# **Preface**

The objective of this tool-kit is to provide a relatively simple and efficient tool to simulate the impact of price reforms on household welfare and government revenues.

The work is motivated by a combination of factors. First, there is currently a large demand on the part of governments in the MENA region and elsewhere in developing and emerging economies to reform consumption subsidies and reduce budget expenditure on these subsidies. This is due to the increasing fiscal pressure generated by the global increase in commodity and food prices and by the volatility of changes in these prices. In the presence of subsidies on imported food and commodity items, governments have difficulties in predicting budget needs and often find themselves financially uncovered when prices increase. The tool-kit should allow analysts to provide <u>timely responses</u> to governments wishing to understand the economic implications of price changes.

Second, simulating the impact of subsidies reforms on household welfare and government revenues is time consuming. The gathering of data, the preparation of the simulation model and the preparation of a report are all time consuming activities that require months on end to be completed. Because of the volatility of global food and commodity prices, by the time a subsidies report is ready either the government has lost interest in the issue or the data on which the report is based is out of date. The toolkit proposed should help analysts to significantly improve on speed of analysis.

Third, there is little consistency across existing studies on subsidies in terms of methods to evaluate the impact of price changes on household welfare and government revenues. Some studies use simple incidence analyses, others make an effort to consider behavioral changes and demand elasticities and others are simply silent on the underlying methodology used. The tool-kit proposed outlines in detail assumptions, economic theory, formulae and empirical issues related to the model so that estimations can be replicated with the same methodology for different products and in different countries.

This first version of the tool-kit aims at being simple and focused. The focus is on selected data, products, assumptions, inputs, outputs. The intention is to provide answers for standard cases and data settings. The only data required is one cross-section household survey. Products are stylized into two prototypes described as singled priced goods (such as bread or sugar where prices are fixed irrespective of quantities consumed) and multiple priced goods (such as utilities where prices change according to quantities consumed). Assumptions are limited to the medium-term scenario where we consider inflation and behavioral changes but not savings and investments. The inputs of the model are the price change, inflation and elasticities and the outputs are changes in household welfare and government revenues.

The work <u>complements other efforts carried out by the World Bank on micro-simulations such as the</u> package ADePT and should eventually be integrated into ADePT in a second stage of the work. During the first stage of the work, we expanded on the treatment of inflation, elasticities and multiple priced goods. There is an explicit treatment of inflation as a separate effect from the price shock simulated. An effort is made to provide guidelines for the estimation of demand elasticities for different types of goods. For the first time, we distinguish between single priced and multiple priced goods and provide tools for the analysis of both types of goods. In particular, the case of multiple priced goods is treated in detail with the support of economic theory and estimation formulae for household welfare and government revenues.

4