SUBSIDIES IN : A LITERATURE REVIEW

June 15, 2006 This publication was produced for review by the United States Agency for International Development. It was prepared by Mona Fetouh.

SUBSIDIES IN EGYPT: A LITERATURE REVIEW

TECHNICAL ASSISTANCE FOR POLICY REFORM II CONTRACT NUMBER: 263-C-00-05-00063-00 BEARINGPOINT, INC. USAID/EGYPT POLICY AND PRIVATE SECTOR OFFICE JUNE 15, 2006 AUTHOR: MONA FETOUH SO 16: COMPONENT G

DISCLAIMER: The author’s views expressed in this publication do not necessarily reflect the views of the United States Agency for International Development or the United States Government.

CONTENTS

PART I – LITERATURE REVIEW...... 1 I. Introduction ...... 1 I. 1 Review of available studies...... 1 II. General subsidy studies ...... 2 III. Food subsidies ...... 2 IV. Non-food subsidies...... 3 IV. 1 Energy ...... 3 IV. 2 Water and electricity subsidies...... 4 V. Impact of subsides...... 5 V. 1 Poverty implications ...... 5 V. 2 Budgetary implications and market distortions ...... 6 V. 3 Political economy ...... 6 VI. Reform options ...... 7 VII. Conclusions and next steps...... 8 VII. 1 Areas of future research...... 8

PART II – ANNOTATED BIBLIOGRAPHY...... 10

APPENDIX – EARLY IFPRI RESEARCH...... 1

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PART I – LITERATURE REVIEW I. INTRODUCTION The subsidy system in Egypt has long negotiated the balance between two goals: providing a safety net for the poor and accounting for a sustainable drain on the budget. In a country where 44% of the population lives in less than $2/day, subsidized consumer goods and social services make food staples and key services affordable to the poor, thus improving health and reducing malnutrition among vulnerable groups. They also offset some of the initial pains of economic reform for these sectors of the population. The current subsidy program, however, constitutes a severe strain on state resources. Direct and indirect subsidies to commodities and some services cost the Treasury LE18 billion in 2004/05, or 14 per cent of total current public expenditure. Direct subsidies on bread, other food and medicine represent LE15.5 billion, or 86%, of that total—public utilities and transport make up the remainder. The most recent budget has moved implicit subsidies on energy to a new line on explicit subsidies—reflecting a move towards greater transparency. Energy subsidies take up LE22 billion of the budget, but this figure increases to LE40 billion (15% of the state budget) for the 2006/7 budget due to the significant recent rise in oil prices, and a 15% rise in consumption. As several officials and article have pointed out, energy subsidies cost more than what is allocated to health and education combined. As an additional consideration, state resources are stretched due to other factors. Domestic debt levels are too high, and the reform program will require more resources in the short and medium term. When subsidies become a budgetary burden and tie up resources which could be spent on more urgent needs for the poor, their initial purpose becomes diluted and ineffective. Prime Minister Nazif has said that it is “ not a matter of whether or not subsidies should be removed, but how and when .” (Business Monthly 2006). Subsidy reform is recognized as a necessary part of the recently implemented economic reform program, but a comprehensive strategy for doing so has yet to surface. The politically sensitive nature of price controls and past experience is undoubtedly a key impediment, particularly in light of the precarious nature of concurrent political reforms. But as research cited here demonstrates, viable options for change can preserve the welfare benefit for targeted beneficiaries, at lower costs.

I. 1 REVIEW OF AVAILABLE STUDIES This paper 1 will look at the sources available for studying the Egyptian subsidy issue and the need for additional research. It is divided into two main sections: a review of the available literature by theme, and an annotated bibliography. The first section is further divided by examining how current research treats subsidies by: a) category; b) implications on poverty

1 This report was produced during the period of May 7 – June 15, 2006.

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alleviation, the budget, market distortions and the political economy; and c) how the literature addresses potential reform options, particularly recommendations on beneficiary targeting. Because this time-limited review is intended to determine the need for further study, it is not an exhaustive review of all potentially relevant subsidy studies, but a practical one--the studies included in this review are generally limited to those conducted in the past 15 years, with an emphasis on more recent papers, and are limited mainly to English-language resources. They focus primarily on Egypt and/or MENA, except in cases where Egypt- specific resources were scarce. Most resources covered focus on the two largest subsidy categories—food and energy, with some discussion on utilities. There is little available on housing subsidies, which have already been addressed in the ongoing USAID/TAPR II housing demand study. Concluding remarks will address gaps in the research and propose recommendations for further study.

II. GENERAL SUBSIDY STUDIES Only two papers covered the Egyptian subsidy system comprehensively, rather than focusing on certain products—Harik (1992) and Helmy (2005). Harik’s holistic coverage, while useful, is less relevant as it predates reforms implemented in the past 15 years. Helmy, however, attempts to present an updated, overarching review of subsidy policy in Egypt and covers food, energy, electricity and education. She draws on most of the resources covered in this review and examines best practice in other countries to develop policy recommendations in each subsidy area. Another potentially comprehensive study has been conducted by the World Bank in 2006. This paper was not yet available for review. The World Food Programme (WFP) survey in 2005, while centered on food subsidies, contained questions on non-food subsidies as well. The questionnaire looked at costs, per governorate, of food, water, electricity, housing, education and medicine and broke down the type of services available and levels of satisfaction per governorate. The WFP used the survey findings in these areas as an input to their analysis of vulnerable groups, but do not draw further conclusions or make policy recommendations on non-food subsidy programs.

III. FOOD SUBSIDIES Subsidies on food products have been reduced since the 1990’s, and now only cover eight staple items—four of which comprise the vast majority of spending—baladi bread, sugar, wheat flour and cooking oil. As bread comprises 40% of the average Egyptian’s daily caloric intake (a figure that is higher for the poorest groups), the choice of these commodities reflects the consumption patterns of the targeted groups. While the costs in terms of total government expenditure has declined, the outlay in L.E. is still high. Subsidized bread and wheat, comprising 75%, or L.E. 11.6 billion, of the total food subsidy cost, is available to all income groups, whereas the other items are distributed on a ration card system. All studies mentioned in this paper have looked at the issue of more effective targeting. Food items are the most exhaustively research aspect of the Egyptian subsidy system. Much of this is due to the fact that the International Food Policy Research Institute (IFPRI) was contracted by the GOE and USAID to conduct a series of studies on the system’s structure and options for reform. Due to the scope of their work, their own literature review is attached

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as an annex to this report, which contains useful lessons learned for further study and policy implementation. The most recent study and the one examined for this review is entitled The Egyptian Food Subsidy System: Structure, Performance and Options for Reform . The focus of this paper is on targeting and cost-effectiveness, and thus has a strong concentration on the budgetary impact of the current system. Conclusions are based on data resulting from the 1997 Egypt Integrated Household Survey (EIHS), which include a community-level subcomponent. The survey’s broad scope—covering income, expenditure, health, education and several other topics in addition to food subsidy use—led to IFPRI recommendations for reducing costs while maintaining the welfare benefit.

