uleac economic integration price transmission and consumer welfare

OutlinePrice Transmission

Assessing the Impact on Consumer WelfareApplication to Lebanon

Economic Integration, Price Transmission, andConsumer Welfare. Lessons Learned and

Policy Reforms

Alban Thomas1

1Toulouse School of Economics

Lebanese Economic Association, Beirut, May 9, 2011

Alban THOMAS Economic Integration, Price Transmission, and Consumer Welfare. Lessons Learned and Policy Reforms



Introduction

Background: Growing concern regardingIncreasing and more volatile commodity pricesDependence upon imported energy sourcesCombination of high unemployment level and rising inflation

Countries with subsidy policies (consumption, energy):less and less sustainable public deficit

Need to maintain local firms’ profitability and protectconsumer welfare




Introduction

This presentation:

Some aspects of price vulnerability and consumer welfarePrice transmission through international trade (imports)and exchange rateExamples: Viet-Nam and IndiaImpact on consumer welfareExample: Egyptian food policyApplication to Lebanon: price transmission and importsubstitution




Outline I

1 Price TransmissionEmpirical MethodsExample: VietnamExchange-rate pass-throughExchange-rate pass-through: The example of India

2 Assessing the Impact on Consumer WelfareThe AIDS Model Applied to Rationed DemandThe Egyptian food policyThe Mixed Demand Model

3 Application to LebanonPrice TransmissionImport substitution




Empirical MethodsExample: VietnamExchange-rate pass-throughExchange-rate pass-through: The example of India

Price Transmission

Market structure

Exports

Exchange Rate

Imports Wholesale market structure

Retail market





Price Transmission

Assumptions often made for small countries:World prices are fixed (given)Perfect transmission of world prices to border pricesDomestic prices are driven by world prices, exchange rates,tariffs, and transaction costs

Price transmission may be affected byTransportation and transaction costsImperfect exchange-rate pass-throughProduct differentiationBorder (and domestic) price policies





Price Transmission

Examples of failure of full-price transmission:

Transportation costs may beNon-stationaryFixed, not proportional to traded quantitiesMultiplicative, not additive (between each other)

Incomplete exchange-rate pass-through:Pricing-to-market exporter strategy (to stabilize final price)Shifts in marginal costs

Price policiesVariable tariffs as stabilization policyNon-tariff barriers (sanitary, quotas)Domestic price-support policies





Empirical Methods

Time-series modeling: comparison between world anddomestic pricesTesting for convergence with dynamic modelsConsider

PDt = µ+ β1PW

t + β2PDt−1 + ut ,

wherePD

t : domestic price level,PW

t : world price level,ut : error term.

Error correction model: account for world-domestic pricegap

εt = PDt − α− βPW

t





Empirical Methods

Combining both equations and taking first differencesyields:

∆PDt = α + γ(PD

t − α− βPWt ) + θ∆PW

t + ut ,

⇔ ∆PDt = α + γεt + θ∆PW

t + ut ,

where ∆PDt = PD

t − PDt−1.

Interpretation of parameters:β: cointegration coefficient, measures long-termrelationship between PD

t and PWt

γ: speed of adjustment (towards long-run equilibrium)θ: intensity of price transmission

Test: convergence if γ 6= 0.





Empirical Methods

Including exchange rate and tariffs

PDkt = eN

t × PWkt × (1 + Tkt )× (1 + τkt )

wherePD

kt domestic price, sector k ,PW

kt : world price (in foreign currency), sector k ,eN

t : nominal exchange rate (local currency per unit offoreign currency),Tkt : ad valorem tariff for sector k ,τkt : transportation and transaction costs for sector k .

We need to construct the tariff-inclusive world pricemeasured in local currency





Empirical Methods

Define CPIHt and CPIF

t : consumer price indices in localand foreign countriesThe real exchange rate at time t is then

eRt = eN

t ×CPIF

t

CPIHt

and the tariff-inclusive world price measured in localcurrency is

PWkt =

(eR

t ×CPIH

t

CPIFt

)× PW

kt × (1 + Tkt )

⇔ PDkt = PW

kt × (1 + τkt ) .





