The Fiscal Role of Food Subsidy Programs

While food subsidies have led to considerable political debate, they have, for the most part, been subjected to only limited economic analysis. Nor has there been much effort to systematically categorize the importance of these subsidies in different countries. The growing interest in the methods of effecting income redistribution, particularly in developing countries, and the attempts to use food subsidies to insulate consumers from the recent exceptional rise in world food prices have, however, made this a subject of particular importance. Further, as a result of this rise in food prices, the financial cost of food subsidy programs has increased sharply, with implications for fiscal and monetary stability and the balance of payments.

Abstract

While food subsidies have led to considerable political debate, they have, for the most part, been subjected to only limited economic analysis. Nor has there been much effort to systematically categorize the importance of these subsidies in different countries. The growing interest in the methods of effecting income redistribution, particularly in developing countries, and the attempts to use food subsidies to insulate consumers from the recent exceptional rise in world food prices have, however, made this a subject of particular importance. Further, as a result of this rise in food prices, the financial cost of food subsidy programs has increased sharply, with implications for fiscal and monetary stability and the balance of payments.

While food subsidies have led to considerable political debate, they have, for the most part, been subjected to only limited economic analysis. Nor has there been much effort to systematically categorize the importance of these subsidies in different countries. The growing interest in the methods of effecting income redistribution, particularly in developing countries, and the attempts to use food subsidies to insulate consumers from the recent exceptional rise in world food prices have, however, made this a subject of particular importance. Further, as a result of this rise in food prices, the financial cost of food subsidy programs has increased sharply, with implications for fiscal and monetary stability and the balance of payments.

This paper discusses the problems of defining and measuring food subsidies (Section I), their efficiency as an instrument for achieving proffered objectives (Section II), and the financial and resource allocation costs that may be associated with their use (Section III). The emphasis is on schemes that have a significant aggregative impact and that are, at least in principle, aimed at benefiting the consumer rather than the producer. The analysis and problems are illustrated by reference to the food subsidy schemes employed in selected countries.1

I. Problems of Definition and Measurement

The problems of defining subsidies have been subject to extensive discussion in recent literature.2 A reasonably broad-ranging definition has been developed by Shoup:

… a government subsidy is a measure that provides to a firm or household in the private sector a financial advantage that is linked with a household’s or firm’s buying or selling some good or service or factor of production, including credit, and that is intended to increase, or to decrease, the purchase, sale, or use of that particular good or service or factor.3

This type of definition, and the analysis usually associated with it, emphasizes the role of subsidies as working through rather than supplanting the price mechanism. Subsidies are thereby distinguished from cash transfers and the free provision of public goods. It is often assumed that the role of subsidies is limited in relation to both the goods and factors covered and the proportion of the population eligible for the subsidy. The definition also emphasizes an “externality” or “merit good” type of justification for subsidies rather than any larger role as an instrument of income redistribution.

From the viewpoint of analyzing the fiscal role of food subsidies, this type of definition has several disadvantages.4 For a developing country in particular, the income redistribution to be achieved through food subsidies may be of primary importance. In this context it makes little sense to exclude the free distribution of food products. Also, a certain artificiality exists in distinguishing the budgetary effects of providing food at prices that are significantly below market prices and of giving it away free. If the use of food subsidies as an instrument to influence income distribution is to be analyzed, their income effects need to be given at least as much attention as their substitution effects. From this viewpoint, food subsidies might also be expected to be a rather more general instrument than is implied by the earlier definition.

In this paper, a food subsidy is considered as any policy measure that results, in the short run, in the direct lowering of the price of food items to certain groups of consumers in relation to what the price of these items would have been without a subsidy.5 This definition stresses certain effects of food subsidies and in doing so in part prejudges the main objectives of these subsidies.6 It also recognizes that in order to categorize a subsidy as benefiting the consumer rather than the producer or to consider its impact on any objective, it is necessary to consider market responses as well as initial legislative intent. The definition is sufficiently broad to encompass both explicit subsidies involving financial flows and implicit subsidies arising from government regulations and other factors.7

In current terminology, subsidies benefiting the consumer are referred to as food subsidies, and those applicable to the producer as agricultural subsidies. For a per-unit price subsidy, in a partial equilibrium framework, the incidence depends on the relative size of the price elasticities of supply and demand. In the standard analysis of the per-unit subsidy, the price advantage to the consumer is likely to be greater in direct relation to the inelasticity of demand and the elasticity of supply (U. S. Joint Economic Committee, 1972, p. 59). If the absence of market friction is assumed, this result holds irrespective of whether the subsidy is initially paid to the producer or the consumer of the product. For broad-based schemes, there is the familiar problem of the adequacy of partial as opposed to general equilibrium analysis. In order to use a partial equilibrium framework, it has to be assumed that the impact on demand and supply conditions in other markets, as well as feedbacks on the market for the subsidized commodity, can safely be ignored (Shoup, 1969, Ch. 1). Also, the method of financing the subsidy is assumed to have no important effects. These assumptions clearly will not hold where food subsidies represent a major instrument effecting income distribution.8

In practice, some qualitative distinctions can usually be made between producer and consumer subsidies on the basis of examination of the features of particular schemes. Subsidies on imported foodstuffs usually benefit the consumer, while those on exports normally accrue to the producer (Shoup, 1969, pp. 157–58). Agricultural subsidies are often accompanied by restrictions on output that effectively limit the elasticity of supply and ensure that the producer largely retains the benefit. More often, the subsidy schemes used in many countries entail considerably more government interference in the market mechanism than is implied in the simple incidence model. These schemes often involve government compulsory purchase at less than market prices with actual financial losses incurred on sales to the consumer. In such circumstances, this clearly represents a subsidy for certain groups of consumers rather than for the producers of subsidized food.