The World Food Programme conducted a comprehensive study and survey in 2005 entitled Vulnerability Analysis and Review of Food Subsidy in Egypt . The primary focus of this research was on food security and the contributions of Egyptian food subsidies to alleviating food insecurity for the more vulnerable groups. Thus, it has a stronger emphasis on the poverty side of the subsidy equation than the IPFRI papers. It addresses the issue of targeting from a poverty/vulnerability standpoint, as the findings conclude that the poorest groups are not receiving a proportional share of the benefit. This analysis implicitly includes cost-effectiveness issues and the better allocation of budgetary resources as well.

The World Bank’s Human Development Group released a study in 1999 on Consumer Food Subsidies in the MENA Region , which provided an overview of subsidy policy, impact and efficiency across the region. The authors posit that where reform has been implemented, the replacement policies have not been well targeted. They cite lessons in subsidy reform from several case study countries, including the importance of a slow pace and public awareness campaigns, and suggest a policy reform agenda which addresses the high cost/benefit ratio of subsidies, while being sensitive and responsive to the political realities of reform. Political economy implications are discussed in more depth in Adams (1999) and particularly in Gutner (2002). A couple of studies look at food subsidies from an agricultural policy perspective. Siam (2006) presents a model which examines the impact of wheat subsidies on a wheat self- sufficiency policy. Like the WFP study, Siam is concerned with food security implications arising from the high level of wheat imports. He concludes that a self-sufficiency policy would not be sustainable and would have a negative effect on the production of other goods, but that subsidies must be better targeted. Adams (1999) analyzes distribution factors in the self-targeting system drawing from the 1997 EIHS. Self-targeting refers to a subsidy system in which subsidies are available to the entire population, but are placed on products which the poor are more likely to consume. The Tuck and Lindert (1996) study offers a perspective on how effective this has been in Tunisia. Adams acknowledges successes in the gradual reforms in place to date and recommends maintaining a similar course.

IV. NON-FOOD SUBSIDIES

IV. 1 ENERGY There are few studies focused on energy subsidies in Egypt despite the fact that expenditure equals or surpasses that of food subsidies (L.E. 22 billion in 2005, versus L.E. 15 billion for food). Energy subsidies have received increasing attention in the Egyptian press after the

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Ministry of Finance agreed to show these costs as a subset of the explicit subsidy line item in the budget, rather than buried in implicit line items as operating costs of public sector energy companies. It also has become a focus due to rising fuel costs, and the revelation that the 2006/7 budget would require an outlay of LE 40 billion—almost twice that of the previous year. Energy subsidies are a focal point of subsidy reform efforts due to the fact that wealthier Egyptians benefit disproportionately from the subsidy. Yousef Boutro-Ghali estimates that the rich benefit by LE 1700 per capita, as opposed to LE 300 for the poor (Business Monthly , 2006). He has stated that only 20% of energy subsidies directly benefit the poor.

Even when the poor do have access to the infrastructure necessary to benefit from energy subsidies, their consumption is significantly lower than middle and higher income households. The lower income groups which benefit most are minibus and taxi operators, who claim that higher fuel prices and subsequently higher fares would have a strong negative impact on poorer urban dwellers. Egypt-specific studies on this topic have been difficult to locate, but the issue has been covered in the local press substantially, particularly following the announcement of the 2006/7 budget. Broader studies such as UNEP and the IEA’s Reforming Energy Subsidies give examples of reform in other countries and recommendations which are potentially useful to Egypt’s own reform efforts. The American Chamber of Commerce in Egypt’s magazine Business Monthl y has addressed the issue in 2003 and 2006 articles, which focus heavily on the distortionary impact of fuel subsidies. Richter summaries efforts thus far (e.g. cutting subsidies on diesel fuel) but notes that lack of political will to follow through on further reforms. Rasromani, writing in the Daily Star (2006) note that Ministers Rachid and Boutros-Ghali, as well as Prime Minister Nazif, have been outspoken on the opportunity cost of the energy subsidy program. Spending on fuel subsidies outstrips spending on health and education combined. The change to the budget line items is a step towards the campaign necessary to justify reform in this sector. Most opposition is expected to come from the public transport sector, and the inefficient industries who rely on cheap fuel costs to remain profitable.

The UNEP/IEA report, which also covers utility subsidies, recommends the removal or extensive reform of fuel subsidies based on experience in the FSU and several other regions. As expected due to UNEP involvement, it has a strong focus on sustainability, and proposes principles to guide the reform process. Inefficient fuel use and disincentives to invest in newer, cleaner technologies add to the monetary costs.

IV. 2 WATER AND ELECTRICITY SUBSIDIES Electricity and water subsidies in Egypt are difficult to measure due to the fact that their costs are implicit. That is, the costs are recorded as the losses of public sector companies in these sectors, rather than in the budget. Perhaps due to the resulting data difficulties, there are not many studies on costs and impact of water and electricity subsidies in Egypt. However, there are several general studies whose conclusions are potentially relevant for Egypt’s own subsidy reform process. Adams (1999) quotes World Bank estimates in 1995 which put the total cost of water and electricity subsidies as higher than food subsidy costs. As these figures represent urban areas only, the final costs that take rural areas into account could even be three to four times higher than the total food subsidy burden. (Transportation subsidies are also difficult to estimate, but IMF attempts show figures which are a fraction of

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the total subsidy cost). Helmy (2005) addresses utility subsidies as part of her more comprehensive overview of subsidy costs and benefits. Unlike fuel subsidies, utility subsidies are viewed as having a greater impact on poverty reduction and a better reach towards the poor. Unlike many parts of sub-Saharan Africa, where many of the most vulnerable groups are not connected to the grid, Egypt’s geographical realities allow for greater electricity coverage among the poor than comparable countries. Thus, there is a strong argument that electricity subsidies are well-targeted, although inefficiencies still exist. Komvies et al (2005) suggest the most efficient methods of targeting the poor and provide a starting point for the consideration of reform options in this sector. Helmy notes the cross subsidy between electricity consumers, whereas agricultural and domestic consumers pay less than the average costs of electricity production and commercial consumers pay more. Water prices in Egypt do not reflect the scarcity of that resources and lead to wasteful use, but subsidies do benefit the poorer elements of the agricultural sector. Little research is available on water subsidies in Egypt, however.