Empirical Methods

Estimation and testingModel I: Levels, log-log

log PDkt = µk + θk log PW

kt + εkt

Model II: Levels, log-log, with domestic inflation

log PDkt = µk + θk log PW

kt + αk log CPIHt + εkt

Model III: First-difference, error correction model

∆PDkt = µk + γk (PW

k,t−1 − PDk,t−1) + θk ∆PW

kt + εkt

Model IV: First-difference, error correction model withinflation

∆PDkt = µk + γk (PW

k,t−1 − PDk,t−1) + θk ∆PW

kt + αk ∆CPIHt + εkt





Empirical Methods

Parameter θk : elasticity of price transmissionby construction in log-log modelsin first-difference models if base-year levels used incomputations (base 100)

Parameter γk : speed of adjustment to long-run equilibriumin sector kParameter αk : degree of inflation pass-through in sector k

Hypothesis testingLaw of One Price (LOP, co-movement between domesticand world prices):

θk = 1.

Neutral inflation pass-through:

θk + αk = 1 ⇔ (θk = 0, αk = 1) or (θk = 1, αk = 0)





Example: Viet-nam

Abbott, P., C. Wu and F. Tarp, 2011. Transmission of Worldprices to the Domestic Market in Vietnam. Working paper,Purdue University.Period: 1999 to 2008Sector-specific regressions, for 87 sectorsClassification of sectors into

Integrated if θk significantly 6= 0 and = 1Segmented if θk significantly 6= 1 and = 0Neutral inflation pass-through if θk + αk = 1Convergence of domestic prices to world prices (significantspeed of adjustment) if γk 6= 0.





Example: Viet-nam

Integrated sectors Integrated sectorsSector θk Sector θkTea, processed 0.84 Rice, processed -0.22Other crops 0.78 Fish -0.08Sugar, refined 3.50 Coffee beans -0.10Vegetables, animal fat 1.64 Processed fruits -0.24Wood products 1.08 Poultry 0.08Machinery 0.61 Milk, dairy -0.16Cement 0.74 Leather goods -0.99Organic chemicals 0.78 Bicycles -0.13Plastic products 0.72 Electrical machinery -1.04Automobiles 3.63 Cigarettes, tobacco 0.00





Example: Viet-nam

Neutral inflation pass-through Non-neutral inflation pass-throughSector αk Sector αkRice, processed 1.97 Confectionery, chocolate 0.35Fish 1.14 Textiles 0.39Tea 0.84 Animal feed 0.50Processed fruits & vegs 1.15 Water, soft drinks 1.58Sugarcane 0.92 Poultry 1.63Other livestock 1.33 Chemical fertilizer 1.73Processed meat 0.91 Alcohol, liquors 2.59Milk, dairy 1.29 paper products 3.82Cement, mortar 1.35 Other machinery 0.52Electrical machinery 0.87 Cattle 3.66





Example: Viet-nam

Significant speed of adjustmentSector γk Sector γkTea 0.85 Tea, processed 0.64Other crops 0.73 Sugarcane 0.77Cattle 1.24 Water & soft drinks 0.95Textiles 0.72 Wood products 0.45Paper products 1.26 Fertilizer 0.91Automobiles 0.85 Chemical products 0.39





Exchange-rate pass-through

Consider an exporting firm maximizing profit over N goods:

Π =N∑

i=1

PXi qi

(PX

ie

)− C

[N∑

i=1

qi

(PX

ie

),w

]

whereqi : quantity demanded of exports, good i , as a function ofexport price (in foreign currency)PX

i : export price (in local currency)Export price in foreign currency is PX

i /ee: exchange rate (price of foreign currency in terms of localcurrency)w : vector of input prices






Assume exchange rate has no effect on exporter’sproduction costDemand for exported good depends on exchange rate e:qi = qi(PX

i /e)

The exporter maximizes profit with respect to export price(in local currency):

PXi = MCi ×

[ηi(PX

i /e)

ηi(PXi /e)− 1

],

where MCi : marginal cost of product i , and ηi : absolutevalue of price elasticity of demand in export market forgood i , ηi = |[∂qi/∂(PX

i /e)]× (PXi /e)/qi |.






⇔ d log PXi = τi + (1− δi)d log MCi + δid log ei ,

whereτi : sector-specific intercept (constant term)

δi =∂ log ηi

∂ log(PXi /e)

×

[1− ηi +

∂ log ηi

∂ log(PXi /e)

]−1

It is a coefficient of pricing-to-market (pass-through).δi = 0 ⇔ full pass-through in currency terms, export pricein domestic currency is only explained by local factorsδi = 1 ⇔ no pass-through, export price in local currencyonly explained by external factors.





