Poverty Effects of Higher Food Prices

Transcription

1 Public Disclosure Autorized Policy Researc Working Paper 4887 WPS4887 Public Disclosure Autorized Public Disclosure Autorized Poverty Effects of Higer Food Prices A Global Perspective Rafael E. De Hoyos Denis Medvedev Public Disclosure Autorized Te World Bank Development Economics Development Prospects Group Marc 2009

2 Policy Researc Working Paper 4887 Abstract Te spike in food prices between 2005 and te first alf of 2008 as igligted te vulnerabilities of poor consumers to iger prices of agricultural goods and generated calls for massive policy action. Tis paper provides a formal assessment of te direct and indirect impacts of iger prices on global poverty using a representative sample of 63 to 93 percent of te population of te developing world. To assess te direct effects, te paper uses domestic food consumer price data between January 2005 and December 2007 wen te relative price of food rose by an average of 5.6 percent to find tat te implied increase in te extreme poverty eadcount at te global level is 1.7 percentage points, wit significant regional variation. To take te secondorder effects into account, te paper links ouseold survey data wit a global general equilibrium model, finding tat a 5.5 percent increase in agricultural prices (due to rising demand for first-generation biofuels) could raise global poverty in 2010 by 0.6 percentage points at te extreme poverty line and 0.9 percentage points at te moderate poverty line. Poverty increases at te regional level vary substantially, wit nearly all of te increase in extreme poverty occurring in Sout Asia and Sub- Saaran Africa. Tis paper a product of te Development Prospects Group, Development Economics is part of a larger effort in te department to monitor te poverty and income distribution impacts of global economic trends and policies. Policy Researc Working Papers are also posted on te Web at ttp://econ.worldbank.org. Te autor may be contacted at dmedvedev@ worldbank.org. Te Policy Researc Working Paper Series disseminates te findings of work in progress to encourage te excange of ideas about development issues. An objective of te series is to get te findings out quickly, even if te presentations are less tan fully polised. Te papers carry te names of te autors and sould be cited accordingly. Te findings, interpretations, and conclusions expressed in tis paper are entirely tose of te autors. Tey do not necessarily represent te views of te International Bank for Reconstruction and Development/World Bank and its affiliated organizations, or tose of te Executive Directors of te World Bank or te governments tey represent. Produced by te Researc Support Team

3 Poverty Effects of Higer Food Prices: A Global Perspective Rafael E. De Hoyos and Denis Medvedev Cief of Advisors to te Under-Secretary of Ministry of Education, Mexico, and Economist, Development Prospects Group, World Bank. Te views expressed ere are tose of te autors and sould not be attributed to te World Bank, its Executive Directors, or te countries tey represent. For teir comments we are grateful to Ataman Aksoy, Maurizio Bussolo, Andrew Burns, Nora Lustig, Will Martin, Hans Timmer, Dominique van der Mensbrugge, and seminar participants at a conference on food prices and poverty organized at te World Bank. Rebecca Lessem and Li Li provided excellent researc assistance. Te usual caveat applies. Address for correspondence: J9-144, Te World Bank Group, 1818 H Street, NW, Wasington, DC 20433; dmedvedev@worldbank.org.

4 1 Introduction Te rapid rise in food prices between 2005 and te first alf of 2008 as raised numerous concerns about potential negative welfare impacts of a world wit iger food prices, particularly among poor ouseolds and tose wit incomes just above te poverty line. 1 At te same time, to date tere ave been few formal assessments of te likely impacts of iger food prices on global poverty, and none using a large sample of developing countries. Tis paper aims to bridge te existing knowledge gap by providing a set of estimates of te likely impacts of iger food prices on poverty and income distribution at te global level using a unique set of ouseold survey data. Te economic effects of canges in relative prices ave been a well-researced subject including contributions by Deaton (1989), Ravallion (1990), and Ravallion and van de Walle (1991) among oters. According to tis literature, canges in food prices can affect poverty and inequality troug consumption and income cannels (see Figure 1). On te consumer side, as food prices increase, te monetary cost of acieving a fixed consumption basket increases ence reducing consumer s welfare. However, for te segment of te population wose income depends --directly or indirectly-- on agricultural markets, i.e. self-employed farmers, wage workers in te agricultural sector, and rural land owners, te rise in food prices represents an increase in teir monetary income. For eac ouseold, te net welfare effect of an increase in food prices will depend on te combination of a loss in purcasing power (consumption effect) and a gain in monetary income (income effect). Clearly, for tose ouseolds wose income as no linkages wit te agricultural markets, for instance urban dwellers, te net welfare effect of an increase in food prices will be entirely determined by te negative consumption effect. For ouseolds wose incomes are closely related to te performance of agricultural markets and for wic food consumption represents a small proportion of teir total budget, iger food prices would be welfare-improving. Terefore, te first-order, or direct, welfare effects of sifts in food prices will be determined by te ouseold s net position on food supply or demand. In te medium run, once quantities produced are adjusted to reflect te new set of prices in te economy, wages and/or employment in te agricultural sectors will increase to attract te necessary factors of production to increase output --tis is wat it is known as te second-order, or indirect, income effect (see Figure 1). 2 Te approac depicted in Figure 1 was undertaken in a recent study by Ivanic and Martin (2008). Using detailed ouseold-level information, te autors find tat te proportion of te population living below te poverty line as increased as a result of iger food prices in eigt of te nine countries included in teir study. In a related study, Friedman and Levinson (2002) identify te urban poor as te most vulnerable group during a period of food inflation. Ravallion (1990) develops and tests a metodology to assess te 1 Between July 2008 and February 2009, international agricultural prices (in nominal terms) ave come down by 32 percent, but are still 45 percent above teir January 2005 levels. 2 Arguably, tere is also a second-order effect taking place in te consumption side, tat is, given te new set of prices, te consumer can cose a different consumption basket. Tis effect is ignored in te present analysis based on te ig degree of correlation among food prices and te little scope tat te poor ave for food consumption substitution. 2