V. IMPACT OF SUBSIDES

V. 1 POVERTY IMPLICATIONS Egypt’s subsidy program grew out of the World War II ration system. But it wasn’t until the 1980’s that subsidy spending grew to peak levels. The stated purpose behind the program has been to reduce the cost-of-living burden on the poorest segments of the population, and to relieve food insecurity. The poverty alleviation effects of food subsidies in particular are studied in the 2005 WFP survey and paper. Alderman (2002) studies subsidies in the context of broader social safety net policies. He compares the effectiveness of subsidy coverage on the poor with that of cash transfers and looks at the questions of distribution— relevant in Egypt considering reports on long bread lines in under-serviced areas. Helmy (2005) offers a useful breakdown of which geographic areas and income groups benefit most from each subsidy. The baladi bread subsidy is estimated to have lifted 730,000 above the poverty line in 2000 (Helmy, 2005) and overall subsidies have reduced the poverty rate from 20.2% in 1995 to 16.7% in 2000. Respondents in the WFP survey indicated that removal or reduction of the bread subsidy would be a severe strain in household resources. The study indicates that in the most vulnerable governorates, subsidized commodities were still hard to afford even at subsidized prices, and sometimes difficult to obtain due to poor distribution. The available literature generally suggests that the poverty alleviation effects of food subsidies should be at a minimum maintained, and ideally improved through better targeting. However, as discussed earlier, the impact of fuel subsidies on the poor is minimal and at a high cost. The poorest income groups are unable to afford private vehicles, and much of the subsidy goes towards propping up certain industries. A better targeted public transport subsidy would have a more direct impact on the poor, and funds from the fuel subsidy might be better allocated, as the GOE has implied, towards increased provision of basic services.

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V. 2 BUDGETARY IMPLICATIONS AND MARKET DISTORTIONS The budgetary burden of the current subsidy program is the most significant impetus for reform. The program now constitutes a drain of at least LE 40 billion a year and is not only increasing the deficit and debt burden, but using resources which would be better spent on other growth and poverty reduction initiatives. With the earmarked increase in fuel subsidies in the next year this figure will rise by over 50%. Reducing the burden on the state budget is a main focus of the 2001 IPFRI paper. The recent newspaper articles on the energy subsidy (Business Monthly, Daily Star ) also highlight this need. All papers reviewed, in fact, contain a discussion on more efficient uses of state resources, and how to reduce the burden on the state coffers while preserving the welfare benefit.

By going outside the market price structure, subsidies also create distortions in several aspects of the economy. Some of the greatest are due to energy subsidies, which have discouraged more efficient technologies since relying on diesel fuel is relatively cheap. The available literature touches on these points, but do no delve into any detailed analysis on the economic costs of such distortions. Helmy (2005) briefly discusses the indirect subsidies involved in financing public corporations in the railway and utility sectors. She also mentions that utility and fuel subsidies have a negative effect on employment, as they encourage energy and capital-intensive industries rather than labor intensive industries. Considering the GOE focus on reducing unemployment as a key goal of the overall economic reform strategy, further studies of these distortions would be helpful in making a case for energy subsidy reform. The World Bank (1999) also notes that food subsidies in the MENA region have hurt agricultural producers and encouraged black marketing.

V. 3 POLITICAL ECONOMY The political economy of subsidy reform and economic reform in general, is a significant factor to consider in the case of Egypt. The memory of the 1977 bread riot, has instilled a cautionary approach to subsidy reform. President Mubarak famously avoided unrest when rather than increasing bread prices, he reduced the size of the baladi bread loaf. Egypt is under pressure to institute democratic reforms, and held its first multi-party presidential elections in 2005. This poses two issues: 1) economic reforms in developing countries have traditionally been more difficult to implement in democracies, as opposed to more autocratic states; and 2) democratization in Egypt reveals some of the vulnerabilities of the current regime, which suffers from the same legitimacy perceptions as neighboring MENA countries. The NDP’s primary opposition comes from the Muslim Brotherhood, as evidenced in the last parliamentary election. While outside the scope of this review, the lack of secular opposition, whether by calculated repression or public realities, constitutes an additional threat to both the current regime and the sustainability of the economic reform program.

There is a great deal written about the political economy of economic reform. However, the studies which focus on the Egyptian subsidy system, while addressing the issue, do not offer extensive consideration. IFPRI, Helmy and Adams dedicate a portion of their studies to the historical background and political economy aspects. Reform recommendations in these papers are in line with political considerations—e.g. gradual changes, preferably

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implemented during economic upswings. Gutner (2002) provides the only dedicated examination to this topic. According to this paper, reform options which minimize political fallout include improving the ration card system, improving baladi bread distribution, and removing or reducing oil and sugar subsidies.