II. Objectives of Food Subsidy Schemes

This section considers the efficiency of food subsidies as instruments for achieving possible goals. Efficiency in this context means how food subsidies can achieve their purpose in a manner predictable for policymakers, how undesirable side effects may be limited, and what the overall benefits are that can be attained at a given cost. An assessment of food subsidies according to these criteria is most meaningful when their efficiency is compared with other potential policy instruments. The actual goals of food subsidies vary between countries and in any one country over time. These aims encompass political as well as economic factors, and the use of food subsidies is influenced by institutional constraints imposed on alternative policy instruments. In most countries, an important stated objective of food subsidies is to change relative prices in a manner that provides a desired redistribution of income. However, this leaves open the question of among what groups income is to be redistributed. A further common aim is to use subsidies to influence overall price stability. While this paper emphasizes these two objectives, it should be recognized that broad-based schemes inevitably have incidental implications for other macroeconomic and growth objectives. Discussion of the possible costs of food subsidies, including aggregate demand effects and any impact on production incentives, is largely postponed until Section III.

distribution of income

The theoretical arguments affecting food subsidies as an instrument of income redistribution are initially examined prior to an analysis of the relevant provisions of particular schemes. Except as otherwise stated, it is assumed that the desired redistribution of income is from rich to poor.

Theory

The assumptions of traditional welfare economics have led to a presumed superiority of cash transfers over price subsidies as a means of improving income redistribution.9 For a given increase in income, the cash transfer allows the consumer to adopt the commodity choices that provide the highest level of satisfaction. The same increase in income obtained through a subsidy requires that a different and, from the viewpoint of the consumer, inferior commodity choice be accepted.10 Also, the distortions in relative prices resulting from a subsidy can involve inefficiencies in production and waste in consumption.11 By analogous arguments, a food-stamp program would be superior to a price subsidy or in-kind transfer insofar as it allowed the consumer a wider choice of commodities.

A justification for subsidies over general income transfers is provided by collective or nonindividualistic preferences. The government might decide that it prefers to provide food rather than cash to poor families. This may be based not only on the “merit good” nature of food but on the potential advantage in providing for the redistribution of the benefit within the family and not merely to the head of household. The “merit good” argument would also serve as a justification for schemes that had improved nutritional standards as the major objective. From the nutritional viewpoint, the emphasis is on the effectiveness of subsidies in increasing consumption of foods with a high nutritional value. For a price subsidy, the choice of commodities subsidized becomes relatively important, as do any substitution effects generated by the change in relative prices. In these circumstances, a food-stamp program that allowed a wider choice of foods might be considered the inferior instrument. Similarly, if the consumer was thought to have a relatively low marginal propensity to consume for goods with a high nutritional value, a simple income transfer may not be favored.

The foregoing analysis compares food subsidies with a lump-sum transfer that is assumed “neutral” in its impact on relative prices in the economy. The practical alternatives to food subsidies may, particularly in developing countries, themselves have considerable limitations. The alternative to expenditure on food subsidies may involve other measures distorting prices in factor or commodity markets, such as wage or capital subsidies, incentives to particular industries, or interference in the pricing policy of public corporations.12 Even if it were decided that some form of negative income tax was a preferable means of redistributing income, there might well be significant administrative problems in introducing such a scheme.13 Also, under certain assumptions the practical effects of food subsidies and cash transfers are similar. Where the marginal propensity to consume and the price elasticity are near one, food subsidies, in-kind transfers, and cash transfers have very similar effects (Reutlinger and Selowsky, 1975, p. 70). This may represent the situation where an attempt is made to aid the poorest groups in certain developing countries. Also, to the extent that food subsidies do not change the consumption of a commodity, they act effectively as an income supplement.

A further general problem relates to the degree of specificity that should be employed in food subsidy programs. An important deterrent to generalized measures is, clearly, cost. The smaller the size of the group to be affected within the total population, the less efficient are generalized measures as opposed to programs aimed at specific groups.14 The target-group approach to alleviating poverty has been emphasized in a recent study by Chenery and others (1974, especially Ch. V). Problems arise, however, in the identification of the relevant homogeneous groups and the prevention of leakages between markets.

Estimated effects

Substantial problems are experienced in any attempt to provide a quantitative appraisal of the impact of food subsidies on income distribution.15 As already indicated, the emphasis on subsidies with a substantial macroeconomic impact precludes the standard partial equilibrium analysis of incidence. A reasonably full analysis would involve such factors as the behavioral response (by income group) of consumers, the impact on different producers’ incomes, and the secondary effects through supply and employment. In addition, the impact of the methods of financing the subsidy would need to be considered. Mellor (1975) uses Indian household income and expenditure data to analyze the possible impact of an increase in relative agricultural prices. The study implies that because of the weight of food items in the expenditure patterns of the poor, the latter will lose most by this measure, while large producers with significant marketable surpluses will gain relative to small units. The change in relative prices assumed in this type of study does not necessarily correspond to the pattern resulting from actual food subsidy schemes. Some qualitative appraisal of the possible impact of such schemes may be obtained by viewing the restrictions placed on the eligibility for benefits and the type of commodities subsidized.

An indication of the criteria used to distribute subsidized food in the countries analyzed is provided in Table 1.16 Most of the schemes are not universal in effect and provide for some statutory or informal rationing. Formal rationing is on a per capita basis, which provides some differentiation by family size. Apart from family size, the most common form of restriction relates to region.17 There is a clear preference for using food subsidies to provide aid for the larger urban centers. In Bangladesh, the statutory rationing areas are restricted to five urban centers, while in Sri Lanka an additional ration is available in urban and deficit areas. Other countries exhibit preference toward urban areas through more informal means. In Pakistan, subsidized food is sold through official ration shops, and the location of these facilities is for the most part restricted to the larger urban centers. Similarly, in Egypt, the largest subsidy in budgetary terms is on wheat, which benefits for the most part the urban population, as maize is the staple foodstuff in rural areas.