Exchange-rate pass-through: The example of India

Mallick, S. and H. Marques, 2008. Exchange RateTransmission into Industry-Level Export Prices: A Tale ofTwo Policy Regimes in India. IMF Staff Papers 55(1),83-107.Assessment of the impact of Indian reforms in 1991:

Trade liberalization (reduction of tariffs, elimination ofquantitative restrictions)Change in exchange-rate regime (devaluation of the Rupeevis-a-vis USD of 30 percent)

Analytical model of exchange-rate pass-through to exports






Impact of trade liberalization in India1980-89 1990-95 1996-2001

Trade (% of GDP) 14.1 19.2 26.7Import duty (%) 45.8 38.3 24.8Exchange rate depreciation (%) -6.8 -10.4 -5.7Import prices (% change) 6.9 7.7 5.9Import volume (% change) 7.5 15.1 6.2

Mallick and Marques (2008).






Estimated equation:

d log PXit = τ + αd log Si + βd log MCi + δid log et + εit

whered log PX

it : change in log export price in domestic currency(Rupee)d log Si : change in log sectoral export share of product id log et : change in log exchange rate (an increaseindicating depreciation)d log MCi : change in log Marginal Cost






Dependent variable: change in log export price1980-1990 1991-2001

Exchange rate (e) 0.040 ††† 0.179 ***†††

Sector share (S) 0.058 * 0.033 **Marginal cost (MC) 0.457 ** 0.294Constant 0.058 *** 0.001

714 Observations, 34 sectors.*, ** and ***: parameter significantly different from 0 at 10, 5, 1 %.†††: parameter significantly different from 1 at 1 %.

Full pass-through between 1980 and 1990 ; incompletepass-through between 1991 and 2001.




The AIDS Model Applied to Rationed DemandThe Egyptian food policyThe Mixed Demand Model

Assessing the Impact on Consumer Welfare

Use of a consumer demand system toEstimate (own, cross) price elasticitiesDerive Compensating (CV) or Equivalent Variations (EV)

Example: the Almost Ideal Demand System (AIDS, Deaton andMuellbauer, 1980)

Simulate price changes of imported food commoditiesApply pass-through elasticity to local marketsEstimate welfare change





Assessing the Impact on Consumer Welfare

Special case of rationed demand:

Some food items may be subsidizedAnd some may be rationed (household-specific rationcards)

Implications: Several Policy reforms can be considered:Increasing prices of importsReduced subsidy rates on subsidized food itemsAnd/or modified rationed quantities (quotas)

Need to specify a relevant household demand model





The AIDS Model Applied to Rationed Demand

Letpu : M1-vector of market pricespr : M2 −M1-vector of fixed prices (for rationed goods).p′ = (p′u,p′r ): a M2 vector of pricesz: vector of associated quotas

The expenditure function is

p′r z + minxu

[p′uxu; V (z, xu) ≥ U

]= p′r z + C(U, z,pu),

wherexu: non-rationed quantitiesxr : rationed-good quantitiesU(., .): direct utility functionV (z, xu) = max U(xu, xr ): indirect utility function





AIDS specification with rationing: the budget share of thenon-rationed good i , i = 1,2, . . . ,M1 for household h is:h = 1,2, . . . ,H as follows:

wih = αi +

M1∑j=1

γij ln pjh +

M2∑j=M1+1

ηijqjh + βi ln[

Rch

a(p)

]+ uih,

whereM2: total number of goodsp: vector of unit priceszj : fixed price of rationed good jqjh: quota on rationed good jRh: total expenditure (on the M goods) of the householdRch = Rh −

∑M2j=M1+1 qjhzj : expenditure on non-rationed

goodsa(p): aggregate price indexuih: error term. Alban THOMAS Economic Integration, Price Transmission, and Consumer Welfare. Lessons Learned and Policy Reforms




Estimated elasticities for the non-rationed goods usingLA-AIDS formulae:

eih =∂ log qih

∂ log Rc= 1 +

βi

wih(Expenditure elasticity),

εii,h =∂ log qih

∂ log pih= −1−βi +

γii

wih(Own-price elasticity),

εij,h =∂ log qih

∂ log pjh=

γij

wih−βi

wjh

wih(Cross-price elasticity),

i = 1,2, . . . ,M1, j = 1,2, . . . ,M1.






