Welfare and distributional impacts of price shocks in Malawi: a non-parametric approach

Abstract

This analysis used measures of Compensating Variation and Net Benefit Ratio to assess the short-run effects of higher prices on different wealth groups in rural and urban areas of Malawi. Compensating Variation analysis indicated that in aggregate terms, both rural and urban households had suffered with the recent price increases, but urban areas were more severely impacted. Relatively better-off households in urban areas had much larger welfare losses than the poorest, while in rural areas there was not much difference across wealth groups. Losses in expenditure on food consumption (particularly dominated by cereals and grains) were higher in rural areas. In both areas, the poorest households carried the heaviest burden of the food price increases. The opposite result was found for non-food items, where negative effects were stronger among urban households and, in both areas, the relatively better-off carried a heavier burden. Accounting for substitution effects in consumption, with households adjusting away from more expensive items, resulted in a significant reduction in welfare losses and poverty incidence in urban, but not in rural areas. In each scenario, female-headed households experienced the most adverse impacts. Results were translated into tangible policy and programmatic recommendations, specifying alternative budget scenarios which could compensate the most adversely affected groups. Net Benefit Ratio Analysis, which brings in supply side considerations, found that, assuming “no wage effects”, doubling the price of food would reduce real income by about a third in urban areas, and by less that a fifth in rural areas, with the poorest in each area suffering the most. This is a reflection of the fact that there are relatively more households that produce and sell in rural areas than in urban areas. Assuming a wage response to price increases, we find that the adverse effects were reduced more strongly in urban areas, which is a reflection of a more active wage labor market in those areas, where wage adjustments help to minimize the negative effects of price shocks. This analysis suggested that policies should be oriented towards supporting household livelihoods by strengthening social protection interventions, including direct cash transfers and labor intensive public works programs, to effectively protect and compensate households for welfare losses that result from price shocks. In order to be able to capture general equilibrium and long-term effects of price shocks and adjustment to them, it is recommended that future research should combine partial equilibrium methods with a general equilibrium framework.