Table 1.

Selected Countries: Distribution of Subsidized Food

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Sources: Food and Agriculture Organization (1975), Kaur (1975), and national sources.

Schemes with formal rationing differentiate according to family size.

Rural areas according to amount of tax payments, urban according to income. Supplies in nonstatutory areas vary according to overall availability.

Where not otherwise provided for.

Achieved through restriction of rationed rice to members of cooperatives.

Wheat consumed largely in urban areas.

The Government distributes lower-quality rice.

Introduced in 1976, and exchangeable for money.

Armed services and central and regional government employees. In rice surplus areas, these wages are generally exchanged for money.

Subsidized rice and barley sold in mixed bags to encourage consumption of the latter.

Informal rationing through availability.

A further important criterion for eligibility relates to employment. To a large extent this tends to complement the urban bias of many food subsidy schemes. In Bangladesh, certain public sector employees are designated priority consumers and are entitled to subsidized food even if they are not otherwise covered by the rationing system.18 Indonesia provides food as in-kind wages to the army, government, and state enterprise employees. In large part, this reflects a response to earlier periods of very rapid inflation in that country. Since 1974/75, a direct “food-for-work” program has been in operation in Bangladesh. In Mali, there is informal rationing through availability to the benefit of urban public employees (Shepherd, 1976).

There is little formal attempt to differentiate food availability according to income. Sri Lanka restricts the free ration to persons not paying income tax, but as nearly all the population is in this category, the level of discrimination is limited.19 In Bangladesh, potential recipients in nonstatutory areas are divided into categories according to tax payments or income, and a ration is provided only to the poorest categories. The United States and Thailand link the availability of food stamps to income.20 It is also noticeable that, except for emergency relief, most schemes involve some payment, which might be a limitation for the poorest groups. This may be particularly true for ration or food-stamp schemes involving some lump-sum payments.

The emphasis on urban populations could be defended as providing identifiable target groups that can most conveniently be aided by food subsidies. If, however, benefits are provided at the cost of the agricultural population, this needs to be seen in the context of evidence for many countries of the relative poverty in rural areas.21 Further, when restrictions effectively limit benefits to the urban employed, then it might be more appropriate to consider these food subsidies as a form of in-kind wage supplement.22 To the extent that food subsidies allow lower urban wages, the immediate beneficiaries are the employers rather than the direct recipients.

A further problem relates to the policing of access to subsidized sales. Such factors as forged ration cards, hoarding, and internal and external leakages to more profitable markets are common in several countries. Smuggling appears to be a particular problem for countries bordering on India. In this situation, the actual beneficiaries of subsidies may be the foreign instead of the domestic consumer.

The distribution of benefits is affected not only by restrictions placed on eligibility but by the characteristics of the commodities subsidized.23 A food subsidy redistributes income according to the pattern of expenditure that consumers make on the subsidized commodity. If the program is aimed at low-income groups, the commodities subsidized should be relatively important in the budgets of the poor; that is, they should have a low income elasticity of demand. For most countries, estimates of this kind are not available for the subsidized commodities.24 In general, the commodities chosen appear to reflect the staple consumption items in each country, with various cereals, sugar, and edible oils most often subsidized. Further, the low quality of the subsidized food provided often serves to differentiate the consumption patterns of rich and poor.25 There are, however, some anomalies. The subsidies on imported wheat in Zambia probably accrue largely to those with higher incomes, while it seems questionable to justify subsidies on such commodities as butter, cheese, and tea in the United Kingdom purely on grounds of income redistribution.26

price stability

The definition of subsidies adopted for this study indicates that they are intended to reduce the price of specified items to certain groups of consumers.27 In some countries, this reduction in price is considered important not only insofar as it affects relative prices and, thereby, income distribution but as an instrument for achieving overall price stability. This approach may be examined under various headings: the effect on the level of prices, the rate of inflation, and the variability of prices.

The effect on the level of prices depends on the weight of the subsidized items in the consumer price index. The more important the subsidized items in the index, the greater is the impact of a given subsidy on the level of prices. The weights of subsidized commodities in the consumer price index of selected countries are indicated in Table 2.

Table 2.

Selected Countries: Weight of Some Subsidized Items in Consumer Price Indices

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Sources: National statistical bulletins.

An obvious problem is how far the available consumer price indices are, in fact, indicative of actual price levels. In many countries, the weights may come from outdated expenditure studies, or the index may apply only to a limited (often urban) segment of the population. Further, problems may arise when subsidies lead to dual-pricing systems and only the lower (rationed) price is reflected in the index. Insofar as the reduced price level involves a significant degree of nonprice rationing, the impact on measured price rise is somewhat illusory, as actual is replaced by suppressed inflation. These problems are illustrated by the available data for Sri Lanka, where the Colombo price index reflects weights based on 1952 expenditure patterns and covers less than 5 per cent of the population. Also, the official rather than free market prices for food are used, with rice actually represented by the free ration.

Even if the available index is accepted as realistic, there are several steps involved in translating an effect on the level of prices into an impact on the rate of inflation. A given subsidy payment may have an initial once and for all effect on the level of prices while leaving the subsequent increase in prices unchanged.28 In order for there to be an impact on the rate of inflation, there has to be some mechanism whereby the initial reduction in the price level itself leads to subsequent further falls or retardation of the rate of increase. Such mechanisms could be provided by wage reaction or expectation theories of inflation. The wage reaction might be formalized in terms of indexing to the cost of living or in policy packages in which wages and subsidies are two elements.29

Against these effects, however, should be set any net aggregate demand impact of subsidies. This impact will depend on the method of financing the subsidies and the relevant marginal spending propensities of those providing and receiving the transfers. Insofar as the transfer is from rich to poor, it may be expected that the aggregate demand effects will be positive. The overall impact on inflation then becomes uncertain and depends on the relative weights of the expansionary impact through aggregate demand and negative effects from expectations.

