# 1 Introduction

The rapid rise in food prices between 2005 and the first half of 2008 has raised numerous concerns about potential negative welfare impacts of a world with higher food prices, particularly among poor households and those with incomes just above the poverty line.<sup>1</sup> At the same time, to date there have been few formal assessments of the likely impacts of higher food prices on global poverty, and none using a large sample of developing countries. This paper aims to bridge the existing knowledge gap by providing a set of estimates of the likely impacts of higher food prices on poverty and income distribution at the global level using a unique set of household survey data.

The economic effects of changes in relative prices have been a well-researched subject including contributions by Deaton (1989), Ravallion (1990), and Ravallion and van de Walle (1991) among others. According to this literature, changes in food prices can affect poverty and inequality through consumption and income channels (see Figure 1). On the consumer side, as food prices increase, the monetary cost of achieving a fixed consumption basket increases hence reducing consumer’s welfare. However, for the segment of the population whose income depends --directly or indirectly-- on agricultural markets, i.e. self-employed farmers, wage workers in the agricultural sector, and rural land owners, the rise in food prices represents an increase in their monetary income. For each household, the net welfare effect of an increase in food prices will depend on the combination of a loss in purchasing power (consumption effect) and a gain in monetary income (income effect). Clearly, for those households whose income has no linkages with the agricultural markets, for instance urban dwellers, the net welfare effect of an increase in food prices will be entirely determined by the negative consumption effect. For households whose incomes are closely related to the performance of agricultural markets and for which food consumption represents a small proportion of their total budget, higher food prices would be welfare-improving. Therefore, the _first-order_ , or direct, welfare effects of shifts in food prices will be determined by the household’s net position on food supply or demand. In the medium run, once quantities produced are adjusted to reflect the new set of prices in the economy, wages and/or employment in the agricultural sectors will increase to attract the necessary factors of production to increase output --this is what it is known as the _second-order_ , or indirect, income effect (see Figure 1).<sup>2</sup> The approach depicted in Figure 1 was undertaken in a recent study by Ivanic and Martin (2008). Using detailed household-level information, the authors find that the proportion of the population living below the poverty line has increased as a result of higher food prices in eight of the nine countries included in their study. In a related study, Friedman and Levinsohn (2002) identify the urban poor as the most vulnerable group during a period of food inflation. Ravallion (1990) develops and tests a methodology to assess the

> 1 Between July 2008 and February 2009, international agricultural prices (in nominal terms) have come down by 32 percent, but are still 45 percent above their January 2005 levels.

> 2 Arguably, there is also a “second-order effect” taking place in the consumption side, that is, given the new set of prices, the consumer can chose a different consumption basket. This effect is ignored in the present analysis based on the high degree of correlation among food prices and the little scope that the poor have for food consumption substitution.

2