5 poverty effects of canges in food prices taking into account te induced wage responses caused by price canges. Te autor finds tat, even including induced wage responses in te analysis, rural poverty in Banglades tends to increase as a result of an increase in te relative price of food staples. A recent study by Aksoy and Isik-Dikmelik (2008) callenges te idea tat iger food prices unambiguously deteriorate te income of te poor. Using ouseold survey data from nine low-income countries, te autors find tat net food sellers are disproportionately represented among te poor, ence suggesting tat an increase in food prices can transfer income from ricer to poorer ouseolds. As one can see, te country-specific and global net poverty effect of iger food prices remains an empirical question to be addressed. Figure 1 Relationsip between International Food Prices and Houseold Welfare Te paper is organized in te following way. A conceptual framework linking international food prices wit ouseold real incomes is briefly delineated in Section 2. Based on te importance of price transmission for poverty impacts (see top part of Figure 1), Section 3 sows te recent canges in domestic food price indices for developing countries and compares tem to te evolution of te international food price index. 3

6 Sections 4 and 5 describe te metodology and present te estimates of direct and indirect poverty impacts, respectively. Section 4 develops two simulations: te first one, particularly relevant for urban areas were te income effects tend to be small or nonexisting, takes into account te consumption effect only, wile te second simulation combines income and consumption effects imputing a ouseold-specific sare of agricultural income in rural areas. Section 5 adds te second-order impacts of iger food prices on poverty to te analysis by linking te ouseold survey data wit a global general equilibrium model in a macro-micro simulation framework. Scenarios in tis section link iger food prices to te recent and expected ( ) trends in te production of biofuels and allow te ouseolds (at te macro level) to re-optimize teir consumption and labor supply coices. Section 6 offers concluding remarks. 2 Food Prices and Poverty: Conceptual Links An increase in international food prices will redistribute resources domestically as long as te pass-troug or link between international and domestic food prices is different from zero (Macro Level in Figure 1). Assuming a positive pass-troug effect, te increase in international food prices will be followed by an increase in domestic food prices enancing a redistribution of resources from non-agricultural to te agricultural sector of te economy. According to Bussolo, De Hoyos and Medvedev (2009), almost 45 percent of te population in te world lives in a ouseold were te main income-generating activity of te ouseold ead takes place in te agricultural sector. Te autors sow tat a large sare of tis agriculture-dependent group, close to 32 percent, is poor and tat tese so-called agricultural ouseolds contribute disproportionately to global poverty: tree of every four poor people belong to tis group (see Table 1). So redistributing resources from agricultural to non-agricultural ouseolds --as an outcome of iger food prices-- could elp reduce global poverty and inequality via iger incomes for farmers. However, ouseold purcasing power will also deteriorate as a result of te increase in prices, making te link between agricultural trade liberalization and global ouseold welfare a complex one. Higer food prices will enance a redistribution of real income between net food producers and net food consumers of agricultural products, wit te welfare of te former improving at te expense of te latter (see Micro Level in Figure 1). 3 Finally, factor prices will also cange following te cange in prices of final products terefore canging te real incomes of ouseolds tat are not directly involved in agricultural production (see Meso Level in Figure 1). Table 1: Poverty is iger among agricultural ouseolds even if teir incomes are less unequal Pop Sares (%) Average Montly Income (US$ of 1993, PPP) Gini (%) 1-Dollar Poverty Incidence (%) Agriculture Non-Agri Poverty Sare (%) World Source: Bussolo, De Hoyos and Medvedev (2009) 3 A ouseold is defined as a net producer (consumer) of agricultural products wen te monetary income it derives from mercandising tese products is greater (smaller) tan te amount spent on tem. 4

