1. Energy Subsidy Reform (ESRx) Module 5
“A Toolkit to Analyze the Distributional Effects of Fuel Subsidy Reform”

2. Module Learning Objectives
Understand how to quantify the distribution of subsidy benefit across different income groups
Identify the channels by which subsidy reform affects households’ welfare
Assess the direct impact of subsidy reform scenarios on households’ welfare
Explain how the price shifting model help in assessing the indirect impact of subsidy reform on households’ welfare
Simulate fuel price reform given specific policy objectives, including mitigating the reform impact on the poor

3. Effects on Household Welfare through Two Channels
Direct impact (Yd):
Stems from higher prices for fuels directly consumed by households for cooking, heating, lighting, personal transportation, etc.
Fuel Price Increases
Indirect impact (Yind):
Stems from the effects of higher fuel prices on the production costs of other goods and services consumed by households

4. Concepts and Notations
Indicator of Household Welfare:
Consumption/expenditure(per capita)
Consumption in-kind
Income
Budget share of product i is it share of household’s spending on that product in their total expenditure:

5. Estimating the Direct Impact of Higher Fuel Prices
Let’s assume that we increase the price Pi of the fuel product i.
What would be the direct impact on household’s welfare?
(1)
For m fuel products
(2)
Removed Text Box for second equation… “If the price increase concerns a number m of fuel products, the total direct impact is the sum of the direct impact of each fuel product”
Would suggest to suggest to write in “Direct Impact”, “Budget share of fuel product i”, and “Increase in the price of fuel i” for the top equation.

6. For Example…
Assume the government implements the following price increases:
Gasoline price: 100 percent
LPG and Kerosene prices: 50 percent
Computation of the direct impact:
Gasoline
LPG
Kerosene
Budget share(%) (A)
0.80
1.5
0.50
Price increase (%) (B)
100 50
Direct Impact (%) (=A*B)
0.75
0.25
1.8
The direct impact on a household that spends 0.8 percent of its budget on gasoline, 1.5 percent on LPG, and 0.5 percent on kerosene would be as follows

7. Estimating the Indirect Impact of Higher Fuel Prices
Estimating the Indirect Impact of Higher Fuel Prices The Price Shifting Model
Two broad group commodities in the economy:
Cost-Push Sectors: Higher input costs are passed on fully to output prices. Assume that there are k commodities in this sector.
Controlled Sectors: Output prices are controlled by the government.
2) The indirect impact of the increase in fuel prices on household welfare is:
(3)
Removed the equation text boxes. Write and explain this on the slide.

8. An Iterative Process Iterations 1 2 3 ….n… Product A Product A
Increase in fuel price
Product B
Product B
Product B
Product C
Product C
Product C
We can design this as a full slide image/diagram. See the next slide as an example.

9. The Input-Output Coefficient Matrix (A)
Sector 1
Sector 2 …
Sector j
...
Sector n
Sector i
aij
aij= the number of units produced by sector i needed to produce one unit of output by sector j

10. Calculating the Price Increases of Non-Fuel Products
The price changes of goods and services consumed by households due to higher fuel prices is given by:
(4)
Vector of price changes for nonfuel products
I: Identity matrix
α :Diagonal matrix with cost-push sectors (=1) and controlled sectors (=0)
A: Input-Output Matrix
Vector of exogenous fuel price changes
Vector of price changes for nonfuel products

11. Calculating the Indirect Impact
Once the price changes of non fuel products calculated
Plug the estimates in equation 3:

12. Deriving the Overall Impact
as percent of household expenditure
= direct impact (Yd)+ indirect impact (Yind)
Overall Impact
In nominal terms
= [direct impact (Yd)+ indirect impact (Yind)] ×household expenditure

13. The estimated effects should be considered as an upper bound
Main Assumptions
There is no substitution effect on the consumption and production side
Higher input costs are fully passed to output prices in push sectors
The only exogenous price changes are in controlled sectors
The estimated effects should be considered as an upper bound

14. Share of each income groups in total consumption of the subsidized product
Share of subsidies of quintile
Si = Cm,i /Cm
where
Cm,i = consumption of fuel product m by households in quintile i
Cm = consumption of fuel product m by all households

15. Presenting the Toolkit.
Inputs:
Household survey data
Input-Output matrix
Parameters:
Cost-push/controlled sectors
Deciles/quintiles
Reform scenario
Output:
Magnitude of directs effects
Magnitude of indirect effects
Distribution of subsidy benefit across income groups
Patterns of expenditures
Results by deciles or quintiles
Results displayed in tables and charts

16. How to use the Toolkit Illustration with the case of Subsidyland
Estimate the impact of the following reform scenario: price increase for kerosene (10%) and diesel (20%)
Inputs :
Household survey data: about 18,000 of households with data on main expenditure categories (e.g. fuels, food, housing, and transport)
Input-Output data with 16 sectors, including fuels, food, transport, services and so on.