A further objective might relate to limiting the variability of food prices. As is well known, the combination of inelastic demand and supply and natural factors affecting production can lead to considerable instability of food prices (Tomek and Robinson, 1972, Ch. 8). One response to this situation has been to build up buffer stocks that can be used to withdraw and to inject supplies into the market to counteract exogenous factors affecting prices. Except where it is necessary to build up initial stocks, this should not lead to any secular subsidy. In fact, in several countries the buffer stock element has tended to be outweighed by government intervention to subsidize certain groups.30 For countries dependent on imported food, an additional element of instability is added. World food prices have, in recent years, been both unstable and difficult to predict, reflecting limited international reserves and the strong impact of a few large buyers (Khatchadourian, 1976). Some countries (e.g., Morocco) justified the subsidies on imported food during the period 1972–74 on the basis that they were attempting to price according to the long-term level of international prices. An obvious difficulty here is identifying the long-term price that would not lead to a secular subsidy. This policy should, at least in principle, be distinguished from the secular objective of insulating the domestic consumer from world market prices.31

III. Some Costs of Food Subsidies

This section attempts to provide an analysis of the various types of cost associated with food subsidy schemes. Three forms of cost are distinguished: the domestic financial cost, the balance of payments effect, and the implications for production incentives.

domestic financial cost

The measured cost of food subsidies represents only a partial indicator of their economic cost. This reflects not only limitations in the quality of data but also, for some countries, inadequate allowance for the shadow price of resources or presentation of information for organizational units that aggregate items making a profit and a loss.32 While this certainly argues for caution in interpreting budgetary losses, such measures remain important as an indicator of pre-emption of resources and possible financial impact. A more prosaic reason for looking at the financial cost of food subsidy programs is that this is often the only measure available.

Budgetary cost

Table 3 provides summary indicators of the budgetary cost of food subsidies in selected countries. The data are presented as a percentage of total expenditure (current plus capital), emphasizing the impact of food subsidies on the structure of government spending. An alternative would have been to present the cost in relation to government revenue, emphasizing the share of this source of finance pre-empted by food subsidies. Only where there was a substantial overall deficit would this have much impact on the measured share. It can also be argued that, insofar as nonrevenue financing is specifically linked to expenditure on food, the share of revenue would exaggerate the pre-emption of resources.33

Table 3.

Selected Countries: Budgetary Cost of Food Subsidies, 1972–751

(In per cent of total expenditure)2

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Sources: National budget documents.

Full data were not available for India, Mali, Tanzania, or Zambia. The budgetary implications of food subsidies in Mali are discussed in the text. Food subsidies in Tanzania were approximately 9 per cent of total expenditure in 1974, while those in Zambia were about 6 per cent of the total in both 1974 and 1975. U.K. food subsidies were about 1 per cent of total expenditure in 1975, while the U.S. food-stamp program has represented less than 0.1 per cent of the total.

Central government expenditure, except for Burma where the consolidated public sector expenditure is used. The data for Pakistan exclude provincial government expenditure on food subsidies, which was equal to about 5 per cent of their expenditure in both 1974 and 1975. For Egypt, total expenditure excludes emergency fund spending linked to defense.

Provisional.

Fiscal year ended June 30.

Fiscal year ended September 30 up to 1973; the 1974 fiscal year was October 1, 1973-March 31, 1974; the 1975 fiscal year ended on March 31.

Fiscal year ended March 31. Excludes in-kind wage payments.

Even allowing for the necessary reservations as to the quality of the data, this table emphasizes the budgetary importance of food subsidies in several of the countries surveyed. In Egypt, Korea, and Sri Lanka, food subsidies accounted for as much as one fifth of total expenditure in 1974 or 1975, while several other countries devoted approximately one tenth of expenditure to this component. The pre-emption of government expenditure by food subsidies should be viewed with particular concern insofar as sources of revenue are limited, and the government sector is expected to play a large part in the development effort.34 The large share of food subsidies in total expenditure in developing countries may be contrasted with the limited quantitative importance of these subsidies in most industrialized countries. Despite its growth in 1975, the U. K. food subsidy program accounted for only about 1 per cent of total expenditure, while the U. S. food-stamp scheme accounted for only about one tenth of this amount.

In 1972–75, there was a marked increase in the budgetary cost of food subsidies. This can be related to the price and quantities of food purchased and distributed. For many countries the primary factor was the exceptional increase in the price of imported food. The increases in world market prices for some of the major subsidized items are indicated in Table 4.

Table 4.

Selected Subsidized Foods: Index of Export Prices, 1973–75

(1972 = 100)

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Sources: Khatchadourian (1976); Commodities Division of the Fund’s Research Department.

Roman numerals indicate quarter.

U.S. No. 1, hard red winter, ordinary protein, f.o.b. Gulf ports.

Thai, white, 5 per cent broken, f.o.b. Bangkok.

U.S. No. 2, yellow, f.o.b. Gulf ports.

Free market price.

Soybeans.