7 Ultimately, te sort- to medium-term poverty effects of iger international food prices will be determined by: (1) te degree of pass-troug; (2) te incidence and severity of poverty among net food producers versus net food consumers; and (3) te extent to wic iger food prices translate into iger income for farmers (in te form of profits and wages). Te degree of pass-troug will be, in turn, determined by domestic market conditions suc as: government intervention in te form of subsidies or price controls, infrastructure and market access, te degree of domestic competition and trade barriers among oters. Net food production/consumption patterns are determined by te importance of te agricultural sector as an income source of te poor and te proportion of total ouseold budget allocated to food consumption. Finally, te relationsip between iger food prices and farmer incomes is a function of te eterogeneity in domestic price transmission among large versus small farmers, and te ability of rural factor (labor) markets to adjust to canges in prices of final products. 3 International vs. Domestic Food Prices Between January 2005 and December 2007, te international food price index increased 74 percent. 4 Is tis a good indicator of te reduction in purcasing power suffered by consumers in developing countries? Te international food CPI reflects canges in te international food prices weigted by commodity-specific global trade volumes. In a world were as little as 7 percent of total food consumption is being traded internationally, te international and domestic food CPIs are only marginally related. Consumption patterns can be quite different between countries wit te importance of internationally traded commodities in domestic food CPIs varying across countries. Te relevant price canges for welfare analysis are te domestic food CPIs wic, altoug tey ave sown a rapid increase between 2005 and 2008, ave a growt rate tat is far from being as large as te increase sown by te international food CPI. Figure 2: Distribution of Cumulative Increases in Nominal Food Prices (LCU, Jan 2005 Dec 2007) Percentage of Developing Countries Percentage Cange in Price Cumulative Increase in International Food Prices = 74 % 4 Using figures from Te World Bank (DECPG). 5

8 Figure 2 sows te domestic increase in food CPI for 76 developing countries between January 2005 and December 2007 and compares it wit te increase in te international food CPI. 5 In all but tree countries, te domestic food price index increased less tan te international food prices (74 percent). Differences between te domestic and international food price indices could be explained by differences in te consumption basket wit domestic food baskets containing non-traded food items. International and domestic food CPIs can also differ due to: (i) a weak price transmission in internationally traded food commodities (Baffes and Gardner, 2003), (ii) imperfect domestic markets caracterized by lack of competition (Levinson, 1996) and poor infrastructure, and (iii) government intervention in te form of subsidies and price controls, and oter market distortions. Te food CPIs in Figure 2 are expressed in local currency units (LCU) and are terefore influenced by local inflation rates. To account for local inflation rates, Figure 3 reports te cange in domestic food CPI relative to te cange in non-food CPI between January 2005 and December 2007 and compares tese indices wit te cange in international food CPI relative to te manufacturing unit value (MUV) index. 6 In 18 of te 76 developing countries included in our sample te non-food price index increased at a faster rate tan te cange in food prices, in oter words, non-food items became relatively more expensive. Tis is not surprising given te large price increases observed in an important non-food item suc as fuels. For te great majority of te developing countries analyzed (58 out of 76) food items became more expensive in terms of nonfood items. On average, relative food prices increased 5.6 percent far below te 31 percent increase registered by te international food CPI relative to te MUV. Figure 3: Distribution of Cumulative Increase in Relative Food Prices (LCU, Jan 2005 Dec 2007) Percentage of Developing Countries Percentage Cange in Relative Price Cumulative Increase in International Food Prices = 31 % As we mentioned before, tere are several reasons wy domestic and international prices can differ; neverteless, tis section sows tat focusing on te international food CPI to 5 Te domestic food CPIs are collected by ILO (ttp://laborsta.ilo.org/) directly from te national statistical offices (or central banks). Te international food CPI is constructed by te researc department at te World Bank (ttp://go.worldbank.org/md63qupaf1). 6 Te MUV index comes from te World Bank (ttp://go.worldbank.org/vdq5aa3vp0) 6

9 make inferences about te welfare effects of domestic price canges could be misleading. Not only te international food CPI can divert from te average domestic food CPI but also price canges across countries sow a ig level of eterogeneity. Terefore domestic price indices sould be use to infer te ex-post welfare effects of price canges. Canges in domestic nominal prices are more relevant for sort-term welfare evaluation since we assume tat prices of all non-food items remains constant. On te oter and, relative prices are more appropriate for a medium- to long-run evaluation of te welfare effects of iger food prices. Te following section sows te possible poverty effects brougt about by te canges in domestic food prices discussed in tis section. 4 Direct Poverty Effects of Higer Food Prices 4.1 Metodology NA Y r Y Let us define te monetary income of ouseold, Y, as te sum of incomes from A profits from agricultural activities, Y, and incomes deriving from all oter sources,. Tese monetary income components are assumed to be a function of te vector of A NA prices in te economy, P, ence Y Y (P) Y (P). Te purcasing power of ouseold,, is defined by te ratio of it money income divided by a ouseoldspecific price index capturing te ouseold s consumption patters in terms of food and non-food expenditure: A NA r Y Y ( P) Y ( P) (1) Y f nf P P (1 ) * P were f P and nf P are food and non-food price indices and is te proportion of ouseold s budget spent on food. Equation (1) captures te dual effect of a price increase depicted in Figure 1, i.e. te possible iger monetary income on te one and, and te loss in purcasing power on te oter. Te canges in real incomes brougt about d P f dt by a cange in relative prices of food versus non-food, p approximated by te following linear expression: (2) Y r A Y p Y p P nf, can be Equation (2) states tat, in te sort term and for sufficiently small canges in p, profits A from farming activities, Y, will increase in te same proportion as te canges in relative prices and te loss in purcasing power will be proportional to te amount of te total ouseold budget spent on food, Y. Terefore, in te sort term, te proportional cange in real income wit respect te base period can be written as follows: 7