VI. REFORM OPTIONS The GOE has long recognized the need for subsidy reform, and have slowly implemented certain reform measures over the past decade. The number of subsidized food items has been reduced from 20 to, effectively, four, and food subsidy costs as a percentage of the state budget have decreased from 14% in 1980 to 7% in 2005. (No such comparison can be made for total subsidies due to the difficulty of estimating energy subsidies before 2005). However, as key GOE officials and all studies covered here recognize, there is room for much improvement, and subsidies continue to represent an unsustainable drain on the budget. While targeting has improved, substantial leakages still occur, and too many of the non-poor benefit from subsidy spending. To address these issues, the Ministry of Social Solidarity was established in December 2005 to identify the poorest segments of the population and devise the most efficient safety nets for this group. Every food subsidy study recommends reforming the ration card system as a means of better targeting. Currently, 75% of the total population possess ration cards for food items (WFP 2005). Alarmingly, this figure is similar across all income strata—approximately equal proportions of high, middle and low income groups have access to the cards, though the figure is a bit lower for urban areas. The ration card system also suffers from administrative problems, with 40% of ration cards including deceased family members and 50% in the hands of persons who are not registered in the ration card system (WFP 2005). IFPRI estimates that 52% of food subsidy expenditure goes to the non-poor. Another option, advocated by IFPRI and Adams, is removing subsidies on sugar and cooking oil, the least well-targeted commodities. These items contribute far less to the nutritional status of the poor than bread does, and the removal or substantial reduction of their subsidies would have fewer political implications. In fact, the GOE’s subsidy reform policy to date has relied on this approach—gradually reducing the food items covered by the program. Removing items covered by the ration card system would also reduce the administrative costs and inefficiencies associated with that system. Helmy and Siam advocate switching to a cash transfer program. This would entail more significant administrative costs, particularly in maintaining databases of eligible candidates. However, laying the administrative foundation for such a system would facilitate other poverty reduction initiatives in the future. Helmy discusses targeting mechanisms of varying accuracy and their potential application to Egypt. She also discusses the new Smart Card system, which has demonstrated success in Mexico and is currently being piloted in the governorate. These cards contain magnetic data on demographics, income and consumption patterns and will result in a database of beneficiaries and new distribution systems. This data would lay the foundation for a potential cash transfer system. Critics of cash transfers are concerned that without system-imposed controls, families will not spend their money on items which are most likely to improve their welfare. However, experience in

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Latin America and elsewhere has demonstrated that a conditional cash transfer system can have a positive effect on malnutrition, school enrollment and basic health care. Galal (2003) offers a more forward-thinking approach to reform, based on his previous research and on the model offered by the World Bank’s 2003 World Development Report , which ties expenditure to performance and thus relies on rigorous monitoring. The idea that creating incentives and accountability leads to more effective and sustainable reform is not new, but its application to the subsidy sector is not widely practiced. Galal’s recommendations on adopting this approach are mostly limited to the other subjects of the paper—health and education services. There are few Egypt-specific recommendations for overhauling utility and energy subsidies. UNEP/IEA (2002) and Komvies et al (2005 and 2006) propose general solutions and lessons learned from other countries which may provide workable options for the GOE. The urgency of fuel subsidy reform brought on by higher world oil prices means that immediate efforts will most likely concentrate in that sector, rather than in utilities. Utility subsidies are also proven to be better targeted towards the poor, and are thus less likely candidates for far-reaching reforms.

VII. CONCLUSIONS AND NEXT STEPS The purpose of this review has been to review available resources in order to determine the need for future research, which would in turn result in additional policy recommendations for the GOE. As the 2006 World Bank paper has not yet been released, findings are preliminary and may change based on the scope of their research.

Helmy (2005) is the only recent study on Egypt which takes a comprehensive approach to the topic, and is not focused on one sector. She notes in her own literature review that there are indeed few if any studies which look at both food and energy subsidy policy in Egypt. The vast majority of studies investigate food subsidies—in fact, it can be said that this sector has had a disproportionate amount of research and attention considering its relative drain on the budget. This is likely because of the ease of data collection, the treatment (until 2005) of energy subsidies in the budget, and the historical and political associations. Food subsidies also have a more dramatic and apparent impact on poverty.

The series of IFPRI studies provide the most exhaustive source of research on food subsidies. Related IFPRI surveys provide valuable data sets and the recent WFP survey continues this analysis. The wealth of data and breadth of policy recommendations in this sector indicator there is no current need for additional research on food subsidies. Egypt-specific reports on energy and utility subsidies however, are largely absent, despite the proportion of government expenditure they represent. In light of current media attention on the fuel subsidy, further analysis might be useful in assisting the GOE to decide on and implement effective reforms which do not compromise the precarious political balance.

VII. 1 AREAS OF FUTURE RESEARCH Subsidy reform is clearly part of the current GOE economic reform agenda, and recent public statements by Prime Minister Nazif and Minister Boutros-Ghali indicate the political

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will to move forward. Making the costs of energy subsidies more transparent and implementing innovative measures such as Smart Cards demonstrate that the government has undoubtedly made use of the wealth of existing studies on both Egypt and case studies within and outside the region. Any further study undertaken should be reflect GOE priorities and participation. Recommendations on food subsidy reform can easily draw from existing research and datasets.

As the government has not yet decided which direction to take in the energy sector, a more in-depth look at costs and reform options for energy prices in the country would be potentially useful in assisting the GOE to reduce spending while incurring minimal impact on the poor. Such a study should be an integrated part of an overall approach to reforming public expenditure. This approach would also benefit from an examination of subsidies to state-owned enterprises, as part of the overall privatization strategy. As this would help address inefficiencies in the utility and energy sectors, it would encourage a subsidy reform policy which takes the larger reform context into account. For example, as an exporter of petroleum products, Egypt could benefit from higher oil prices if these gains were not offset by subsidy spending in the sector. Although both energy and utility subsides are not extensively addressed, the former requires greater attention due to both the size of expenditures and the relatively small poverty alleviation impact. Research into the current structure and reform options for fuel subsidies would complement the existing research on food subsidies and allow the GOE to develop a holistic approach to subsidy reform, which would in turn enable Egypt’s ongoing progress towards equitable growth.

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PART II – ANNOTATED BIBLIOGRAPHY

Adams, Richard H. Jr. 1999. Self-Targeted Subsidies: The Distributional Impact of the Egyptian Food Subsidy System . The World Bank, Washington D.C. Adams looks at how self-targeted food subsidies affect the incomes and nutritional status of the poor in Egypt, and at how much is leaked to higher income consumers. It pays particular attention to the history of subsidization in Egypt and to political economy aspects—namely, the effect of the 1977 riots and the resulting attitudes towards and options for reform. It contains analysis on distribution based on data resulting from the 1997 household budget survey. After analyzing political factors and the impact of each subsidized commodity on various rural and urban income groups, Adams proposes recommendations for reform. This paper is a follow up to Adams previous collaboration with Sonia Ali, “The Egyptian Food Subsidy System: Operation and Effects on Income Distribution,” World Development 24 (November 1996): 1777-1791. Adams concludes that food subsidies are indeed well targeted, particularly in urban areas, through the self-targeting mechanism of subsidizing inferior goods. Like IFPRI studies, he recommends removing subsidies on sugar and cooking oil.