The price of wheat and maize almost tripled between 1972 and the peak in 1974, while the price of edible oil more than doubled over the same period. Rice and sugar prices quadrupled by the second quarter of 1974 and the start of 1975, respectively. Although commodity prices began to decline in 1975, this was not necessarily immediately reflected in the size of the subsidy, owing to the lagged effect of food contracted for in 1974 but delivered in 1975.35 For the same reason, these indices need not correspond generally to the movement of prices in any given country.36

Table 5 presents data on the relationship between the domestic selling price and the import or domestic procurement cost in selected countries. Insofar as the prices are unit values and inclusive of all costs, a ratio of less than 100 indicates a per-unit subsidy. In practice, however, all costs are not always included, and, in particular, information on handling and administrative costs are usually deficient.37 Nevertheless, the year-to-year movements in the ratio serve to indicate the response of domestic prices to recent increases in costs. In most countries surveyed, domestic selling prices did not keep pace with the rapid rise in import prices. For some countries (e.g., Bangladesh and Mali), the financial costs of the higher import prices were further exacerbated by poor domestic supply conditions. To a lesser extent there were also examples of increases in the subsidy on domestic procurement. In part, the higher payments for domestic crops may be seen as a further reaction to the increased cost of importing food. For many countries, these declining ratios reflect delayed or inadequate adjustments of domestic selling prices rather than the absence of any adjustment at all. Also, in some countries restrictions on the amount of food offered at the subsidized price or various forms of dual-pricing systems were introduced.38

Table 5.

Selected Countries: Indicators of the Response of Food Subsidy Schemes to Import and Domestic Cost Increases, 1972–751

(In per cent)

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Sources: Information obtained by Fund staff from national sources.

The correspondence between fiscal and calendar years is as indicated in Table 3. Prices are unit values, and costs exclude administration and handling expenses unless otherwise indicated.

Provisional.

Rationed sugar only.

Sales index refers to Jakarta and Thai milled rice, 5 per cent broken kernels, f.o.b. Bangkok used as indicator of import price.

Ration prices used for sales. This substantially underestimates the per-unit subsidy, as it takes no account of the free ration. Figures in parentheses indicate ratios when import prices are adjusted to the more depreciated Foreign Exchange Entitlement Certificate rate.

Includes handling costs.

Sources of finance

Insofar as the subsidy is channeled through the budgetary system, it is usually neither possible nor particularly meaningful to try to isolate the exact sources of finance. At any point of time it becomes a policy decision whether, in the event of a change in the subsidy, any particular revenue item should be altered or in what form recourse to financing should be changed. This situation usually prevails even if the food subsidy is channeled through some extrabudgetary fund and separate sources of finance are indicated within these accounts.

The specific source of finance becomes relevant when it is likely to affect the size of the subsidy or the pricing or tax policy pertaining to another commodity.39 This not only leads to the possibility of additional distortions in resource allocation but also vitiates any system of expenditure control. Mali provides a good illustration of this type of problem. The financial subsidy is reflected in the loss of public enterprises and does not enter the budgetary system. For the most part, finance is acquired through direct access to the banking system, thereby bypassing the statutory limitation on government borrowing from the Central Bank. Since 1972, losses on food items have been a major factor in increased credit to the economy.40

A further form of financing that warrants particular attention is through funds generated by foreign food aid.41 For the sake of simplicity, it is assumed that the food is provided in the form of a grant or loan with no immediate costs. This aid can provide the basis for a domestic food subsidy program. Ignoring administrative and handling costs, the food could be given away domestically and the financing would come from international aid. If correctly accounted, the budget would show as food subsidy expenditure the implicit value of the food with the loan or grant from abroad entered as finance. To the extent, however, that the implicit value of the food is not shown as an expenditure item, this leads to an underestimation of the size of the subsidy. Even though the aid is given in the form of food, unless it is tied to this purpose, there is no necessary reason why it should be used to subsidize domestic food sales.42 If the food is sold at full market value, this generates counterpart funds that, within the limits imposed by any agreements, can be used to finance other expenditure.43 To the extent that food aid is used to subsidize domestic sales, the opportunity cost is the expenditure that could otherwise be generated by the counterpart funds resulting from the sale of the food at market prices.44 Although from a budgetary viewpoint food aid need not be tied to domestic food subsidies, for countries with a foreign exchange constraint, the availability of food on concessional terms considerably eases the balance of payments problems of importing to support a food subsidy program. Concomitantly, the reduced availability of aid in recent years has significantly increased the cost of maintaining subsidy schemes based on imported food.

balance of payments

The importance of various subsidized food items in total imports is illustrated in Table 6.45 It is clear that for most of these countries the necessity to import food has pre-empted a substantial share of available foreign resources, while the increased price of these imports tended to exacerbate the problem during the period 1972–74. This latter occurrence can be seen more directly when related to exports, where for countries with deteriorating terms of trade (e.g., Bangladesh and Sri Lanka) the pre-emption of foreign resources rose to exceptional levels.46 For some countries (e.g., Bangladesh, Mali, and Pakistan), aid provided a substantial part of the finance, although as previously indicated, in general the availability of food on concessional terms declined during this period.

Table 6.

Selected Countries: Food Imports and the Balance of Payments, 1972–75 1

(In per cent; X = value of exports, M = value of imports)

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Sources: National foreign trade statistics.

The correspondence between fiscal and calendar years is as indicated in Table 3.

Provisional.

Year ended March 31.

Includes beverages and tobacco.