Elasticities of the non-rationed goods with respect torationed-good quotas and fixed prices:

εqij,h =

∂ log qih

∂ log qjh=ηijqjh

wih−

qjhzj

Rch

(βi

wih+ 1)

(quota elasticity),

εzij,h =

∂ log qih

∂ log zj= −

qjhzj

Rch

(βi

wih+ 1)

(fixed-price elasticity),

i = 1,2, . . . ,M1; j = M1 + 1, . . . ,M2.






Definition of complementary or substitute rationed goodsaccording to Madden (1991)Let zk and zs: denote two quantity-constrained goods, withrespective prices qk and qs

xm: non-rationed good with unit price pm

Goods zk and zs are substitutes if (δqk / δzs) (zs/qk ) < 0and complements otherwisezk and xm are substitutes (resp. complements) if

(δqk / δpm) (pm/qk ) >0 (resp. <0)and(δxm / δzk ) (zk /xm) <0 (resp. >0).





The Egyptian Food Policy

Application to reform of consumer food subsidy policyBackground:

Historical and social importance of Egyptian food subsidypolicyDue to budget limitations in recent years with soaring foodprices, reforms have been proposed2007 - 2008: 129 % increase in cereals’ price in EgyptBread crisis, urban riotsInsufficient local production: dependence on imports is 54% for wheatEgypt was the first importer of wheat in 2009

Egyptian food subsidies: 1.8 % of GDP in 2007-2008, 2.1% in 2008-2009





The Egyptian Food Policy

Egyptian food policy:40 % of calorie needs of low-income households in 2000Allow to maintain 730,000 households above the povertyline76 % of food subsidies are allocated to bread

The two components of the food subsidy system:Subsidized and rationed goods (20 products in 1989, 2 in1997 (sugar, cooking oil), 5 in 2004, 4 in 2008 (cooking oil,sugar, rice, tea)Subsidized but non-rationed goods

baladi bread (flour 82 %), 5 piastres / loaf (pita)baladi flourspecific outlets (Tamween), no social criteria





The Example of Egypt

Food Subsidy Budget by item in EGP Million for 2009-2010

Subsidies Budget EGP million PercentBread subsidy

Imported wheat 6368 48.40Domestic Wheat 2993 22.75

Corn 688 5.23Total 10,049 76.37

Rationed Goods SubsidyCooking oil 1675 12.73

Sugar 1434 10.90Total 3109 23.63Total 13,158 100.00





Elasticities from LA-AIDS model, non-rationed products

Income Subs. cooking oil Subs. sugar Subs. cooking oil Subs. sugarquota quota price price

Cereals 1.1165*** -0.0284*** 0.0706 -0.0291*** -0.0127***(14.15) (-5.25) (1.13) (-14.15) (-14.15)

Subsidized flour -0.1307 -0.0003 0.6692*** 0.0034 0.0014(-0.78) (-0.03) (5.15) (0.78) (0.78)

Free-market flour 1.1911*** -0.0273*** 0.0010 -0.0311*** -0.0135***(12.60) (-3.39) (0.01) (-12.60) (-12.60)

Subsidized bread 1.1039*** -0.0377*** -0.5027*** -0.0288*** -0.0125***(12.17) (-4.71) (-6.93) (-12.17) (-12.17)

Free-market bread 2.1307*** -0.0416*** -0.7059*** -0.0557*** -0.0242***(17.62) (-3.80) (-7.32) (-17.62) (-17.62)

Beans 0.8970*** -0.0260*** -0.0707* -0.0234*** -0.0102***(17.41) (-7.75) (-1.76) (-17.41) (-17.41)

Meat and Fish 1.0068*** -0.0294*** 0.1491*** -0.0263*** -0.0114***(25.29) (-11.49) (4.86) (-25.29) (-25.29)

Miscellaneous 1.1625*** -0.0260*** -0.2357*** -0.0304*** -0.0132***(47.00) (-16.11) (-12.41) (-47.00) (-47.00)

Cooking oil 0.7597*** -0.0233** -0.0391 -0.0198*** -0.0086***(8.17) (-2.23) (-0.53) (-8.17) (-8.17)