Ahmed, Akhter U., Howarth E. Bouis, Tamar Gutner, and Hans Löfgren. 2001. The Egyptian Food Subsidy System: Structure, Performance, and Options for Reform . Research Report 119. International Food Policy Research Institute, Washington, D.C. This comprehensive report is one in a series of studies by IFPRI on Egypt’s food subsidy system. The series resulted from a USAID grant and close collaboration with the GOE. Due to the scope of IFPRI research on this topic, their own literature review is included as an annex to this paper. As the resource cited above is their most recent product on this topic, it is the one discussed in the body of this review. The report examines how to reduce costs while maintaining the welfare effects of the current system. It looks at targeting, leakages and options for reform. It examines effects for each subsidized commodity, determining that sugar and oil are the least well targeted, and that baladi bread distribution should be concentrated in poorer neighborhoods. It also notes an urban bias, and suggests that rather than implementing far-reaching reforms such as increasing bread prices or instituting food stamps, there are more feasible and less politically sensitive options—such as reforming the ration card system, reallocating supplies to poorer governorates and mixing maize and baladi wheat flour.

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Alderman, Harold. 2002. Subsidies as a Social Safety Net: Effectiveness and Challenges . The World Bank, Washington D.C. Alderman looks at the effectiveness of subsidies as social protection, and which types of subsidies are better at targeting poorer income groups. His discussions of the benefits of subsidies over cash transfer programs provide a useful alternative view on reform options. It also contains an in-depth analysis on distribution—i.e. who benefits from varying subsidy types. Alderman’s analysis of pricing from multiple perspectives—nutrition, administrative and political costs, distribution etc is sound, comprehensive and a potentially useful input into the reform process in Egypt.

El-Bakry, Rehab. May 2006. Thinking outside the box. Business Mon thly. American Chamber of Commerce in Egypt. Business Monthly interviews the Minister of Social Solidarity. Minister Molselhi outlines his plan to determine where the money is going and how it is being used by implementing surveys to track ration card and cash transfer recipients. This will be used for future policy changes, and to determine a sample for the country’s first Smart Card system—which will distribute assistance while demanding accountability from recipients. Molselhi’s IT, project- focused background is the catalyst for this new approach.

Consumer Food Subsidy Programs in the MENA Region . 1999. Human Development Group, Middle East and North Africa Region. The World Bank, Washington D.C. This World Bank report provides an overview of consumer food subsidy programs in MENA, analyzing costs, efficiency and links to agricultural policy. It draws upon lessons learned in other countries to provide recommendations for reform. The paper makes a case that current systems are plagued by excessive leakages, inefficient targeting and negative impacts on the agricultural sector. The authors suggest a gradual approach to reform which is tied into a broader poverty alleviation strategy. The annex contains useful data on Egypt, particularly on food expenditures and distribution.

Al-Fiqi, Mona. January 26 – February 1, 2006. More efficient subsidy. Al-Ahram Weekly 779 In keeping with recent media attention on subsidies and the budget, Al-Ahram weekly reports on Omneia Helmy’s recent ECES study in light of the announcement from the Minister of Social Solidarity, Ali El-Moselhi, that funds earmarked for subsidies may be increased. The budget released in May reflected this prediction. The article mentions a report that the government plans to increase the electricity subsidy for all but the poorest households by 5%. It also mentions a consumer survey indicating that respondents would prefer that subsidized butagaz be available to households only.

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Galal, Ahmed. 2003. Social Expenditure and the Poor in Egypt . ECES Working Paper Series. Egyptian Center for Economic Studies. . Egypt. Galal assesses the efficiency and equity of food subsidies, health, and education in Egypt and makes policy recommendations based on analysis of various proposed reform approaches. This paper is unique in providing a different philosophy to reform—rather than simply improving inputs, there should be greater emphasis on incentives and accountability. The paper only truly demonstrates this approach, however, to the provision of health and education services rather than to subsidy transfers.

Gutner, Tamar. 2002. The political economy of food subsidy reform: the case of Egypt. Food Policy 27. pp. 455–476. This article is a useful overview of food subsidies from a political economy perspective, which retains relevance in the current political reform climate. Gutner examines the broader issues behind economic reform and political systems and responses. He then looks at Egypt’s own history, from Nasser’s socialist promises to the 1977 riots to later gradual reform steps. Finally, he presents the options for reform in the current political climate. This paper provides a necessary overview of an important aspect of subsidy reform, which would benefit from updates considering recent political developments.

Harik, Iliya. 1992. Subsidization Policies in Egypt/Neither Growth Nor Distribution. International Journal of Middle East Studies 24, Cambridge University, Cambridge, UK. pp. 481-499. While Harik’s article is somewhat dated, it provides a good overview of the mechanics of the subsidy system in Egypt and the recent history. It is also comprehensive—covering food, energy and water subsidies. Harik finds that subsidy expenditures to be a growth and productivity impediment that the government has been impeded from acting by the recent past. His recommendations are less relevant due to timeliness, but he suggests that giving more autonomy to SOEs would be one path to reform, along with rationalization.

Helmy, Omneia. 2005. The Efficiency and Equity of Subsidy Policy in Egypt . ECES Working Paper Series. Egyptian Center for Economic Studies, Cairo, Egypt. This study assesses the efficiency and equity of the current subsidy policy in Egypt and offers options for reform. It is the only current paper which addresses subsidies holistically, rather than focusing on one commodity or sector. Helmy shows that current subsidies of commodities and social services have contributed to poverty alleviation, but at a high cost— increased burden on the treasury, price distortions and commodity arbitrage, and leakage of subsidies to non-target groups. To reform the current subsidy policy, the paper suggests better targeting and pricing mechanisms, and more efficient and equitable public spending on social services. She makes the case for a gradual shift away from price-based subsidy to conditional cash transfers and a new wage policy.

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Komives, Kristen, Vivien Foster, Jonathan Halpern, and Quentin Wodon. 2005. Water, Electricity, and the Poor: Who Benefits from Utility Subsidies? The World Bank, Washington D.C. This very comprehensive World Bank publication provides an overview of the different types of subsidy mechanisms for consumer utilities and how well targeted each is. As in their later paper, the authors conclude that the most common type (quantity-targeted) are the least effective. It weighs negative effects such as waste of scarce resources (e.g. water) with benefits to the poor. The authors note that while utility subsidies are studied extensively in Latin America, the FSU and Africa, no case studies exist for MENA countries. The methods and conclusions of this publication are an excellent reference and starting point for any utility subsidy reform efforts in Egypt.