In some forms of food subsidy schemes, imports may effectively become a residual item. If the government sets consumer prices at a level where there is excess demand, then available supplies must be shared by nonprice-mechanism rationing or supplemented by imports. Several countries not only set the price of subsidized food items but also try to ensure free availability at that price or specify the size of the ration at amounts greater than available domestic supply. Further, the problems of excess demand are often exacerbated by low prices for domestic purchases.47 There are definite elements of this mechanism in Sri Lanka, where the Government sets the domestic purchase price of paddy and determines the amount and price of rice available on the free and paid ration. To the extent that the quantity and price decisions are adhered to, and ignoring variations in stocks, rice imports may become an essentially residual item. Also, the foreign exchange allocation system emphasizes the importance of food imports by giving them priority in the process of rationing foreign exchange.48

The residual nature of food imports is not a necessary feature of food subsidy schemes. The required amount of food imports can be changed by altering the domestic buying or selling price or the ration available to the consumer. There is, however, a trade-off between the alteration of these factors and the amount of imports. The recent exceptional rise in international food prices implied a substantial change in the terms of this trade-off. The resource cost of measures that affect the relative price of domestic and international procurement and sale were similarly increased. While such measures are best discussed as resource allocation costs, it should be noted that export restraints, dual exchange rates, and measures affecting domestic procurement prices may also have a substantial balance of payments impact.

production incentives and resource allocation

Food subsidies financed by the fiscal or monetary system have implications for resource allocation and production incentives according to the particular tax or monetary instruments used. However, in addition to explicit cash subsidies, many countries have various forms of implicit subsidy, owing to government measures to directly alter relative prices for the benefit of the consumer.49 A common form of such implicit subsidy occurs when the government uses its purchasing or regulatory power to force a direct transfer from the food producer to the consumer.50 Such practices are seen particularly where, as in many developing countries, the government plays an important role in the purchasing and marketing of subsidized food.

Even if the subsidy scheme operates through the government (or its agent) purchasing the food and then providing for its sale at a lower price, this need not necessarily affect producer prices. The important factor here is that the government should purchase domestically in a free market.51 There are, however, several reasons why domestic producer prices are usually affected by these subsidy schemes. In particular, there is a direct trade-off between the financial cost of the subsidy and the price paid for the product to the domestic producer.52 There is clearly a temptation to reduce the cash cost by placing part of the burden on the producer. Further, where market circumstances or systems dictate significant government interference in the market, it might be difficult to know what the free market price would otherwise have been.

Depressed producer prices are usually enforced by various forms of compulsory government purchase. An indication of such measures in selected countries is provided in Table 7. Several countries requisition part of the crop of essential food items. In Egypt, the general principle adopted in the pricing of such items is to work backward from the socially determined consumer price to the producer price (Food and Agriculture Organization, 1973, pp. 1, 2, and 10). Other countries have sufficient monopsony power to provide low-priced produce to the consumer without explicit cash transfers. This occurs in Mali, where the Government sets the producer price and then works up to the consumer price in a manner that, at least in principle, should not lead to any overt subsidy. Restrictions on interregional transport in many countries (e.g., India and Indonesia) are used to support government procurement objectives.

Table 7.

Selected Countries: Factors Affecting Domestic Procurement and Production Incentives

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Sources: U.S. Comptroller General (1975); national sources.

A particular example of the depression of domestic producer prices to the advantage of the consumer occurs with export crops. In several countries (e.g., Burma, Nepal, and Thailand), mechanisms have evolved for insulating the domestic consumer from export price developments by diverting to the domestic market part of the crop that would otherwise have been exported. Such mechanisms include government monopoly purchase at prices below those of the world market, and levies and taxation on export crops.

A further form of government intervention affecting domestic market incentives is to subsidize imports. Such imports change the relative price to the consumer of domestic and internationally procured crops as well as increasing the total food supply on the market. Dual exchange rate systems represent a particular example of such price distortions. In Sri Lanka, a de facto dual exchange rate exists, with imports of flour and rice costing 65 per cent less in local currency than items imported at the depreciated rate. Valuing food imports at the depreciated rate would more than double the measured subsidy.53

Implicit subsidies from the producer to the consumer cannot be easily assessed. In principle, the subsidy should be measured as the difference between the price the producer would have received on the free market and the amount actually paid. As already indicated, where there is significant government intervention, a measure of this notional free market price might not be readily available. When a parallel free or black market price does exist in the country, this provides some guidance as to the opportunity cost of governmental food purchase. If, however, the government takes a substantial portion of the crop, this will affect prices in the truncated free market and a black market price will incorporate a risk premium. Alternatively, where there is actual or potential international trade, the export or import price may provide some guide to the relevant shadow price. Some indicators of implicit subsidies are provided in Table 8, where the ratios of domestic purchase costs to possible shadow prices are indicated. To the extent that the shadow price is accepted as the relevant one and the coverage of the data is adequate, a ratio of less than 100 is indicative of an implicit subsidy. In practice, both the choice of shadow price and the quality of the data are subject to challenge. Nevertheless, the decrease in this ratio in recent years suggests that in several countries there has been a significant increase in the importance of these types of implicit subsidy.

Table 8.

Selected Countries: Indicators of Implicit Subsidy, 1972–751

(In per cent)

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Sources: Information obtained by Fund staff from national sources.

The correspondence between fiscal and calendar years is as indicated in Table 3. Prices are unit values, and costs exclude administration and handling expenses.

Provisional.

Export price to Tanzania.

Coarse rice.

Import price for rice adjusted to the more depreciated Foreign Exchange Entitlement Certificate (FEEC) rate.

The complex of input subsidies and explicit and implicit taxation applicable to agriculture in many countries makes difficult any unambiguous assessment of the overall impact of government policies on producer prices. Also, under certain circumstances, government compulsory procurement of part of the crop, with the rest sold on the free market, might not leave the producer with a lower average price.54 There seems, however, to be reasonable evidence that in many developing countries there has been recourse to depressed producer prices as a means of financing consumer subsidies. For many countries, empirical evidence is strongly suggestive of a significant supply response to producer prices.55 Particularly in the long run, the concomitant reduced availability of food has considerable implications for domestic consumers and the balance of payments.

