to the availability of resources to
respond to the increased demand for domestic production.
Since land and
labor supplies are assumed to be constrained in all the agricultural
sectors, overall there is an induced increase in the use of capital.
In
53.
addition there is a sharp shift in the use of land and labor in agriculture
away from non-staple food and cotton, in particular, towards staple food
production.
The induced price increases in agriculture and the non-staple food
sector are all about 20 per cent reflecting the pressure on domestic
resources in the agricultural sectors.
The distributional effects are those which might be expected in the
circumstances.
In general the rural income groups benefit at the expense
of the urban groups,
expenditures.
with respect to both their gross incomes and total
The lowest classes of income recipients in urbiin and rural
areas have the largest changes, negative and positive, respectively.
This
shows up, in turn, in the substantial corresponding changes in the household
consumption of each group.
The urban income groups are forced to reduce
their consumption across the board and the rural income groups raise their
consumption.
The macroeconomic changes are also quite important.
by more than
8
per cent.
Imports fall
The trade deficit is decreased by 29 per cent
and both government and private savings rise.
Overall prices of the
consumption baskets of the various income groups rise from 6.6 to 13.7
per cent.
This type of subsidy policy change is clearly stimulating to the
economy.
The extent to which the stimulation takes the form of real
output or price increases depends on the availability of unused resources
and/or the speed \d.th which new resources can be supplied or existing
resources transferred to the staple food sector.
will, in reality, require price increases.
of this type wil]
But the latter also
Thus, while subsidy reduction
achieve the most obvious goals of Improvement in the
54.
balance of payments and government deficit, those achievements will come
at the expense of price stability.
also be of concern.
The shifts in income distribution must
The putative experiment of providing subsidies, where
none before existed, would reduce the share of the lowest rural income
classes especially.
The response, in shifting from staple to non-staple
food production corresponds to the recent actual changes in Egyptian
agriculture.
That does not imply that subsidization of staple foods is
alone responsible for the observed shift but it does suggest that such
subsidization may have been an influence contributing to the shift in
the use of agricultural resources.
This is a test which provides a different type of general equilibrium
analysis of the old issues of the effects on the domestic economy of an
exogenous supply of food aid.
at especially favorable prices.
In this case much of the grain is purchased
The outcomes are not uniform in all the
sectors and in some sectors the impact is rather perverse.
Yet the overall
effects on incomes and output correspond to what might have been expected
from previous partial equilibrium analyses.
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55.
Test
7
This is a test of the differential effects of
subsidy rate on textiles which are assumed to
there is also a direct supply.
For this test
textiles will be reduced by 20%, i.e. 17 from
change in the production
be imported but for which
production subsidies on
86 to 69.
Qualitatively this test is analogous to Test
are shown in Tables 7-1 through 7-
that test, however,
5
.
The precise results
The magnitude of the change in
is substantially larger.
also qualitatively similar.
5.
The results are, in general,
The overall effect is deflationary for the
same reasons which explain the impact of other types of reductions in
subsidy rates.
In this case, however, the output effects and price effects
are concentrated in the textile rather than the agricultural and food
processing sectors.
The balance of payments deficit is reduced as a result of the general
deflation in the economy and the government deficit also is reduced,
primarily because of the reduction in government spending on the textile
subsidies.
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56.
Conclusions
In spite of its length,
this paper has not exhausted the analysis of
subsidy policies, having confined itself to conditions under which there
is
rationing when there are direct subsidies and avoiding a full and explicit
analysis of the pricing implications of production subsidies.
Nonetheless
some new emphases, if not completely novel conclusions, emerge.
The quantitative, general equilibrium tests confirm the preceding
partial equilibrium analyses which indicated that the effects of subsidy
policies will vary depending on the character of the change, the demand
conditions for the commodities to which the policies are applied and the
conditions of domestic production.
Recent analyses of subsidy policies using a general equilibrium model
have emphasized the deflationary effects of reductions in food subsidies.
Results presented here demonstrate that this result is obtained
when the policy change consists of an increase in the prices at which the
rationed and subsidized goods are sold.
in the amounts made available,
When the policy change is a decrease
the overall and sectoral effects can be quite
different and may, in the aggregate, be stimulating. The different results are
a
consequence of the domestic supply response to decreases in subsidized supply. It
may be inferred that there would be analogous reactions to a decrease in
subsidies resulting from an increase in price, if the price increase was
sufficient to decrease, if not eliminate, the need for rationing.
In this
latter case also there would be some "spillover" to the domestic market.
The GEM models provide a general equilibrium framework for the analysis
of alternative subsidy policies.