10 Y r (3) ( ) p Y were is te sare of total ouseold income tat is accrue to profits from farming activities. Hence, in te sort term, iger food prices will benefit net producers of agricultural goods ( ) and urt net consumers of agricultural products ( ). Equations (2) and (3) assume tat production and consumption patterns remain constant after te cange in prices (Deaton, 1989) and terefore tese results sould be complemented wit a medium- to long-term analysis. 4.2 Simulation Results Te simulations presented ere make use of te Global Income Distribution Dynamics (GIDD) dataset tat as been recently developed at te World Bank. Te GIDD dataset consists of 73 detailed ouseold surveys for low and middle-income countries, 21 of wic include information on food expenditure by ouseold. 7 Togeter, tis dataset covers 63 percent of te population in te developing world--te major missing country being Cina. Te majority of te surveys (54) use per capita consumption as te welfare indicator, wile te remaining surveys--all but one for countries in Latin America-- include only per capita income as a measure of ouseold welfare. Te welfare measures are expressed in 2005 PPP prices for consistency wit te $1.25 and $2.5 a day poverty lines recently developed in Cen and Ravallion (2008). 8 All te ex-ante poverty simulations presented in tis section capture te ceteris-paribus effects of canges in relative food prices observed between January 2005 and December 2007 (see Figure 3). Te results presented ere differ from Ivanic and Martin s (2008) estimates in several ways: (1) te country coverage is substantially different, (2) wile Ivanic and Martin s (2008) focus on te poverty effects of canges in 7 food items, we assess te poverty of canges in prices of te total food basket, (3) Ivanic and Martin s (2008) use te canges in international prices of teir 7 food items as te price sock wereas we use te domestic cange in te food CPI relative to te non-food CPI Loss in Urban Houseold Purcasing Power As it is clear from equation (3), te sare of total ouseold budget tat is spent on food,, is an important element determining te deterioration in purcasing power originated from an increase in food prices. For some countries, tis information is readily available from ouseold surveys, owever, in several cases one as to estimate or impute tis value. In 21 out of te total 73 countries included in te GIDD s sample, ouseold-level information on total food expenditure was available. Using te information for tese 21 7 See Table 9 in Annex II for a complete country list. A complete description of te dataset is available at ttp:// 8 Most of te ouseold surveys in te GIDD are for years between 2000 and Wen te GIDD dataset did not include te newest ouseold survey available from te World Bank s PovCal, te GIDD s survey mean income (or consumption) was modified so tat te extreme poverty eadcount matced te latest information available from PovCal. 8

11 relatively large countries, a developing countries Engel curve was estimated wic was ten used to impute te values of food sares in all oter countries, ˆ ; te metodological details if tis procedure are explained in De Hoyos and Lessem (2008), wic ecoes te tecniques developed in Cranfield, Preckel, Eales and Hertel (2002). For urban dwellers, were, most likely, te quantities of food produced are close to zero, te welfare effects of iger food prices will be largely determined by te loss in purcasing power. To capture te small income effects in urban areas, we assume tat Y in equation (2) is zero for all ouseolds in tis strata, terefore Y r ˆ Y p. Te A results of te simulation focusing on te loss in purcasing power in urban areas can be seen as an instructive way of summarizing te following country-specific information: i) domestic canges in food prices, ii) te initial incidence and severity of poverty in urban areas, iii) te proportion of te total budget spent on food among poor urban ouseolds. Table 2 sows te urban poverty impacts of te negative consumption effects brougt about by te increase in te relative price of food using a poverty line of $1.25 per day in Given te large number of results, Table 2 sows regional weigted average poverty effects, owever country-specific impacts can be requested from te autors. According to Table 2, te extreme poverty eadcount in urban areas increased by 2.86 percentage points as a result of te rise in food prices observed between January 2005 and December Additionally, te average gap between te poor s income and te poverty line grew 0.51 percentage points. Tis deterioration in te poverty indices translates into an additional 68 million individuals below te poverty line and an increase of [20.6] percent in te monetary cost of alleviating total urban poverty under perfect targeting conditions. 9 To understand better te relationsip between food prices and urban poverty Table 2 presents te elements tat determine te increase in urban poverty: (1) te relative cange in domestic food prices faced by urban ouseolds; (2) te proportion of te total budget tat poor urban ouseolds allocate to food; and (3) te initial incidence and intensity of poverty among urban dwellers. As it was discussed in Section 2, te magnitude of te food price increase faced by ouseolds is, in all regions, significantly lower tan te canges registered by te international food price index. Te weigted average increase in relative food CPI for urban areas in te developing world is 4.10 percent wit food prices increasing at slower rates in Latin America and te Caribbean (LAC) and Eastern Europe and Central Asia (ECA) and quite te opposite in East Asia and te Pacific (EAP) and te Middle East and Nort Africa (MENA). Notice tat, on average, food prices decreased wit respect nonfood prices in ECA, as it was mention earlier, tis could be te result of iger energy prices in tis region. LAC and ECA are regions were te expected poverty effects are mild given tat poor ouseolds in Latin America spend a relatively low proportion of teir total budget on food and because te initial poverty rates in tese two regions are rater low. On te oter and, poverty indicators in oter regions sow a considerable 9 Using te cange in te poverty deficit as te cost measurement, Dessus, Herrera, and de Hoyos (2008) sow tat, on average, 90 percent of te additional cost of alleviating urban poverty can be attributable to te reduction of real income of ouseolds classified as poor before te price increase. 9