IV. Conclusions

The paper has analyzed the role of food subsidy programs in selected countries. Emphasis has been on providing information on the various forms of food subsidies used and assessing the efficiency and costs of the different types of scheme as instruments for achieving possible objectives. In particular, the role of food subsidies as a major tool for income redistribution has been analyzed. From a theoretical viewpoint, the standard arguments on consumer choice, with some reservations, are for cash rather than in-kind transfers. It can, however, be maintained that, for reasons of both cost and administrative convenience, food subsidies, particularly in developing countries, may represent an efficient instrument for influencing target poverty groups. A review of the provisions of actual schemes raises considerable doubt as to how far they are consistent with the achievement of such objectives. Few schemes affect those too poor to purchase at the subsidized price, while many seem to provide a “back door” method for raising the wages of the urban employed.

In assessing whether a generalized food subsidy may be an appropriate instrument for affecting the rate of inflation, the distinction between the impact on the level and rate of change of prices becomes important. For food subsidies to affect the latter, there has to be either expectations or wage adjustment reactions to the initial drop in prices. Also, the aggregate demand effects of financing the subsidy need to be set against any reduction of inflation from such factors. The proper instrument for reducing the variability of prices is a buffer stock scheme. However, many supposed buffer stock schemes, in recent years, have effectively involved substantial subsidies. In part, this arises from the extension of the price stability argument to attempts to insulate the domestic consumer from violent swings in international food prices. While it may be reasonably argued that domestic prices should not follow every change in international markets, many schemes appear to be trying to stabilize at a medium-term price that might involve substantial secular subsidies.

A distinction can be made between the financial costs involved in subsidies and those arising from distortions in resource allocation. The financial cost of food subsidies as measured by budgetary, monetary, or balance of payments data has increased considerably in recent years. This reflects the failure to pass on in full to the domestic consumer the very large rise in import prices and, to a lesser extent, increased domestic costs. In several countries, food subsidies have become one of the largest components of government expenditure. This also reflects a tendency for food imports to become an effective residual in schemes that attempt to set both domestic prices and the supply available to the consumer.

Food subsidy schemes need not necessarily affect the level or structure of production incentives. Nevertheless, insofar as reduced payments to the producer limit the direct financial cost of food subsidy schemes, the temptation exists for some form of compulsory procurement at less than market prices. The presence of large-scale subsidized imports also affects the free market price. In practice, the degree of government intervention and the complexity of subsidies and taxes mean that it is almost impossible in some countries to distinguish the overall effect on domestic incentives. Insofar as food subsidies reduce supply, there may be a trade-off between the increase in short-run and long-run benefits to the consumer.

Further research on food subsidies should concentrate on case studies of individual countries. Emphasis might be given to analyzing, in a given country, the differential efficiency of food subsidies and other instruments for redistributing income. In particular, studies are needed of the practical limitations of substituting for large-scale food subsidy schemes either cash transfers or small target-oriented programs. In analyzing the effects of present schemes, further use could be made of consumer expenditure surveys to provide some indication of the distribution by income groups of the benefits of food subsidy programs. Any large-scale study of income redistribution effects should incorporate implicit subsidies and allow for any impact on producer prices and incomes in the rural sector. Econometric analysis of the effects of food subsidies on the rate of inflation, while relevant, may be expected to encounter significant empirical problems.

APPENDIX

Table 9.

Organizational Aspects of Food Subsidy Schemes

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P.E. = public enterprise.

Budan Urusan Logistik.

Office des Produits Agricoles du Mali (OPAM); Société Malienne d’Importations et d’Exportations (Somiex); Société d’Exploitation des Produits Oléagineux du Mali (SEPOM). (See also footnote 40 in the text.)

Caisse de Compensation (Price Stabilization Fund—PSF), and Office National Interprofessionnel des Céréales et des Légumineuses (ONICL).

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*

Mr. Davis, economist in the Fiscal Analysis Division of the Fiscal Affairs Department when this paper was prepared, is currently in the English Division of the IMF Institute. He holds degrees from the Universities of York and Manchester, England, and has written several articles in the field of public finance.

The author wishes to acknowledge the information provided by colleagues specializing in the countries discussed. The views expressed and any errors remain solely the responsibility of the author.

1

Countries were selected on the basis of availability of data and the need to illustrate a variety of schemes. For the most part, Asian and African countries are discussed. A full list of the countries covered and of the main commodities subsidized is provided in the Appendix.

3

Shoup (1972), pp. 307–308.

4

Some more general criticisms are given in Prest (1974), pp. 21–22.

5

This represents a modification of the definition used by Gottlieb (1958), p. 42.

6

The objectives of food subsidies are discussed in Section II.

7

This distinction is elaborated in Section III.

8

A further problem, which can be dealt with satisfactorily only in a general equilibrium framework, is the treatment of subsidies on intermediate goods, such as fertilizers. Subsidies on intermediate goods are not discussed in this paper.

9

This is the analogue of the more usual discussion of direct versus indirect taxes.

10

In terms of the Pareto optimality conditions, the subsidy interferes with the necessary condition that the marginal rate of substitution of any two products in consumption equals the marginal rate of transformation in production, equals relative prices. The traditional arguments against in-kind transfers can be challenged even within the framework of maximization of utility based on individual preferences. Buchanan (1968) has pointed out the inconsistency of taking account of the individual preferences of the recipient, but not of the donor, of income transfers. A general model incorporating taxpayers’ and beneficiaries’ preferences is developed by Garfinkel (1973).

11

Clarkson (1975, Appendix B) attempts to distinguish three effects of bonus food stamps—general purchasing power, specific purchasing power, and waste. He estimates that $1.00 worth of bonus food stamps has a value to the recipient of only $0.82.

12

See Chenery and others (1974, Ch. IV) for a general discussion of different methods of redistributing income in developing countries.