Sugar 0.2507*** -0.0069** 0.7095*** -0.0065*** -0.0028***(5.76) (-2.16) (20.88) (-5.76) (-5.76)





Hicksian Price Elasticities from LA-AIDS model

Cereals Subs. Non Sub. Subs. Non Sub. Beans Meatflour flour bread bread

Cereals -1.6642*** -0.0830 -0.0602 0.1996* 0.1577*** 0.1426*** -0.0616Subs. -0.1053 -1.0593*** 0.1144 0.1148 -0.0412 0.2355*** 0.1791***FlourNon Sub. -0.1308 0.0653 -1.3310*** 0.5578** 0.0200 -0.1010 0.0674FlourSubs. 0.3844** 0.0580 0.4212** -2.2598*** 0.1276** -0.1825*** -0.0516BreadNon Sub. 0.9628*** -0.1308 0.0592 0.4466** -2.0912*** 0.2276*** -0.1318*BreadBeans 0.2053*** 0.0837** -0.0354 -0.1425*** 0.0472*** -1.1529*** 0.0623*Meat -0.0034 -0.0110 0.0142 -0.0386*** -0.0079** -0.0041 -1.0497***and FishMisc. 0.0321 -0.0043 0.0005 0.0131 -0.02451*** 0.00067 -0.0178*Cooking oil 0.0664 0.0222 -0.0026 0.0343 0.0023 0.0067 0.0964***Sugar 0.0082 0.0828 -0.1877*** -0.5670*** 0.0031 0.0812*** 0.2955***

Notes. 498 observations. t-statistics are in parentheses. *, **and *** respectively denote a parameter significant at the 10, 5and 1 percent level.





The Mixed Demand Model

AIDS model: OK for effects of market, fixed price andquota effects on non-rationed goodsCannot be used to derive elasticities for rationed-goodbudget sharesA more structural model: the Mixed Demand model

We follow Moschini and Rizzi (2007)Let

x = (x1, ..., xN1)′: vector of goods with predeterminedpricesz = (z1, ..., zN2)′: vector of goods with predeterminedquantitiesp and q: price vectors associated with x and z respectively.





The Mixed Demand Model

Mixed demand of a representative consumer derived from:

maxx ,q

u(x , z)− v(p,q) such that p′x + q′z = y ,

whereu(x , z) and v(p,q): direct and indirect utility functionsrespectivelyy is consumer’s income (or total expenditure)

Marshallian mixed demandsx∗ = x(p, z, y) andq∗ = q(p, z, y)

At the optimum, we haveu(x∗, z) = v(p,q∗, y) = vM(p, z, y),

where vM(p, z, y): mixed utility function.Alban THOMAS Economic Integration, Price Transmission, and Consumer Welfare. Lessons Learned and Policy Reforms




Compensated (Hicksian) demand functions:

5pc(p, z,u) = xh(p, z,u),

and compensated price-dependent functions of z:

5zc(p, z,u) = −qh(p, z,u).

Relationship between Hicksian and Marshallian demands:

x(p, z, y) = xh[p, z, vM(p, z, y)], q(p, z, y) = qh[p, z, vM(p, z, y)],

The mixed utility function vM(p, z, y), can be derived bysolving for u in

c(p, z,u)−5zc(p, z,u).z ≡ y .

This is the mixed cost function cM(p, z, vM(p, z, y)).





Moschini and Rizzi (2007) specify a cost function that isaffine in u:

c(p, z,u) = F (p, z) + G(p, z).u,

where F (., .) and G(., .) are homogeneous of degree 1 in p.Mixed utility function becomes

vM(p, z, y) =R − F (p, z) +5zF (p, z).z

G(p, z) +5zG(p, z).z.

Moschini and Rizzi (2007) specify functions F and G as

F (p, z) = δ′p + (a′p)(µ′z),

G(p, z) = β′p+(a′p)(γ′z)+0.5p′Bpa′p

+0.5(a′p)(z ′Γz)+p′Lz,





which yield mixed demand equations:

x∗i = δi +(µ′z)

ai +

βi +

N1∑j=1

βijpj

a′p+

N2∑j=1

λijzj + ai[γ′z

−0.5p′Bp

(a′p)2 − 0.5(z ′Γz)

]}vM

q∗r =(a′p)µr +

(a′p)γr +

N2∑j=1

γrjzrj +

N1∑j=1

λjr pj

vM ,

for i = 1,2, ...,N1 and r = 1,2, ..N2.