The model thus can provide a more satisfactory
answer to the questions raised a number of years ago as to the effects of the
provision of food to developing countries under economic assistance programs.
Some of the conclusions previously reached were confirmed and all were
57.
substantially enriched.
In general the analyses showed that the distributional
effects of reducing subsidy rates tend to be regressive while the effects of
reducing the quantities of subsidized imports tend to shift the distribution
of income toward the agricultural sector.
Table 8 shows in a summary fashion the distributions of disposable
Income and total consumption expenditures which result from each test of
subsidy policy.
There are changes which shift incomes from rural to urban
groups or vice versa and from lower to upper income groups and vice versa.
Obviously the results produced by the tests which have been made only
Illustrate the many outcomes which are possible.
It is also obvious from
these exercises, which show a diversity and a ramification of implications
that have not heretofore been made explicit, that subsidy policies have in
the past been made without full consideration of their implications.
The
tools which have been used here to analyze these implications are far from
adequate, but they can be used to produce more insights and policies which
are more likely to achieve the effects desired than any other analytical
methods now available.
58.
Table
8
Distributions of Disposable Income
Inc ome
Class
Initial
Condition
Test
1
2
3
4
5
6
7
Urban
Lowest 60%
.206
.205
.200
.206
.194
.209
.185
.207
Mid 30%
.212
.213
.206
.219
.201
.214
.191
.212
Upper 10%
.229
.236
.226
.231
.220
.232
.207
.230
Lowest 60%
.147
.145
.154
.147
.161
.144
.176
.147
Mid 30%
.107
.105
.111
.106
.117
.105
.126
.107
Upper 10%
.098
.096
.103
.097
.108
.096
.116
.098
Rural
Distributions of Total Consumption Expenditure
Income
Class
Initial
Condition
Test
3
4
Urban
Lowest 60%
.246
.245
.239
.245
.232
.248
.225
.245
Mid 30%
.254
.257
.248
.255
.242
.257
.233
.254
Upper 10%
.210
.215
.205
.211
.201
.211
.192
.210
Lowest 60%
.140
.138
.149
.140
.157
.137
.170
.140
Mid 30%
.080
.078
.086
.080
.091
.078
.096
.080
Upper 10%
.070
.068
.073
.069
.077
.068
.084
.070
Rural
Footnotes
(1979-1) and (1979-2).
1.
See Taylor, L.
2.
Eckaus, R.S., McCarthy, F.D. and Mohie Eldin, A.
3.
Taylor, L.
,
(1979-1).
4.
Taylor, L.
,
(1979-1).
5.
Taylor, L.
,
(1979-2); McCarthy, F.D. and Taylor, L.
6.
Fisher, F.M.
7.
See Neary, J. P. and Roberts, K.W.S. (1980) for an enlightening
general equilibrium analysis of household behavior when there
is rationing.
8.
Eckaus, R.S., McCarthy, F.D. and Mohie Eldin, A.
9.
Taylor, L.
10.
,
,
(1963), and Schultz, T.W.
(1980).
(1960).
(1979-2).
See Fisher, F.
(19 79).
(1963) for a corresponding result.
(1979).
Bibliography
1.
Eckaus, R.S., McCarthy, F.D. and Mohie Eldin, S., "Multlsector
General Equilibrium Models for Egypt," M.I.T. Department of
Economics Working Paper No. 2 33, March 25, 1979.
2.
"A Theoretical Analysis of the Impact of Food Surplus
Fisher, F.H.
Disposal on Agricultural Production in Recipient Countries,"
Journal of Farm Economics, 45, 1963, 863-875, reprinted in
Bhagwatl, J. and Eckaus, R.S. (ed.) Foreign Aid, 1970.
3.
"Macro Food Planning Policy:
McCarthy, F.D. and Taylor, H.
A General Equilibrium Model For Pakistan," The Review of
Economics and Statistics 62, 1, Feb., 1980, 107-121.
,
,
,
4.
Neary, J. P. and Roberts, K.W.S., "Household Behavior Under Rationing,"
European Economic Review 13, 1, January, 1980, 25-42.
,
5.
Schultz, T.W. , "Value of U.S. Farm Surpluses to Underdeveloped
Countries," Journal of Farm Economics , 42, 1960, 1019-30, reprinted
in Bhagwati, J. and Eckaus, R.S., op. cit.
6.
Taylor,
L.
,
"Food Subsidies in Egypt," (mimeo) M.I.T. Oct., 1979 (1).
7.
Taylor, L.
,
"Macro Models for Developing Countries, 1979 (2).
665!i
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