Macro-economic Implications of Electricity Subsidies by Paul Dorosh, IFPRI
IFPRI Macro-economic Implications of Electricity Subsidies Dario Debowicz, Paul Dorosh and Angga Pradesha Productivity, Growth and Poverty Reduction in Rural Pakistan Pakistan Strategy Support Program (PSSP) December 13-14, 2012 Islamabad, PakistanINTERNATIONAL FOOD POLICY RESEARCH INSTITUTE
Resolving Pakistan’s Electricity Crisis: IFPRI Macro-economic Implications of Alternative Policy Options Dario Debowicz, Paul Dorosh and Angga Pradesha International Food Policy Research Institute (IFPRI) First presented in Islamabad, Pakistan 25 July, 2012 This presentation is based on a note written by Dario Debowicz, Paul Dorosh and Angga Pradesha. Sherman Robinson, Haroon Sarwar Awan, Wajiha Saeed and Syed Hamza Haider also provided valuable inputs to the disaggregation of the Social Accounting Matrix and analysis of Pakistan’s energy sector. This work was funded by the United States Agency for International Development (USAID) through IFPRI’s Pakistan Strategy Support Program.INTERNATIONAL FOOD POLICY RESEARCH INSTITUTE
Plan of Presentation Introduction: Electricity Shortages and Subsidies Methodology: Data and Model Simulations • Additional load shedding with no change in the subsidy; • No additional load shedding; increased subsidy financed through domestic borrowing and thus reduced investment • No additional load shedding financed through an increase in money supply (monetizing the fiscal deficit). Concluding Observations: Growth, Employment and Inflation Tradeoffs
Pakistan’s Energy Sector: MajorProblems Frequent electricity shortages (load-shedding) • Load shedding as a percentage of demand (actual sales plus load shedding) increased from 2.8% to 22.9% from 2007 to 2010. Arrears in payments Massive fiscal subsidies which are often seriously underestimated in the budget • In 2007-08, 2009-10 and 2010-11, the realized (actual) value of the subsidy was two to three time the budgeted amount.
Pakistan Energy-Related Subsidies2006-07 to 2011-12 (mn rupees)Source: Calculated from data from Federal Budget in Brief (various years).
Methodology Dynamic economy-wide real-side CGE model plus a simple equation determining aggregate price level• Data base: 2007-08 Pakistan Social Accounting Matrix (SAM) • 62 Activities; 27 factors of production; regional disaggregation of agriculture; 19 household groups Key model features: – Disaggregation of agricultural sectors – Links to upstream (processing) activities – Inclusion of non-agricultural industries and services – Regionalization by province – differentiation among household with different resources and sources of income
Main sources of data for the SAM• 2007-08 National Accounts • Value added by 15 sectors • Macroeconomic Aggregates• 1990-91 Input-Output Table (97 sectors)• 2007-08 Agricultural Statistics of Pakistan• 2007-08 Pakistan Integrated Household Survey (consumptiondisaggregation)• Commodity level trade data from the Ministry of Finance• 2000-2001 SAM for Pakistan which uses the 2001 PakistanRural Household Survey (for household income disaggregation)
Rules for Supply-Demand Balances (Model Closure)• Commodity markets • Prices adjust to equate supply and demand• Capital is fixed by sector • Total livestock capital is fixed but is mobile across region• Land is fixed by region, but is mobile across crops• Labor markets • Urban skilled labor: Nominal wages are fixed; levels of employment (and unemployment) are endogenous • Other labor: Total supply of labor of each skill type is fixed (and fully employed); real wages of other labor adjusts so that demand for labor is equal to supply
Design of Simulations• Compare three alternative policies to address the electricity crisis: • 1) additional load shedding with no change in the subsidy; (the base scenario assumes 25 percent load shedding in 2011-12). • 2) no additional load shedding with an increased subsidy resulting in a larger budget deficit (implicitly financed through domestic borrowing and thus reduced investment); and • 3) no additional load shedding financed through an increase in money supply (monetizing the fiscal deficit).• Each simulation is run twice: once assuming flexible real wages and full employment and a second time with open unemployment.
Productivity Effects of Electricity ShortagesTotal factor productivity in each sector is reducedaccording to the following formula: ECOSTa αa PLa = ES TCOSTaPLa : % decline in output (productivity loss)ES: Electricity Shortage (% load shedding),ECOSTa : cost of electricity (intermediate input) in sector a;TCOSTa : total cost of production of sector a,αa : substitutability factor in sector a.