Marshallian own-price and income elasticities from MixedModel, non-rationed food products

Own Price Elasticity Income ElasticityCereals -0.80*** 1.24***

Subsidized flour -0.06*** 0.54***Free-market Flour -0.62*** 1.07***Subsidized bread -0.12*** 0.63***Free-market bread -1.10*** 1.04***

Beans -0.76*** 0.92***Meat and Fish -0.58*** 1.12***Miscellaneous -0.80*** 1.01***

Cooking oil -0.10*** 0.91***Sugar -0.13*** 0.78***

Notes. 498 observations. t-statistics are in parentheses. *, ** and ***respectively denote a parameter significant at the 10, 5 and 1 percentlevel.





Elasticities for rationed food products from Mixed ModelPrice of rationed good

Marshallian elasticity Hicksian elasticitySubsidized Subsidized sugar Subsidized Subsidized sugarcooking oil cooking oil

Subsidized cooking oil -0.03* 0.0080 -0.0299* 0.0093(-3.61) 0.18 (-3.75) (0.20)

Subsidized sugar 0.0127 -0.12* 0.0125 -0.1169*(0.17) (-2.96) (0.17) (-2.9)0

Price of non-rationed goodCereals 0.7894*** 0.1772 0.7869*** 0.1986

(3.16) (0.56) (3.18) (0.63)Subsidized Flour 0.1252 -0.0646 0.1242 -0.0560

(1.32) (-0.61) (1.33) (-0.53)Free-market flour -0.3704* -0.0762 -0.3715* -0.0667

(-1.82) (-0.30) (-1.83) (-0.26)Subsidized Bread -0.1574 -0.1315 -0.1590 -0.1181

(-1.03) (-0.66) (-1.04) (-0.59)Free-market bread 0.1642** 0.0347 0.1638** 0.0383

(2.05) (0.33) (2.04) (0.37)Beans -0.0286 -0.0346 -0.0307 -0.0158

(-0.28) (-0.27) (-0.30) (-0.13)Meat and Fish 0.1344 0.3255* 0.1268 0.3914**

(0.98) (1.90) (0.95) (2.36)Miscellaneous 0.2817 0.7059** 0.2729 0.7817***

(1.27) (2.54) (1.14) (2.68)Cooking oil 0.1416 0.2332** 0.1409 0.2393**

(1.38) (2.01) (1.38) (2.08)Sugar -0.0539 -0.3965*** -0.0553 -0.3840**

(-0.37) -(3.61) (-0.38) (-2.05)





Elasticities of non-rationed goods with respect to rationed-goodquotas, from Mixed Model

Rationed-good quotaMarshallian elasticity Hicksian elasticity

Quantity of Subsidized Subsidized sugar Subsidized Subsidized sugarnon-rationed good cooking oil Cooking oilCereals -0.0370*** -0.0140 -0.0304*** -0.0047

(-3.29) (-0.60) (-2.72) (-0.2)Subsidized flour -0.014 0.0080 -0.0111 0.0120

(-1.33) (0.42) (-1.07) (0.64)Free-market flour 0.0377* 0.0093 0.0433** 0.0174

(1.82) (0.23) (2.11) (0.43)Subsidized bread 0.0145 0.01797 0.0178 0.0226

(1.04) (0.63) (1.29) (0.79)Free-market bread -0.0422* -0.0230 -0.0367* -0.0152

(-1.95) (-0.53) (-1.70) (-0.35)Beans 0.0016 0.0016 0.0065 0.0085

(0.32) (0.16) (1.25) (0.83)Meat and Fish -0.0018 -0.0072* 0.0040** 0.0011

(-0.93) (-1.85) (2.06) (0.3)Miscellaneous -0.0037 -0.0152** 0.0015 -0.0076

(-1.20) (-2.42) (0.5) (-1.21)Cooking oil -0.0237 -0.0688** -0.0189 -0.0619**

(-1.39) (-2.28) (-1.11) (-2.06)Sugar 0.0049 0.0521* 0.0091 0.0579**

(0.40) (2.01) (0.73) (2.25)





Results

Cereals are substitutes to subsidized cooking oilMeat, miscellaneous food products, and cooking oil aresubstitute to subsidized sugarFree-market flour is complement to subsidized cooking oilFree-market sugar is complement for subsidized sugarNo relationship between subsidized cooking oil and its freemarket counterpart.

