Agriculture Import Liberalization and Household ... - World Bank Group

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(SASAR), World Bank D.C. Email: [email protected] ... crop price, the follow farm-household model based on Minot and Goletti (1998) is adopted: ( ) ..... net sellers, it is paddy farmers that form the bulk (almost 92 percent) that likely to be.
Agriculture Import Liberalization and Household Welfare in Sri Lanka Ganesh Seshan 1 and Dina Umali-Deininger2 May 2006

Keywords: import liberalization, farm-households, welfare, poverty, rice, Sri Lanka 1 Ganesh Seshan is a consultant (ETC) at the Social and Economic Development Group (MNSED), Middle East and North Africa Region, World Bank. D.C. Email: [email protected]

Dina Umali-Deininger a is Lead Agriculture Economist at the South Asia Agriculture and Rural Development Group (SASAR), World Bank D.C. Email: [email protected]

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The findings, interpretations, and conclusions expressed in this paper are those of the authors and do not necessarily reflect the views of the Board of Executive Directors of the World Bank or the governments they represent.

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JEL Classification: F14, F16, O24, Q12

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1. Introduction This note sets out to forecast the distributional impact of reducing import duties on rice, chillies, onions, potatoes and wheat in Sri Lanka. Outcomes are quantified for 3 hypothetical scenarios, from a 50 percent cut in custom levies to a 75 percent reduction and finally a 100 percent cut or complete removal of custom levies. Lower domestic prices for the commodities in question are expected to benefit net consumers at the expense of net sellers. The extent to which is an empirical question which can only be resolved by looking at the data. In doing so, this work adopts a partial equilibrium approach focusing only on the markets for the commodities of interest, using the latest 2002 HIES household survey data to estimate the changes in real income and poverty status that arises from import trade liberalization in the agriculture sector. 2. Methodology The reduction of import duties on specific food crops is expected to lower domestic retail prices. The extent to which prices decline depend on the magnitude of the import duty reduction and other custom levies, including distribution cost and possible markup adjustments to retail prices. Appendix A details the components that constitute a retail price for the commodities that are examined in this study. To investigate the impact on household welfare or real income due to changes in a food crop price, the follow farm-household model based on Minot and Goletti (1998) is adopted: ∆whi  1 = Pi .HRhi + Pi 2 Yh

( )

2

( )

1 HRhε Si − Pi .CRhi − Pi 2

2

CRhε Di ,

(1)

where ∆wic is a second-order or long-term change in real income for household h due to changes in the price of crop i , Yh is household income, Pi = ∆Pi / Pi ,0 is the proportional change in the price of crop i , HRhi is the value of crop i harvest of household h as a fraction of income, Yh , similarly, CRhi is the value of consuming crop i by household h as

4 a fraction of income, Yh , ε Si is the supply-price elasticity of crop i and ε Di is the (compensated) demand-price elasticity of crop i . The model can easily be extended to cover multiple crops. If the elasticities are set to zero, this expression collapses to the welfare measure popularized by Deaton (1989, 1997) and is commonly referred to as the Net Benefit Ratio (NBR) which is a static or short-term welfare measure of price changes that assumes no quantity or dynamic responses by consumers and producers. With the exception of rice where supply and demand price elasticities are available 3, the welfare consequences for the remaining food commodities, i.e. onions, chillies, wheat flour and potatoes relies on the NBR measure. The current levies charges and rates for the commodities of interest are provided in Table 1 using 2004 data to determine import unit values from which the tariff-equivalent rate of a specific custom duty can be derived. Table 1 Sri Lanka: Levies for Selected Commodities, 2004 Commodity Name Rice (milled) Flour of wheat Potatoes Onions Chillies

Import Unit Custom Value Duty (Rs) (Rs/kg) 27.94 20 28.88 n/a 61.12 20 19.17 10 69.55 30

Tariff Equivalent Rate 71.6% 2.5% 32.7% 52.2% 43.1%

VAT rate PAL rate SRL rate SUR rate n/a n/a 15.0% 0.5% n/a

2.5% 2.5% 2.5% 2.5% 2.5%

0.1% 0.1% 0.1% 0.1% 0.1%

n/a n/a 10.0% n/a n/a

Note: Import unit values are constructed from value and quantity data. Source: WITS, FAOSTAT, Sri Lanka Customs.

