# **1. Introduction**

The basis for poverty and inequality analysis is household welfare, which is commonly measured by household consumption (Deaton and Zaidi 2002; Ravallion 2008).<sup>2</sup> A key component of welfare measurement is price adjustment. To compare the welfare level of households over time and across regions, household consumption aggregates need to be adjusted by accounting for inflation (that is, temporal price adjustment) and cost-of-living differences across regions (that is, spatial price adjustment).<sup>3</sup> Inappropriate adjustments of such price difference cause a bias in poverty estimation. Spatial price adjustment becomes particularly important when policy makers need to know not only who is poor but also where poverty is concentrated.<sup>4</sup> Despite the importance of spatial price adjustment on welfare measurement for poverty and inequality analysis, its underpinning theory is not necessarily clear to guide the practice. Many low- and middle-income countries apply different methods, without a rigorous methodological foundation, often facing the limited availability of price data suitable for spatial price adjustment as the biggest challenge.<sup>5</sup> The recently collected survey by the World Bank illustrates how the current practice of spatial price adjustment varies among Sub-Saharan African countries (Figure 1).<sup>6</sup> In its internal process of developing a regional poverty database, the World Bank collected from 47 Sub-Saharan African countries information about the data sources and methods used for price adjustment. In terms of data sources (Panel A), about 40 percent of African countries rely on survey unit values, which is a proxy measure of prices calculated by dividing households’ expenditures by the purchased quantity for each good based on household budget or welfare surveys. While unit values might be useful in cases where price data are lacking, the problems related to unit values have been reported in several studies (Gibson and Kim 2019; McKelvey 2011). Another 26 percent of the countries use market price surveys, which are often collected in parallel to the official household budget or welfare surveys. A small number of countries use their Consumer Price Index (CPI) data for spatial price adjustment. The methodology of spatial price adjustment is more divided with countries applying different approaches (Panel B), including the Paasche index (25 percent), Laspeyres index (15 percent), Fisher index (13 percent), and so on.

> 2 Some countries rely on household income, instead of consumption, for poverty measurement (Ferreira et al. 2016).

> 3 ‘Region’ refers to subnational regions in this paper unless otherwise noted.

> 4 For example, as the cost of living in African cities is high relative to their income levels (Nakamura et al. 2019), urban poverty can be underestimated without adequate spatial price adjustment.

> 5 Some approaches to circumventing the data limitation include the Engel curve method (discussed in Appendix B of this paper) and price data collection from local experts (Gibson and Le 2018).

> 6 Africa refers to Sub-Saharan Africa in this paper unless otherwise mentioned.

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