Simulation 1: Additional Load Shedding We model additional load shedding (an increase of 50 percent, i.e. from 25 percent to 37.5 percent of the time) with no change in the subsidy. Assuming flexible real wages, reduced sectoral productivity results in a 1.3 percent decline in real GDP. • Under an assumption of open unemployment (Simulation 4), real GDP falls further (1.5 percent) and employment declines by 0.6 percent. Investment also falls (by 1.2 percent with flexible real wages and 1.6 percent with open unemployment) because the reduction in real GDP implies lower incomes and lower total savings in the economy, thereby limiting finances available for investment.
Simulation Results: Macro-economic Effects of Alternative Electricity Policies Sim 1 Sim 2 Sim 3 Sim 4 Sim 5 Sim 6 No load shedding; Load shedding; No load shedding; monetized no increase in increase in subsidy increase in Sim 1 with open Sim 2 with open Sim 3 with open Base subsidy and budget deficit subsidy unemployment unemployment unemployment (% change) (% change) (% change) (% change) (% change) (% change)Real GDP 17,238.0 -1.3 0.0 0.0 -1.5 -0.1 0.0Fiscal balance -683.0 0.3 19.7 1.0 0.8 19.7 1.0Investment 1,983.5 -1.2 -3.8 0.4 -1.6 -4.0 0.4Inflation 12.0 0.0 0.0 1.6 0.0 0.0 1.6Unemployment 5.9 0.0 0.0 0.0 0.6 0.3 -0.1 Base data: Real GDP and fiscal balance are in billions of Pakistan rupees 2010/2011; inflation and unemployment are percentages. Sources: Model simulations; Pakistan SAM 2010/11.
Simulation Results: Macro-economic Effects of Alternative Electricity Policies 2.0 1.0 0.0 Real GDP Investment Inflation Unemployment -1.0 Percent -2.0 -3.0 -4.0 -5.0 Load Shedding Increased Subsidy Increased Subsidy MonetizedNote: Change in inflation and unemployment are in percentage points.Source: Model simulations
Simulation 2: Increased Electricity Subsidy If the electricity subsidy is increased (by an assumed 50 percent) so that load shedding is unchanged from the base scenario… The fiscal deficit increases by 19.7 percent (by 0.7 percent of real GDP). • Under an assumption of open unemployment, real GDP declines by 0.1 percent and unemployment increases by 0.3 percent, but the change in the fiscal deficit is the same: 19.7 percent. In both simulations, the decline in total savings in the economy causes a reduction in investment (by 3.8 to 4.0 percent).
Simulation 3: Additional Load Shedding Financing an increased energy subsidy through expansion in money supply prevents a short-run decline in real GDP but could potentially increase money supply and the price level by about 2 percent. Real GDP is essentially unchanged under both labor market closures: fixed real wage and open unemployment. The electricity subsidy is essentially financed through an inflation tax (a loss in the value of money held by households and enterprises) equivalent to about 0.8 percent of total household expenditures. A full analysis of these policy options would require a fully specified financial sector. These simulations were done using a simple monetary sector framework assuming the subsidy leads to an equivalent increase in M2 with a constant velocity of money.
Household Income Effects In Simulation 1, the urban poor have smaller declines in incomes than the rural poor or the national average as the decline in total factor productivity in non-agricultural sectors leads to an increase in returns to informal sector capital (a major source of income of the urban poor). In Simulation 2, by contrast, the large decline in investment reduces demand for unskilled non-agricultural labor in construction and other activities, reducing the incomes of the urban poor by more than other groups. Finally, in simulation 3, both rural and urban poor suffer larger declines in real incomes than the urban non-poor since this latter group enjoys a gain in returns to formal capital.
Simulation Results: Household IncomeEffects of Alternative Electricity Policies Source: Model simulations
Tradeoffs Between Output/Employment, Growth and Price Stability• If there is no increase in the electricity subsidy and total load shedding increased by 50 percent relative to 2010/11, real GDP could decline by 1.3 to 1.5 percent with up to a 0.6 percentage point increase in unemployment.• An increase in the electricity subsidy financed through government borrowing in the domestic economy could prevent a significant decline in real GDP and employment, but reduce investment by 3.8 to 4.0 percent of GDP and hamper future growth.
Tradeoffs Between Output/Employment,Growth and Price Stability• Financing an increase in the electricity subsidy through increases in the money supply could likewise prevent a fall in real GDP or employment, but would raise money supply and the aggregate price level by about 2 percent.
Next Steps• Further refinement is needed on: Productivity effects of electricity load shedding across sectors Behavior of the labor markets in Pakistan to enable better estimates of the effects of policy on employment. A fuller specification of the monetary and financial sectors to better estimate the effects of budget deficits on inflation.• Other approaches to the modeling the macro- linkages between real output, money supply and price level are also being planned: Full specification of financial sector in a CGE model Dynamic stochastic general equilibrium model