Three possible scenarios are considered which custom levies are reduced by 50 percent, 75 percent and 100 percent respectively. To further nuance the analysis, within each scenario, two possibilities are considered: (a) only a reduction in (import) custom duty and (b) a reduction in custom duty and other custom levies, including the surcharge, Social Responsibility levy (SRL) and Port and Development levy (PAL). The predicted change in retail prices are provided in Table 2. These price changes are fed into equation (1) for each food crop, produced and or consumed by a household and the resulting real incomes variations are derived at the household level.

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Price elasticities for rice are obtained from Table 12 in Weerahewa (2004).

5 Table 2 Sri Lanka: Predicted Percentage Change in Retail Prices Reduction in Custom Duty by:

Scenarios

50% 1(a)

75% 2(a)

Rice Flour of wheat Potatoes Onions Chillies

-20.6% -1.2% -12.9% -16.9% -14.8%

-30.9% -1.8% -19.4% -25.3% -22.2%

100% 3(a) -41.1% -2.4% -25.8% -33.7% -29.6%

Reduction in Custom Duty & Other Custom Levies by: 50% 1(b)

75% 2(b)

-21.3% -2.4% -14.4% -17.7% -15.7%

-31.9% -3.6% -21.2% -26.5% -23.5%

100% 3(b) -42.6% -4.8% -27.6% -35.4% -31.3%

Source: Author's calculation based on equation A.2

3. Data Lower domestic food prices are expected to primarily benefit lower-income households where expenditure on food constitutes a large share of total expenditure. Table A.1 in the annex provides a breakdown of household expenditure on rice, onions, chillies, potatoes and wheat. On average, Sri Lankan households allocate 11.5 percent of their consumption on rice, while the budget shares for onions, chillies, potatoes and wheat flour are approximately 1 percent respectively. The rice budget share for households in the lowest income quintile is 19 percent compared to 4 percent for the richest households in the 5th income percentile. Agricultural households also spend relative more on food consumption relative to non-agricultural households. Figures 1 to 5 shows the budget shares for various food items across the income distribution. The vertical line is the national consumptionbased poverty line. Rice consumption clearly stands out in terms of its place in household consumption.

6 Figures 1-5: Food Shares across Household Wheat Flour Expenditure Share: All Households 30 20 0 8

10

12

6

8

10

log real per-capita monthly expenditure (2002)

Chilli Expenditure Share: All Households

Potato Expenditure Share: All Households

12

20 10 0

0

10

20

Potato Budget Share (%)

30

log real per-capita monthly expenditure (2002)

30

6

8

10

12

log real per-capita monthly expenditure (2002)

6

8

10

log real per-capita monthly expenditure (2002)

10

20

30

Rice Expenditure Share: All Households

Rice Budget Share (%)

6

0

Chilli Budget Share (%)

10

Onion Budget Share (%)

20 10 0

Wheat Flour Budget Share (%)

30

Onion Expenditure Share: All Households

6

8

10

log real per-capita monthly expenditure (2002)

12

12

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The degree to which price changes effects producer and consumer welfare in the short-run depends on the production and consumption shares of the respective household. Using rice marketing for illustration, Table A.2 in the annex provides a breakdown of paddy production, consumption and net sales by various household categories. Rice production is equivalent on average to 4.1 percent of income, proxied by total expenditure, while as noted earlier, the mean budget share of rice is 11.5 percent. This results in a share of net sales to income or a net benefit ratio of -7.4 percent (4.1-11.5). Thus, a 10 percent decrease in farmgate and retail rice prices would raise short-term household real income by 0.74 percent on average. Similarly, a 20 percent fall in rice prices arising from an equivalent reduction in rice import duties would raise real income in the short-run by 1.48 percent. This figure is the difference between a gross savings equivalent to 2.3 percent of income generate by lower rice prices and a loss of farmer’s income amounting to 0.82 percent of initial income. The negative NBR for urban, rural and estate households indicates that on average, households, particularly in the estates will benefit from lower rice prices. The importance of rice in household incomes is highest in the North-Central province with a positive NBR. It comes as no surprise, that farmers in this province will lose in real income terms in the short-run, from a reduction in domestic rice prices. The last three columns of Table A.2 shows the percentage of households that are net sellers 4 (NBR>0), that have no net sales (NBR=0), and that are net buyers (NBR