Komives, Kristin, Jonathan Halpern, Vivien Foster, and Quentin Wodon. 2006. The Distributional Incidence of Residential Water and Electricity Subsidies . World Bank Policy Research Paper 3878. World Bank, Washington D.C. While not focused on Egypt, this study examines commonly held beliefs about water and utility subsidies which are relevant for Egypt. The main topics studies are whether such subsidies disproportionately benefit the poor as believed, and whether poverty alleviation effects are overshadowed by market distortions and poor use of resources. The authors examine different subsidy schemes and which methods are most effective. They determine that the most common type—quantity-based consumption subsidies—is the most regressive.

Oil has been the backbone of the petroleum sector for decades. Now that its heyday has passed, will the industry cope? May 2003. Business Monthly , American Chamber of Commerce in Egypt. This article looks at the issue of energy subsidies from the perspective of the local petroleum sector. A drain on national resources and reserves as propped up by artificially low prices, whose costs on the oil sector translate to additional lost export opportunities. This, along with a culture of careless fuel use (and the resulting environmental impact), and the disincentive to investors must be weighed against the political implications of raising the subsidy, especially the potential impact on the public transport sector.

Rasromani, Waleed Khalil. June 5, 2006. The question of subsidies. The Daily Star Egypt . p. 2. The Daily Star covered the recent debates on the 2006/7 state budget and Minister Youssef Boutros-Ghali’s warnings that failure to act on rising fuel subsidy costs would translate into growing and unsustainable debt in the future. The newly-formed Ministry of Social Solidarity is studying reform alternatives and has begun identifying the poorest segments of the population. Minister of Trade Rachid has also been vocal about the outlays on energy being better used on health and education. The article contains a good overview of key issues with the energy subsidy: benefits to the distributors rather than consumers, the budget line item, LPG subsidies and imports and the effect of subsidizing inefficient industries. The outcry

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from the industrial sector should be smoothed by MTI initiatives to provide training and technical assistance.

Reforming Energy Subsidies. 2002. United Nations Environment Programme and International Energy Agency. This publication’s focus is on the effect of energy subsidies on sustainability. It studies the economic, social and environmental effects of subsidies in this sector and proposes paths to reform. It acknowledges the benefits of utility subsidies, such as those on electricity, for the poor, but advocates the removal or extensive reform of fossil fuel subsidies. The paper does not however give many concrete proposals for reform as it does principles for sound reform. It is a bit more extensive in its electricity recommendations. Though the paper is broad and global, the recommendations and conclusions are in line with general thinking on energy subsidy reform in Egypt.

Richter, Frederik. June 2006. Subsidies fuel budgetary pressure. Business Monthly 22 (6). pp. 38-9. This article, spurred by the announcement that the budget for fuel subsidies would almost double this coming year, looks at the distortions caused by artificially low fuel prices and the efforts that the GOE are implementing to reduce costs in light of high oil prices. In an unpopular move, diesel subsidies were cut in 2004 and in 2005, two less subsidized, higher- octane premium fuels were introduced (self-targeting on superior goods). The GOE has backtracked on announcements to raise fuel prices, despite the fact that it is among the worst-targeted subsidies. A ration card scheme has been proposed, but not decided on.

Siam, Gamal M. 2006. An assessment of the impact of increasing wheat self- sufficiency and promoting cash-transfer subsidies for consumers in Egypt: A multi- market model . ESA Working Paper No. 06-03. Food and Agriculture Organization, Rome, Italy. This paper looks at wheat subsidies in relation to a larger agriculture production strategy and the goal of wheat self-sufficiency. As Egypt is a major wheat importer, increased self- sufficiency is viewed as a step towards greater food security. The author present a model which looks at the impact of alternative programs (e.g. cash transfers) on wheat production and importation, rural and urban household income and the government budget. It analysis repercussions of three policy scenarios: wheat self-sufficiency at 65%, 75% and 100%; replacing subsidies with cash transfers and raising the price of wheat by 20%. Siam concludes that a cash transfer system would allow for better targeting and fewer leakages and would be a politically acceptable reform path.

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Tuck, Laura, and Kathy Lindert. 1996. From Universal Food Subsidies to a Self- Targeted Program: A Case Study in Tunisian Reform . World Bank Discussion Paper No. 351. The World Bank, Washington D.C. Though this paper focuses on Tunisia, there are many similarities between the Tunisian subsidy experience in terms of history, structure and reform undertaken. Like Egypt, Tunisia moved from universal food subsidies to a self-targeted system, focusing on subsidizing inferior goods. Tunisia has also experienced similar political sensitivities and bread riots following the attempted removal of price controls on several major food products. The reformed system in Tunisia has indeed had a dramatic effect on relieving the budgetary burden. Furthermore, a greater proportion of subsidies now directly benefit poorer income groups. The study is useful for Egypt because although they have employed similar strategies, Tunisia’s self-targeting scheme is more sophisticated in its targeting measure— for example, eliminating subsidies on cube sugar and shifting subsidies towards less refined brown sugar. The authors make recommendations for additional reform measures.

Vulnerability Analysis and Review of Food Subsidy in Egypt . 2005. World Food Programme Egypt, Cairo, Egypt. The World Food Programme recently undertook two wide-reaching surveys to assess the impact of food subsidies on food security. The surveys aimed to identify and characterize vulnerable groups, determine the effect of subsidies on these groups and provide data and recommendations for reform. The study is valuable for the wealth of data produced and the contribution to the subsidy debate from a poverty alleviation/malnutrition standpoint. Short, medium and long term policy recommendations include changing the basket of commodities, switching to a cash subsidy system, and obtaining better estimates of targeted populations. The survey included questions and resulting data on other social assistance such as housing, water and medical subsidies.

World Bank Egypt Subsidy Study. 2006 This study has not yet been released and was not available for review.