12 deterioration as a result of iger food prices. Wit an increase in te eadcount ratio of 6.34 percentage points, East Asia is, by far, te region experiencing te largest increase in poverty; tis region by itself saw an increase of 51 million individuals in urban areas below te extreme poverty line. Tis massive increase in te number of poor is explained by te importance of food items in poor urban ouseolds and a large increase in food prices. Middle East and Nort Africa also experienced a relatively large increase in urban poverty due to a sarp increase in te relative prices of food in tis region (12.54 percent). Table 2: Urban Poverty Effects of te Canges in Relative Food Prices (Jan Dec. 2007) Region Sock to ˆ among te Food Prices (%) Poor (%) Initial (circa 2005) Cange P 0 P P 1 0 P 1 Number of Poor (Million) East Asia Eastern Europe Latin America Middle East Sout Asia Sub-Saaran Africa Developing World * Notes: (1) Te regional canges in food prices are weigted averages of te cumulative increase in domestic food CPIs relative to non-food CPI observed between January 2005 and December 2007; (2) te poverty line is set at $1.25 (2005, PPP) per day; (3) te sare of food consumption to total consumption among te poor is computed as described in De Hoyos and Lessem (2008); (4) to get te increase in number of poor te regional cange in eadcount was applied to all countries in te region; (5) East Asia does not include Cina and te Middle East includes only Jordan, Morocco and Yemen. Tese results sould be taken wit caution as tey represent an upper bound of te real poverty impact. In te medium-to long-run, urban ouseolds would cange teir consumption patterns towards less expensive food baskets; additionally, some of te general equilibrium effects of iger incomes in te agricultural sector will eventually benefit urban areas. Tese effects will be explored in more detail in section Poverty Effects in Rural Areas As we already mentioned, te adverse poverty effects of iger food prices documented in te previous section could be compensated by an increase in farmers income. Since te incidence of poverty among agricultural ouseolds --te beneficiaries of iger food prices-- is iger tan among non-agricultural ouseolds (see Table 1), a net poverty reduction as a result of a rise in food prices is not an implausible outcome (Aksoy and Isik-Dikmelik, 2008). Te GIDD dataset classifies eac ouseold as rural and urban according to te official domestic classification. Tis classification of rural ouseold agglomerates into a 10

13 single group: large land owners, self-sufficient farmers, agricultural wage earners, and ouseolds tat indeed do not derive income from agricultural activities. Additionally, te GIDD dataset identifies a welfare aggregate (income or consumption) only at te ouseold level. Tis posses a serious callenge since, as oppose to te information on food sares,, we do not ave information on te level and distribution of te proportion of total ouseold income tat is accrue to agricultural self-employment activities. Bot and vary across ouseolds but, as oppose to tere is no economic teory tat we can use to estimate a relationsip between and oter observable caracteristics like ouseold per capita income. In order to get plausible values of we rely on te information from te Rural Income Generating Activities (RIGA) project. RIGA is a FAO-World Bank funded project tat uses LSMS ouseold surveys to disentangle te sources of rural income wit te purpose of understanding te relationsip between te various income generating activities. 10 Taking te reported sare of self-employed agricultural income at te ouseold level for 19 countries located in 5 of te 6 World Bank developing regions, we estimate a simple polynomial relationsip between te sare of income tat is attributable to self-employment agricultural incomes,, and per capital ouseold income (or consumption),, and regional fixed effects: y (4) 2 ˆ * y * y 0.44* LAC 0.49* SAS 0.38* EAP 0.30* ECA N 930,692 ; R Tis simple specification is enoug to give a rater good fit of te data wit an R 2 of 0.5. According to te observed data, controlling for income differences, te sare of selfemployed income in rural areas is igest in Sub-Saaran Africa and muc lower in Latin America and Sout Asia. Te results of tis simple specification are used to impute te sare of self-employed agricultural income in all rural ouseolds taking into account teir per-capita ouseold income (or consumption) and regional location. Figure 4 sows te difference between te observed and imputed agricultural selfemployed income sare for eac percentile of per capita consumption in rural areas. Te sare labeled all countries sows tat te average sare in te poorest ouseolds in rural areas is close to 80 percent wile tis falls to 15 percent for ouseolds in upper percentiles. Figure 3 also sows te prediction power of te model by comparing te observed sares,, versus te fitted values, ˆ, for two rater different countries, Nigeria and Panama. Te country-specific fitted values in Figure 3 are based on two separate regressions tat excluded Nigeria and Panama, respectively. Overall, te 10 For more details on te LSMS ouseold surveys see ttp:// For a complete description of te RIGA project including publication of te first results see Carletto et. al. (2007) and visit: ttp:// 11