13

The limited scope of income tax in many developing countries may be indicative of this. One justification presented for food subsidies in the United Kingdom is the difficulty of increasing the claimant rates for social security benefits.

15

It should not, however, be suggested that these problems are any more severe than for other categories of government expenditure. See De Wulf (1975).

16

Measures aimed at disaster relief are not discussed.

17

Further differentiation in the size of the subsidy by region occurs insofar as price differentials are not allowed to reflect variations in costs. This occurs in Indonesia, Mali, and Tanzania.

18

Hospitals, prisons, orphanages, and employees of large works are also in this category.

19

The free and paid rations are also available to farmers.

20

A further restriction, which has the greatest effect on higher-income groups, is dual-pricing schemes. In some countries a basic ration is provided at a subsidized price, while further amounts are sold at higher or even profitable prices, for example, sugar in Sri Lanka and tea and sugar in Egypt. More generally, if there is rationing, a transfer may occur between those receiving the ration and those forced to do without or to buy at free or black market prices.

21

See, for example, evidence presented in the Food and Agriculture Organization study on Egypt (1973). Chenery and others (1974) suggest that as many as three fourths of the poor may be located in rural areas. A discussion of the possible relationship between food subsidies and domestic agricultural prices is provided in Section III.

22

The earlier comments on the relative merit of income and in-kind transfers would hold equally for wage payments.

23

See the Appendix for the main commodities subsidized in the countries surveyed.

24

It has been estimated for Sri Lanka that in January and February 1973 those with monthly incomes of less than SL Rs 200 a month had their income increased by free and subsidized food by 14 per cent, while for those in the highest-income groups the comparable rise was 1 per cent (Central Bank of Ceylon, 1974). Even if the poor receive the greatest percentage increase in income, the largest absolute rise may still accrue to the rich.

25

For example, the rice officially distributed in Nepal and Pakistan is meant to be of a lower quality than that available on the free market.

26

In some countries the choice of subsidized commodities (e.g., sugar) may not be consistent with maximizing nutritional impact. For the United States, it has been suggested that the food-stamp program may have encouraged consumption of convenience foods rather than of nutritious foods (Clarkson, 1975).

27

An exception would be a per-unit subsidy paid to the consumer, which would normally lead to some increase in price. See U. S. Joint Economic Committee (1972), p. 61.

28

U. K. calculations, based on the weights of the subsidized items, indicate that in December 1975 the savings on the food and retail price indices were 5.7 percentage points and 1.4 percentage points, respectively. Between January and December of that year the points saved actually fell, so that it could be argued that during the year food subsidies had no beneficial effect on the rate of inflation.

29

Gottlieb (1958) discusses the relationship between consumer subsidies and wage indexing. Pakistan and Sri Lanka have, in recent years, introduced several policy packages involving simultaneous changes in subsidies and wages.

30

See Okonkwo (1975) for a study of price stabilization in Indonesia.

31

This provides a justification for subsidies not only for food importers but also for such exporters as Nepal and Thailand.

32

Implicit subsidies arising from inadequate definition of costs are discussed in production incentives and resource allocation (later in Section III).

33

Bangladesh provides an example of this type of situation. The share of food subsidies in revenue was 37 per cent, 26 per cent, and 15 per cent in 1973, 1974, and 1975, respectively.

34

In this context, a comparison between the budgetary importance of food subsidies and capital expenditure might be of interest. The classification of capital expenditure has a considerable arbitrary element, while the impact of this form of investment on growth remains a matter of debate. From national budget data, the ratio of food subsidy to capital expenditure in 1974 and 1975 is as follows:

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35

The lagged effect of earlier contracts also explains why Burma made losses on export sales in 1973/74.

36

Differences in transport costs and sources of imports also affect relative prices in different countries.

37

These costs also tended to rise over the period surveyed because of the impact of higher petroleum costs on transport charges.

38

Sri Lanka, for example, made substantial adjustments in the food subsidy scheme in October 1973. Over the period 1970/71–74, the quantum distribution of rice and sugar declined by 43 per cent and 65 per cent, respectively. See Central Bank of Ceylon (1975), p. 183.

39

The relevant point here is that cross subsidization not only disguises the size of the subsidy but also presents the possibility that the purchase price on a profitable item or earmarked revenue may be adjusted to offset losses on food sales.

40

Food subsidies in Mali are for the most part channeled through three public enterprises—Somiex (Import and Export Company of Mali), OPAM (Agricultural Marketing Agency), and SEPOM (Malian Oil Processing Company); see the Appendix for the names of these enterprises in French. These accounted for nearly three fourths of the total credit increase in both 1973 and 1974. Further, there appears to be a significant amount of cross subsidization within these enterprises. See Shepherd (1976).

42

Even if the aid is formally tied, to the extent that it replaces programs that would have existed in any event, funds are released for other uses.

43

These funds are temporary as long as the aid is repaid.

44

There may also be implications for domestic production incentives.

45

For an earlier account of this problem, see Ridler and Khatchadourian (1974).

46

The consequent balance of payments problems were exacerbated by the increases in oil prices.

47

Both through effects on total supply and the share procured by the government.

48

These mechanisms are discussed in Kelly (1976).

49

Tax subsidies would represent another example of this type of measure.

50

For a discussion of explicit and implicit taxation of producers, see Bhatty (1975)

51

In Korea, for example, the Government does not have monopsony power in its domestic purchases, and there is a substantial free market.

52

See Government of India (1975) for an explicit recognition of this trade-off.

53

Another example of this type of problem is in Colombia, where it has been estimated that the official exchange rate underestimates the shadow price of imported wheat by about 40 per cent (Dudley and Sandilands, 1975).

54

This might occur if the reduced amount entering the free market were purchased by high-income consumers with inelastic demand.

55

See, for example, Krishna (1967) and Singh (1975).