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APPENDIX – EARLY IFPRI RESEARCH From: A Review of Food Subsidy Research at IFPRI , Impact Assessment Discussion Paper No. 12 by Curtis Farrar, 12 January 2000

FOOD SUBSIDIES IN EGYPT From 1980 onward, IFPRI’s research on food consumption shifted focus and scope. Its intention of producing a synthesis of experience with food subsidies in South Asia gave way to wider geographical coverage. The expansion was led by research in Egypt on a larger scale than anything IFPRI had done before at the country level. Generous funding from the Office of Nutrition at the U.S. Agency for InternationalDevelopment (USAID) made this fresh approach possible. At the time, Egypt and the agencies aiding Egypt, particularly USAID, the World Bank, and the IMF, were anxious about the state of the food subsidy system. Fortified by strong political support, that system was consuming 10 percent or more of current government expenditures and providing cheap rations to 90 percent of the populace. Suspicions of waste were rife, fueled by the fact that bread was so cheap it was sometimes being used to feed livestock. Despite the stated national goal of food self-sufficiency, Egypt produced only a quarter of the wheat and edible oil it consumed (Alderman, von Braun, and Sakr 1982). With a total budget of $500,000 for the years 1981–83, IFPRI was asked to cover the following issues: • household decision-making and how it was influenced by perceived costs of subsidized foods; • the extent to which both consumers and non-consumers obtained benefits from the subsidy program, legitimately or otherwise; • direct effects of subsidy policies on the real income, consumption, and nutrition of various population groups, with emphasis on the urban and rural poor; • the implications of procurement and pricing policies for domestic food production and the income of farmers and others in rural areas; • government expenditures on subsidies, sources of financing these costs, the distribution of the cost burden, and the implications for investment and inter-sectoral terms of trade; and • the impact of food subsidies on trade and foreign exchange (Alderman and von Braun 1986a, 1–2). This project was different in several important ways both from earlier work on subsidies and from IFPRI’s research in general up to that point. Instead of relying on information already available from government sources or limited data collected by researchers themselves, the

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project was based on a large household survey (Pinstrup-Andersen in von Braun and Puetz 1993, 13). IFPRI could not use the extensive rural surveys conducted by the Egyptian Government, which were more than five years old and did not contain the details needed to analyze the distribution of subsidy benefits. Moreover, it was doubtful that IFPRI could obtain access to the raw data collected by the government. Accordingly, three survey rounds with broad geographic coverage, two rural and one urban, were conducted between December 1981 and June 1982. Three thousand households were surveyed. The second rural round resurveyed a portion of the households to obtain information on seasonal factors. The survey work was carried out through a contract with the Institute of National Planning, a governmental body. With logistical help from the Ford Foundation, two IFPRI staff members lived in Cairo from February 1981 through August 1982 in order to oversee the data collection (Alderman and von Braun 1984, 13–14; Anderson, Herdt, and Scobie 1988, 72).

Another significant difference from earlier work involved the nationality of the principal researchers. Previous subsidy studies had been done primarily by nationals of the country under study, either by academics who spent time as visiting researchers at IFPRI or by IFPRI staff members from the country concerned. The work on Egypt, however, was done preponderantly by IFPRI staff members from industrialized countries. Per Pinstrup- Andersen, who served as project coordinator, was a Dane. An American and a German supervised the data collection and wrote much of the analysis. A New Zealander conducted the research on the impact of food subsidies on trade and the budget. Only one Egyptian appeared on the list of senior researchers. He coauthored an initial descriptive study of the Egyptian food subsidy system. Notwithstanding the absence of Egyptians from the research team as such, extensive cooperation took place between IFPRI and Egyptian officials, scholars, and their institutions, from the planning of the project through to its completion and the presentation of results (Anderson, Herdt, and Scobie 1988, 72). The fact that IFPRI researchers resided in Egypt for long periods, that senior IFPRI staff frequently visited Egypt, and that Egyptian economists spent time at IFPRI as visiting research fellows greatly facilitated this collaboration. Yet one can surmise that the objectivity of this research may owe something to the fact that the authors were not participants in the domestic political scene in Egypt. The principal difference, however, between the Egypt project and earlier IFPRI projects, not only on food subsidies, but in general, was simply the scale of the output. USAID funding proved sufficient to support four full research reports:

• Egypt’s Food Subsidy and Rationing System: A Description (Alderman, von Braun, and Sakr 1982) was essentially a background study for the project. It closed with a summary of the major research issues to be addressed. • Food Subsidies in Egypt: Their Impact on Foreign Exchange and Trade (Scobie 1983) reflected collaboration between IFPRI’s Consumption and Trade programs. Grant Scobie, who wrote this report as a consultant, spent a year as a visiting researcher in the Trade program, just as the Egypt project was getting under way. At the time Scobie was working on a study of the management of wheat imports in Egypt, as part of the Trade program’s research on international food security. His work served as a useful introduction to the trade aspects of the subsidies research (Scobie 1981). Scobie fulfilled an additional project task with a report on the budget impact of subsidies, published later as an IFPRI working paper (Scobie 1985).

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• The Effects of Food Price and Subsidy Policies on Egyptian Agriculture was a collaborative effort between an IFPRI researcher and a professor at the University of Göttingen (von Braun and de Haen 1983). It made extensive use of microeconomic quantitative models developed by the Institute of Agricultural Economics at the University of Göttingen and IFPRI’s partner in the household survey, the Institute of National Planning, Cairo. Under this collaborative arrangement, IFPRI was able to benefit from a related research project funded by the Volkswagen Foundation and implemented by its German and Egyptian collaborators, and was also able to enhance relationships with the European agricultural research community.

• The Effects of the Egyptian Food Ration and Subsidy System on Income Distribution and Consumption was prepared by the two IFPRI research fellows who had been deeply engaged in the project since its beginning. This study showed that the Egyptians in general were well fed in comparison with people in other developing countries, and that the poor did receive considerable benefit from the food subsidy system (Alderman and von Braun 1984). The order of publication and the interval between the first three reports and the fourth report led to IFPRI’s involvement in a public exchange that illustrated two points: first, the publication of research on sensitive topics before it is complete can be risky; second, the donor world at that time eagerly awaited results supporting the goals of structural adjustment. In April 1984, the Economist published a set of articles on the need for further economic reforms in Egypt, accurately citing conclusions of the first three IFPRI reports, and then decrying the harm done by food subsidies to the Egyptian economy ( Economist 1984a). Researchers von Braun and Alderman wrote to the editor, pointing out that the report describing the benefits of the system to the Egyptian poor was still to be published and suggesting that agencies seeking rapid reform often tended to overlook such benefits (Economist 1984b). The latter passage caused concern at high levels in USAID but no long- term damage to the relationship with IFPRI. Field research on and analysis of Egyptian food subsidies in fact had been basically completed by mid-1983. The results were immediately taken to Cairo for detailed discussion with the users, well before the completion of the full set of formal publications listed above. An all-day presentation in July 1983 for the Egyptian and expatriate research communities in Cairo was followed by a series of smaller sessions in the offices of several ministers, deputy ministers, and under secretaries who had been instrumental in defining the scope of the study. They had also been consulted by resident IFPRI staff and had visited IFPRI while the study was under way. According to one observer, “Egyptian policymakers were particularly eager to use the studies to project the likely effects on wages and income distribution of changes in subsidy policy and to investigate alternative methods for targeting.” (Anderson, Herdt, and Scobie 1988, 72) IFPRI prepared a follow-up proposal to use the results of research in the manner just described. The proposal produced apparently favorable reactions in both USAID and Egyptian circles, but never received the formal Egyptian government approval that USAID required to provide funding. No explanation was given. IFPRI now found itself without the resources needed to prepare a comprehensive synthesis of this work. When it became clear that a USAID follow-up was unlikely, the Ford Foundation’s Cairo Office provided a grant to cover some part of the follow-up work.