We now use these results to simulate a policy reform.Compensating Variation: amount leaving households withthe same utility level( welfare) after price change(s).





Simulation of policy reform

Policies A: remove subsidies on baladi bread and baladiflour

A1: Remove subsidy on baladi flour (results in 43 percentprice increase)A2: Remove subsidy on baladi bread (results in 57 percentprice )A3: A1 + A2

Policies B: remove subsidies on baladi bread and baladiflour, in a context of rising food prices

B1: A1 + 50 percent increase in cereals’ priceB2: A2 + 50 percent increase in cereals’ priceB3: A3 + 50 percent increase in cereals’ price





Median expenditure variations for Scenario A1, by region typeand income quartile

Rural UrbanQ1 Q1-Q2 Q2-Q3 Q3-Q4 Full sample Q1 Q1-Q2 Q2-Q3 Q3-Q4 Full sample

Cereals -7.74 -5.43 -4.64 -3.72 -5.04 -4.44 -2.87 -2.51 -1.85 -2.66Subs. flour 39.63 38.53 38.45 38.06 38.61 40.60 40.51 40.38 40.32 40.44Non sub. flour -1.70 -0.68 -0.43 -0.28 -0.67 -0.61 -0.19 -0.11 0.01 -0.16Subs. bread -0.76 -0.45 -0.20 0.02 -0.33 -0.40 -0.12 0.00 0.06 -0.07Non subs. bread -3.20 -3.14 -2.37 -1.86 -2.64 -2.44 -1.78 -1.61 -1.30 -1.67Beans 1.99 3.20 3.78 3.78 3.28 1.34 1.57 1.84 1.78 1.65Meat & Fish -5.57 -3.95 -3.31 -2.69 -3.55 -2.97 -1.92 -1.66 -1.29 -1.77Misce. -3.40 -2.67 -2.10 -1.68 -2.26 -1.82 -1.25 -1.08 -0.86 -1.20Non sub. oil -2.36 -1.69 -1.41 -1.07 -1.62 -1.37 -0.89 -0.70 -0.58 -0.82Non sub. sugar -1.94 -2.09 -1.82 -1.62 -1.90 -1.08 -0.95 -0.89 -0.77 -0.91Subs. oil 3.45 4.46 5.73 7.96 5.03 2.49 3.46 4.17 5.60 3.82Subs. sugar -0.50 -1.59 -2.21 -4.20 -1.77 -0.60 -1.12 -1.54 -2.09 -1.34CV 3.39 2.59 2.10 1.67 2.24 1.84 1.22 1.05 0.81 1.17





Median CV relative to total expenditure (percent), all scenarios,rural regions, by income quantile

RuralCV/Expenditure Q1 Q1-Q2 Q2-Q3 Q3-Q4 Full SampleScenario A1 3.31 2.52 2.05 1.65 2.18Scenario A2 4.07 3.01 2.63 2.07 2.74Scenario A3 7.50 5.36 4.70 3.71 4.98

Scenario B1 6.73 6.04 5.58 5.18 5.77Scenario B2 7.70 6.25 6.14 5.47 6.27Scenario B3 10.52 8.89 8.12 7.26 8.66

CV: Compensating Variation





Median CV relative to total expenditure (percent), all scenarios,urban regions, by income quantile

UrbanCV/Expenditure Q1 Q1-Q2 Q2-Q3 Q3-Q4 Full SampleScenario A1 1.80 1.20 1.02 0.79 1.13Scenario A2 4.81 3.50 2.74 2.55 3.10Scenario A3 6.65 4.62 3.83 3.32 4.23

Scenario B1 4.50 3.97 3.66 3.53 3.78Scenario B2 7.52 5.94 5.37 5.37 5.74Scenario B3 9.20 7.15 6.50 6.17 6.87

CV: Compensating Variation




Price TransmissionImport substitution

Application to Lebanon

First application: investigate price transmissionSecond application: Explore substitutability between localand imported goodsMain constraint: consider sectors relevant both for localand imported commoditiesCompare Consumer Price, Producer Price, Import Priceindices