14 imputed sare was not substantially different from te observed one, wit te average absolute difference between observed and imputed sares in Panama and Nigeria being around 7 percentage points. In te sort-run, incomes of self-employed farmers will increase in proportion to te increase in prices of teir produce. Te lack of ouseold-level information on rural income sources, implies tat, as a result of iger food prices, all rural ouseolds experience an increase in nominal income equal to ˆ Y p. Terefore, as long as ˆ ˆ, ouseold will experience a reduction in real income as a result of iger food prices. For te same increase in price, given te iger value of ˆ estimated by specification (4), rural ouseolds in Sub-Saaran Africa experience a iger increase in nominal income compared wit rural ouseolds in Latin America. Figure 4: Observed and Imputed Sare of Agricultural SE Income Self-employment Agricultural Sare, % Panama Nigeria All Countries Percentiles of Per-Capita Consumption (1) Using data from RIGA; (2) te percentiles are country-specific Te rural poverty effects of a simulation accounting for te consumption and income effects assuming ˆ are presented in Table 3. Despite te fact tat we are allowing for positive income effects in te relatively poorer rural areas, indicators in all regions sow deterioration in terms of te incidence and dept of poverty. Notice tat, altoug te initial poverty eadcount is muc iger in rural areas, te increase in tis poverty indicator is smaller tan in urban areas capturing te offsetting income effects of iger food prices taking place in rural ouseolds. For eac region except for Latin America, te cange in te rural poverty eadcount ratio is smaller tan te cange taking place in urban areas. At te global level, te eadcount ratio in rural areas increases by 2.06 percentage points representing an additional million individuals falling below te poverty line. Te rural poverty deficit, i.e. te resources needed to alleviate extreme 12

15 poverty in rural areas, jumps by 6 percent after te cange in relative prices--muc lower tan 21 percent increase taking place in urban areas. Given te importance of self-employed agricultural incomes for rural ouseolds in Sub- Saaran Africa, iger food prices are not translated into a significantly iger poverty rate in tis region. Despite te relatively mild increase in te incidence of poverty in rural Sout Asia an extra 19.5 million individuals fall sort te extreme poverty line after te price sock. As in urban areas, te deterioration of rural poverty indicators is more acute in East Asia wit tis region accounting for 62 million out of te total 87 million new poor. Table 3: Rural Poverty Effects of te Canges in Relative Food Prices (Jan Dec. 2007) Region Sock to Food Prices (%) Food Sare Among te Poor (% of total Y) Initial (circa 2005) Cange P 0 P P 1 0 P 1 Number of Poor (Million) East Asia Eastern Europe Latin America Middle East Sout Asia Sub-Saaran Africa Developing World * Notes: (1) Te regional canges in food prices are weigted averages of te cumulative increase in domestic food CPIs relative to non-food CPI observed between January 2005 and December 2007; (2) te poverty line is set at $1.25 (2005, PPP) per day; (3) te sare of food consumption to total consumption among te poor is computed as described in De Hoyos and Lessem (2008); (4) to get te increase in number of poor te regional cange in eadcount was applied to all countries in te region; (5) East Asia does not include Cina and te Middle East includes only Jordan, Morocco and Yemen Total Poverty Effects Overall, te number of individuals living on less tan $1.25 a day, 2005 PPP increased by 155 million as a result of te cumulative increase in te relative price of food observed between January 2005 and December 2007 (see Table 4). Notice tat tis result contrasts wit te 105 million reported in Ivanic and Martin (2008). Tere are several reasons beind tis difference: (i) te present paper uses data for 73 developing countries as opposed to 9, (ii) te estimates of Ivanic and Martin (2008) are based on nominal price canges for 7 commodities wereas our study takes te cumulative cange in food CPI relative to non-food CPI as te price sock, (iii) te income/consumption ouseold aggregates are expressed in 2005 PPP and te newly developed $1.25 and $2.5 poverty lines are used to measure te initial poverty indices (see Cen and Ravallion, 2008), and (iv) Ivanic and Martin (2008) total poverty estimates are valid for low-income countries covering a total population of 2.3 billion wereas our estimates are for all te developing world covering a population equal to 5.4 billion. Given all tese differences, te 13

16 discrepancy of 50 million between te number of new poor presented in tis study and te number of new poor estimated in Ivanic and Martin (2008) is indeed a small one. Table 4: Total Poverty Effects of te Canges in Relative Food Prices (Jan Dec. 2007) Region Sock to Food Prices (%) Food Sare Among te Poor (% of total Y) Initial (circa 2005) Cange P 0 P P 1 0 P 1 Number of Poor (Million) East Asia Eastern Europe Latin America Middle East Sout Asia Sub-Saaran Africa Developing World * Notes: (1) Te regional canges in food prices are weigted averages of te cumulative increase in domestic food CPIs relative to non-food CPI observed between January 2005 and December 2007; (2) te poverty line is set at $1.25 (2005, PPP) per day; (3) te sare of food consumption to total consumption among te poor is computed as described in De Hoyos and Lessem (2008); (4) to get te increase in number of poor te regional cange in eadcount was applied to all countries in te region; (5) East Asia does not include Cina and te Middle East includes only Jordan, Morocco and Yemen. Te results presented in Table 4 ide important eterogeneities across countries. Figure 5 sows te canges in poverty eadcount and gap for eac of te countries in our sample. Te canges in food prices ave different impacts in different countries wit te net poverty effect --in terms of poverty eadcount and gap-- being close to zero (less tan a fift of a percentage point) for 60 percent of te countries included in our sample. In around alf of te developing countries analyzed, iger food prices raise te eadcount ratio by at least 0.2 percentage points; Indonesia, Yemen, Etiopia, Pakistan, and Banglades are te countries wit te igest adverse poverty effects wit increases in te eadcount ratio of more tan 3.5 percentage points. By contrast, in 7 developing countries te cange in relative prices reduces te incidence of poverty by at least 2 percentage points. In 5 of tese 7 countries, te reduction in poverty is attributable to a reduction in relative food prices (Dominican Republic, Sri Lanka, Madagascar, Benin, and Moldova). Neverteless, in Kenya and Mali te reduction in poverty in rural areas is large enoug to compensate for te poverty increase observed in te cities and pull down te national poverty eadcount by 0.42 and 0.75 percentage points, respectively. 14