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Alderman and von Braun wrote a report for the Foundation on the “Implications of Alternative Food Subsidy Policies in the 1980s.” This unpublished report provided the basis for a final report to USAID (and thus to the Egyptian government) and an article in Food Policy (Alderman and von Braun 1986a and 1986b). The following key points from the Food Policy article summarize the results of this research. Alderman and von Braun reviewed six scenarios for the Egyptian food subsidy system in the 1980s and listed 25 “generalized research conclusions.” The scenarios started from the picture of the situation in 1981–82 that emerged from the data collected by IFPRI and its Egyptian collaborators. Scenarios assumed varying price changes, ranging from a fifty percent decline in the real level to an increase up to the world price for all food except wheat products, the price for which was increased only halfway up to the world price. Targeting was introduced in one scenario by retaining the basic ration only for the poorest 25 percent of the population, and in a second by adding a pay raise for government employees. The sixth and final scenario incorporated increases in the price and changes in the distribution structure actually adopted by the government in 1982 and 1984. The authors pointed out that they had not tried to predict the policy priorities of the Egyptian authorities. However, their model could be adapted to forecast changes in the food subsidy budget, foreign exchange, inflation, exchange rate, individual level of food consumption and nutrition, and income distribution resulting from any set of proposed policy changes. The forecast was valid for the five years following its base point in 1981–82. It became less relevant further into the future. The analysis was meant to provide policymakers in Egypt with a mechanism for considering the implications of policy objectives and the trade-offs among those objectives. The conclusions of IFPRI’s study of food subsidies in Egypt included the following points: • The introduction of food subsidies was not an isolated decision made in the early 1970s when budget costs began to be significant. It was rather the outcome of earlier policies to finance industrial growth through implicit transfers of income from producers to consumers. As self-sufficiency in food production declined, a natural transition took place from implicit to explicit subsidies, with the cost transferred from the producers to the government.

• The budget cost of the subsidies could be measured directly, but an additional, concealed, social opportunity cost arose from the use of an exchange rate below the normal rate for commodity transactions and below the free market rate. A further cost arose from the preemptive use of foreign exchange for food imports when foreign exchange was scarce or international food prices high. This action diverted resources that would otherwise have been used for the import of capital goods and raw materials. By this mechanism, instabilities in the international food markets slowed domestic capacity utilization and overall growth.

• The rising cost of subsidies contributed to the budget deficits, but was only one factor and could not be held solely responsible for the financial difficulties of the Egyptian government. • The price distortions caused by food subsidies could not be blamed exclusively for the slow growth of Egyptian agriculture. The impact of the subsidies was reduced by other policies that succeeded in raising investment in agriculture and reducing the burden on

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farmers. There were also other factors not related to subsidies that hindered the growth of agriculture such as poor management of the water supply and other inputs, and an inefficient system of agricultural extension.

• The subsidy system provided widespread benefits to consumers, both urban and rural. Analysis of income transfers through the ration component showed a clearly progressive effect on income distribution. Some elements of the system favored particular groups more than others, however, and the subsidy of certain commodities with positive income elasticities provided larger income transfers to those with higher incomes.

• The ration system proper, which provided fixed amounts of flour and/or bread, was reasonably efficient. But the de facto rationing of other subsidized foods through queuing at the cooperatives where they were distributed did have resource costs. These costs should be deducted from the value of the resource transfer. In 1982 about six percent of the wheat supply was used as livestock feed, leading to wastage of the subsidized costs of processing and distributing that wheat for humans. The resulting output of livestock products partially offset this wastage. • The Egyptian economy faced difficult choices between current consumption and investment. Decisions were also needed about food subsidies, energy prices, and other matters. In light of these policy needs, the authors noted the following: “Conclusions from a model built on the basis of the in-depth partial analysis reported [in this article] provide the basis for policy guidance for answers to the following question: if a decision on food subsidy policies is to be made, what are the effects of alternative options on macrovariables as well as on the various segments of the population and the poor, in particular? Accounting for fiscal and economic costs of food subsidies only makes sense if those outlays are related to the benefits of food subsidies¼ Therefore, the policy options should be simultaneously evaluated for their costs and for the distribution and magnitude of their benefits.” (Alderman and von Braun 1986b, 236. Emphasis in the original.)

The article concluded by pointing out that policy changes in areas other than food subsidies—in energy prices, for example—could help the government meet diverse goals, including, indirectly, increased food consumption. No specific Egyptian government actions taken after the completion of research can be traced directly to the research itself. No strongly formulated recommendations came out of the project. The results could have been used to argue that many aspects of subsidy policy, while costly, were effective in redistributing income and favored the rural as well as the urban poor. The study offered the general conclusion that price reform was not the panacea for increasing food production that it might have appeared to be. Moreover, this was a situation in which political sensitivities drove decisionmaking to a great extent, and large costs were willingly paid for critical national goals. It seems clear, however, that IFPRI’s research conclusions did provide a methodology for appraising the impact of various possible policy changes, and that this methodology was widely known to the government decisionmakers and policy analysts. As IFPRI went back to Egypt in the mid- 1990s, Egyptian colleagues found occasion to refer back to the earlier studies as the standard to which the Institute would be held in the new research.

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Technical Assistance for Policy Reform II BearingPoint, Inc, 18 El Sad El Aali Street, 18 th Floor, Dokki, Egypt Country Code: 12311 Phone: +2 02 335 5507 Fax: +2 02 337 7684 Web address: www.usaideconomic.org.eg