Application to Lebanon

The data

Source: National accounts (retrospective 1997-2007, and2008-2009)10 sectors of the Lebanese economy

11. Agricultural products12. Livestock and fish13. Energy14. Food industry15. Textile, leather16. Non-metal ores17. Metals, machines & equipment18. Wood, rubber & chemicals19. Furniture110. Other industrial products





Price Transmission

Model for price transmission in first differences:

∆PDkt = µ+ γεkt + θ∆PW

kt + α∆CPIt + ukt ,

where∆PD

kt = PDkt − PD

k,t−1,εkt = PD

kt − α− βPWkt ,

β: cointegration coefficient (long-term relationship betweenPD

kt and PWkt ),

γ: speed of adjustment (towards long-run equilibrium),θ: intensity of price transmission,α: degree of inflation pass-through (to sectors).





Price Transmission

Estimation results, all sectors

Dependent variable: ∆PDt

Parameter Estimate Std. error t-studentα -0.9204** 0.3542 -2.60γ 0.6002*** 0.0822 7.29β 0.4057*** 0.0906 4.48θ 0.1814*** 0.0493 3.68δ 0.6113*** 0.1158 5.28R2 0.5683N 120





Price Transmission

Test results, all sectors

Test Hypothesis Test statistic p-valueγ = 0 No convergence 15.52 0.0000θ = 1 Law of One Price 275.46 0.0000θ + α = 1 Neutral inflation 3.85 0.0521

pass-through

Interpretation:Significant convergenceNo Law of One Price (sectors are segmented)Neutral inflation pass-through





Price Transmission

Estimation results, sector by sector

Dependent variable: ∆PDt

Sector α γ β θ δ

11 -0.8620 0.8571*** 0.8756*** 0.5873*** -0.077512 -2.4661 0.9238*** 0.7898** 0.3147 0.076714 -1.04 0.5538* 0.5771* 0.5695*** 0.4942**16 -0.4744 0.5179* 0.5593 0.2724 1.3733*18 0.0854 0.4580 1.1135** 0.4622* 0.7148**110 0.4109 0.8010** 1.1266*** 0.5996*** -0.2148





Price Transmission

Test results, sector by sector (p-values)

Sector γ = 0 θ = 1 θ + α = 111. Agricultural products 0.010 0.0735 0.265212. Livestock 0.021 0.0383 0.311514. Food industry 0.110 0.0754 0.717016. Non-metal ores 0.129 0.1682 0.189218. Wood, rubber 0.169 0.0802 0.5125110. Other industrial products 0.035 0.1094 0.0748

Interpretation:Significant convergence for sectors 11, 12 and 110Law of One Price in all sectors except 12Neutral inflation pass-through in all sectors





Import substitution

Estimation of a simple AIDS-type model, for 2 goods: local(D) or imported (M)Share of imported commodities, sector k

wMkt = αk + γD,M

k log pDkt + γM,M

k log pMkt + βk log

(Rkt

P∗t

)+ ukt ,

whereRkt = pD

ktqDkt + pM

kt qMkt ,

P∗t =∑

i=D,M w ikt log P i

kt

Computation of substitution elasticities: local vs. importedcommodities





Import substitution

Price elasticities, local vs. imported commoditiesSector Own-price Cross-price

elasticity elasticity11. Agricultural products -0.6553 -1.039112. Livestock & fish -1.0673 -0.468713. Energy -0.8274 0.207914. Food industry -0.3488 -0.878115. Textile, leather -1.2373 -0.234716. Non-metal ores -1.5458 1.551717. Metals, equipment -0.9528 -0.504018. Wood, rubber -1.3890 0.015019. Furniture -0.3899 -1.4419110. Other industrial products -0.3122 0.4405All -0.8933 -0.5214





Import substitution

Interpretation

Strongly elastic import demands: Textile & leather,non-metal ores, metals & equipment, wood & rubberPoorly elastic import demands: food industry, furniture,other industrial productsAlmost all local products are complements, not substitutes


uleac economic integration price transmission and consumer welfare

Technology

consumer welfareapplication

consumer welfareexample

world price level

domestic price level

aspects of price vulnerability

kt wherepdkt domestic

consumer welfarethe

lebanoneconomic integration