17 Figure 5: Canges in te Poverty Headcount and Gap due to te Increase in Food Prices Notes: (1) te poverty line is set at $1.25 (2005, PPP) per day; (2) using data from te GIDD. 5 Incorporating Indirect Poverty Effects of Higer Food Prices Altoug international agricultural prices ave retreated substantially from teir peak in July 2008, tey remain more tan 45 percent above teir January 2005 level. Wile tis is clearly not convincing evidence of a reversal in te long-term trend of declining agricultural prices, tere are several reasons wy te scope for additional declines may be limited: slower progress in development of new tecnologies, limited take-up of existing advanced tecniques due to infrastructure and institutional constraints, sooner- or largertan-expected damages from climate cange, or large and growing additional demand for agricultural output from biofuels. In fact, te latter as played a major role in te spike in food prices, according to Mitcell (2008) and World Bank (2009, Capter 2). Tis section explores te implications of te continued ig demand for firstgeneration biofuels troug 2010, satisfied troug increased production of corn, sugar cane, and weat for etanol, and oil seeds for biodiesel. Tis is done by linking a recursive-dynamic global computable equilibrium (CGE) model wit te GIDD microsimulation model. Te CGE model contrasts a baseline scenario, in wic te demand for biofuels (as a sare of total demand for a specific crop) remains at 2004 levels, wit a biofuels scenario in wic demand follows its istorical pat troug 2007 and is projected troug 2010 using current mandates and production trends. 5.1 Metodology Te general equilibrium model used in tis paper is te World Bank's Environmental Impacts and Sustainability Applied General Equilibrium model (ENVISAGE). Te detailed description is available in van der Mensbrugge (2008), wile te next two paragraps summarize its most relevant features. Production is modeled wit a series of nested CES functions tat allow for different degrees of substitutability across inputs, wic include intermediate inputs, energy, skilled and unskilled labor, different capital 15

18 vintages, land, and natural resources. Te latter are sector-specific, wile land as limited transformation across agricultural uses. New capital vintages and skilled labor are freely mobile across sectors, wile te mobility of old vintages is limited. Unskilled workers are freely mobile witin farm and non-farm activities, but te movement from farm to nonfarm employment is limited wit a Harris-Todaro migration function. Consumer demand is modeled wit a nesting of Cobb-Douglas and constant-differences-in-elasticity (CDE) utility functions. International trade is specified wit nested CES and CET functions wic allow for limited substitution between domestically produced goods and imports or exports (te Armington assumption). Te model contains an integrated climate module wic links CO 2 emissions to canges in global temperature wit feedbacks to agricultural productivity (following te approac of Nordaus and Boyer, 2000, and Nordaus, 2007, and calibrated wit estimates in Cline, 2007). Te current version of te model is based on te GTAP database wit a 2004 base year, wic as been aggregated to 26 country/regions and 22 sectors (Table 8). Te model is solved forward, in recursive fasion, until 2010, wit labor force and population growt rates lined up to te UN s medium variant population forecast. TFP growt in agriculture is set at 2.5 percent per annum wit no differentiation across sectors or regions, based on estimates in Martin and Mitra (1999). Labor-augmenting productivity growt in te oter sectors is endogenized to acieve te World Bank's forecasted growt of real GDP. Te macro closure as government expenditures as a sare of GDP fixed at 2004 levels, wile a demograpically-driven savings function determines te allocation of private expenditures between consumer demand and domestic investment. Te manufactured export price index of te ig-income countries is te numéraire. Te distributional analysis is carried out wit te World Bank s GIDD model, wic generalizes te existing CGE-microsimulation metodologies e.g., Bourguignon, Bussolo, and Pereira da Silva (2008), Cen and Ravallion (2003), and Bussolo, Lay, and van der Mensbrugge (2006) at te global level and is described in detail in Bussolo, De Hoyos, and Medvedev (2008a). 11 Te conceptual framework of te model is depicted in Figure 6. Te expected canges in population structure by age (upper left part of Figure 6) are exogenous, meaning tat fertility decisions and mortality rates are determined outside te model. Te cange in sares of te population by education groups incorporates te expected demograpic canges (linking arrow from top left box to top rigt box in Figure 6). Next, new sets of population sares by age and education subgroups are computed and ouseold sampling weigts are re-scaled according to te demograpic and educational canges above (larger box in te middle of Figure 6). Te impact of canges in te demograpic structure on labor supply (by skill level) is incorporated into te CGE model, wic ten provides a set of link variables for te micro-simulation: (a) cange in te allocation of workers across sectors in te economy, (b) cange in returns to labor by skill and occupation, (c) cange in te relative price of food and non-food consumption baskets, and (d) differentiation in per capita income/consumption growt rates across countries. Te final distribution is obtained by applying te canges in tese link variables to te re-weigted ouseold survey (bottom link in Figure 6). 11 Te detailed description of te metodology can also be found at ttp:// 16

19 Te data for te exercise is a combination of te 73 ouseold surveys described earlier in section 4.2 and more aggregate data on income groups (usually vintiles) for 25 ig income and 22 developing countries. Te final sample covers more tan 90 percent of te world s population (see Table 9 in Annex II for country coverage). Figure 6: GIDD metodological framework Population Projection by Age Groups ( Exogenous ) Education Projection (Semi- Exogenous ) Houseold Survey (new sampling weigts by age and education) CGE (Growt, New Wages, New Prices, Sectoral Reallocation) Simulated Distribution 5.2 Simulation Results In te baseline scenario, prices of agricultural products continue to rise modestly from teir 2004 levels, wit te total increase reacing nearly 5 percent above te OECD industrial exports price index (MUV) by Tis gradual rise in prices is driven partially by lower crop yields due to climate cange, partially by a re-orientation of te food consumption basket in developing countries to meats and more processed foods, wic raise te demand for feed grains and are tus less efficient in meeting caloric intake requirements, and partially by te lack of investment in agriculture due to years of declining prices. However, tis rise in agricultural prices is fully offset by a decline in te price of processed food were large productivity gains are realized in fast-growing developing countries suc tat te price of te agriculture and food bundle (at te global level) remains nearly constant trougout te model orizon. 17

20 Wen rising demand for biofuels is introduced into te model, agricultural producers dramatically accelerate te output of biofuel crops by sifting resources away from oter agricultural activities. Tis is illustrated in Figure 7, wic sows te contribution of eac agricultural activity in te model to te total increase in agricultural output. Te production increases vary substantially by country and type of grain (Table 5), wit te largest gains realized in countries wit relatively more abundant land, iger initial demand (e.g., te legislative mandates adopted in te US and te EU), and te existing penetration of biofuel tecnologies (e.g., Brazil is more competitive in sugar-base etanol tan oter producers). At te same time, te supply expansion is limited by te amount of additional land tat may be brougt under cultivation wic we assume is limited in te six-year orizon of te model as well as te additional labor tat may be attracted to te agricultural sector, wic is limited by te large and persistent wage gaps between rural and urban incomes in te developing world. 12 Terefore, output of oter agricultural goods suc as rice, oter crops, and livestock declines relative to baseline as farmers find it more profitable to focus on biofuels. Given tat many biofuels crops use land intensively, te returns to land rise substantially, ranging from above 40 percent in Brazil to just under 4 percent in Japan. Te returns to unskilled labor rise substantially less: for developing countries as a wole, unskilled wages increase by 11 percent wile land prices go up by 16 percent. Figure 7 Impact of biofuels on global agricultural production Percent difference in real output relative to baseline Rice Weat Corn Oil seeds Sugar cane Oter crops Livestock Agriculture Source: Simulations wit World Bank s ENVISAGE model. 12 In oter words, altoug iger prices of agriculture contribute to a faster closing of rural-urban wage gaps in developing countries (relative to te baseline scenario) and reduce te incentive to migrate at te margin, an average agricultural worker still finds it advantageous to move to an urban area were earnings tend to be muc iger. Tis labor market rigidity limits te supply response in developing countries. 18

21 Table 5 Biofuels impact on output prices and volume of select crops (percent cange in 2010 relative to non-biofuels scenario) Oter cereal grains Oil seeds Output price Weat Sugar cane and beet Agriculture Oter cereal grains Oil seeds Output volumes Weat Sugar cane and beet Agriculture United States Canada Japan Rest of ig income EU 27 and EFTA Cina Indonesia Rest of developing East Asia India Rest of Sout Asia Russia Rest of Europe and Central Asia MENA Energy exporters Rest of MENA Argentina Cile Brazil Colombia Mexico Peru Venezuela, R.B Bolivia and Ecuador Paraguay and Uruguay Central America Caribbean Sub Saaran Africa Hig income countries East Asia and Pacific Sout Asia Europe and Central Asia Middle East and Nort Africa Sub Saaran Africa Latin America and te Caribbean Developing countries World total Te increase in factor incomes is offset by a rise in consumer prices. Te world price of agricultural goods increases by 10 percent relative to te base year (2004) and by 5.6 percent relative to te baseline price in 2010, wile te price of agriculture and processed food rises by 2.2 percent. Te incidence of te price increases is eavily biased towards te poorer regions of te world (Figure 8). Tis is not particularly surprising, since te two poorest regions Sout Asia and Sub-Saaran Africa do not produce large amounts of biofuels but consume large amounts of grains. As a result of tis vulnerability, combined wit limited producer gains in tese regions, Sout Asia and Sub-Saaran Africa experience te largest welfare losses (in percentage terms) in te biofuels scenario (Table 6). 19