Shadow Prices for Trade Strategy - World Bank Documents

Shadow Prices for Trade Strategyand Investment Planning in Egypt O'

SWP521John M. Page, Jr.

WORLD BANK STAFF WORKING PAPERSNumber 521

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WORLD BANK STAFF WORKING PAPERSNumber 521

Shadow Prices for Trade Strategyand Investment Planning in Egypt

John M. Page, Jr.

The World BankWashington, D.C., U.S.A.

Copyright © 1982The International Bank for Reconstructionand Development / THE WORLD BANK1818 H Street, N.W.Washington, D.C. 20433, U.S.A.

All rights reservedManufactured in the United States of America

This is a working document published informally by The World Bank. Topresent the results of research with the least possible delay, the typescript hasnot been prepared in accordance with the procedures appropriate to formalprinted texts, and The World Bank accepts no responsibility for errors. Thepublication is supplied at a token charge to defray part of the cost ofmanufacture and distribution.

The views and interpretations in this document are those of the author(s) andshould not be attributed to The World Bank, to its affiliated organizations, or toany individual acting on their behalf. Any maps used have been preparedsolely for the convenience of the readers; the denominations used and theboundaries shown do not imply, on the part of The World Bank and itsaffiliates, any judgment on the legal status of any territory or any endorsementor acceptance of such boundaries.

The full range of The World Bank publications is described in the Catalog ofWorld Bank Publications; the continuing research program of the Bank is outlinedin World Bank Research Program: Abstracts of Current Studies. Both booklets areupdated annually; the most recent edition of each is available without chargefrom the Publications Distribution Unit of the Bank in Washington or from theEuropean Office of the Bank, 66, avenue d'Iena, 75116 Paris, France.

Library of Congress Cataloging in Publication Data

Page, J. M. (John M.) 1949-Shadow prices for trade strategy and investment

planning in Egypt.

(World Bank staff working papers ; no. 521)1. Shadow prices--Egypt. 2. Egypt--Commerical policy.

3. Investments--Goverment policy--Egypt. I. Title.II. Series: World Bank staff working paper ; no. 521.HB235.E34P33 1982 338.5'2'0962 82-8594ISBN 0-8213-0009-1 AACR2

ABSTRACT

This paper presents estimates of efficiency and social accounting

prices for commodities and factors of production in Egypt which are

appropriate for the period 1979-1985. Shadow price estimates for commodities

are based on a modified input-output method which decomposes domestic supply

prices into foreign exchange and primary factor content. Particular attention

has also been given to modeling of the market for skilled and unskilled labor

in the formal sector and to determination of the shadow wage.

ACKNOWLEDGEMENTS

The paper was prepared as an element of the work program on Problems

of Trade Strategy and Investment Planning in Egypt coordinated by the Egypt

Division of the Europe, Middle East and North Africa Regional Office. I am

grateful to Vinod Dubey, Kemal Dervis, Amar Bhattacharya, Heba Handoussa, and

participants in seminars at the World Bank and the Egyptian Institute for

National Planning for helpful comments and contributions on previous drafts.

Table of Contents Page No.

Chapter 1: Introduction and Summary 1

1.1 Concepts and Assumptions 11.2 Method 81.3 The Main Results and Some Implications 15..

Chapter 2: Accounting Ratios for Commodities 27

2.1 The Valuation of Commodity Inputs 272.2 Exchange Rate Changes & Multiple Exchange Rates 432.3 Data and Assumptions 48

2.3.1 The Cost Composition of Traded Goods 492.3.2 Non-Traded Goods and Services 52

2.4 Household Income and Expenditure: Conversion Factors forConsumption and Savings 54

2.5 Conversion Ratios for Other Expenditure Categories 70

Appendix 2-1: Cost Coefficients for Commodities in Egypt 73Appendix 2-2: An Accounting Price for Cotton 99

Chapter 3: Discount Rates, The Value of Public Income, andConsumption Distribution Weightt 103

3.1 The Marginal Productivity of CaDital at Border Prices 1043.2 The Consumption Rate of Interest 1123.3 The Accounting Rate of Interest 1153.4 Relative Weights for Per Capita Consumption 118

3.5 A Possible Value for n 1223.6 The Value of Public Sector Income (v) 1253.7 Consumption Distribution Weights and the Critical

Consumption Level 139

Appendix 3-1: Rural-Urban Price Differentials in Egypt 1979/80 144

Chapter 4: Shadow Wage Rates for Skilled and Unskilled Labor 147

4.1 Labor Force, Wage and Employment Trends in Egypt 1474.2 A General Formula for the Shadow Wage 1554.3 The Shadow Wage for Skilled Labor 1594.4 Shadow Wages for Unskilled Labor 170

Appendix 4-1: Formulae for the Shadow Wage When Wages are BidUp and Test for Biases in the Estimates of Shadow Wages 192

References

List of Figures and TablesPage No.

Chapter 1

Table 1-1: Calculating the Accounting Ratio for a Commodity 11

Figure 1-1: Distribution of Accounting Ratios 14

Table 1-2: The Main Accounting Ratios 20

Chapter 2

Table 2-1: Accounting Ratios for Factors of Production in Egypt 29

Figure 2-1: Modified Input-Output Tableau for AccountingPrice Estimates 31

Table 2-2: Accounting Ratios by Category/Egypt 33

Table 2-3: Accounting Ratios for Urban Consumption 60

Table 2-4: Accounting Ratios for Rural Consumption 61

Table 2-5: Accounting Ratios for Savings of Households 66

Table 2-6: Alternative Values of the Accounting Ratio for

Workers' remittances 66

Table 2-7: Conversion Factors for Investment 72

Figure A2-1: Shadow Price Determination in SegmentedCommodity Markets 74

Table A2-2: Accounting Ratios by Category/Egypt 83

Table A2-2-1: The Elasticity of Demand for Cotton Exports 101

Table A2-2-2: Sensitivity Analysis of Marginal Export Revenue 101

Table A2-2-3: The Accounting Price for Cotton Exports 102

Chapter 3

Table 3-1: Estimates of the Marginal Productivity of* Capital ICOR Method 106

Table 3-2: Estimates of the Marginal Productivityof Capital Share Method 106

Table 3-3: Financial and Economic Rates of Return to

Some Public Sector Industrial Investments 108

Table 3-4: Rates of Return to Public Sector Industry 109

Table 3-5: Possible Values for the Consumption Rate of Interest 114

Table 3-6: Alternative Estimates of the Accounting Rate of

Interest 117

Table 3-7: Relative Weights for Marginal Changes in Urban

Incomes at Different Income Levels 120

Table 3-8: Relative Weights for Marginal Changes in Rural

Incomes at Different Levels Measured at Urban Prices 121

Table 3-9: An Estimate of n from the Egyptian Tax Tables 125

Table 3-10: The Social Value of Urban Consumption Subsidies 128

Table 3-11: The Value of Public Sector Subsidies 129

Table 3-12: The Value of Public Investment 137

Table 3-13: Best Estimates of the Value of Pubic Income

in Alternative Uses 138

Table 3-14: Consumption Distribution Weights for Urban

Households 140

Table 3-15: Consumption Distribution Weights for RuralHouseholds 141

Table A3-1: Rural and Urbar Relative Prices 1980 149

Chapter 4

Table 4-1: Labor Force in Egypt by Industry, 1960-76 152Table 4-2: Labor Force [n Egypt by Industry, 1971-79

Ages 12 to 65 153Table 4-3: Money Wages in Agriculture, Establishments and

Public Administration, 1966-76 153Table 4-4: Average Wages in Construction and Agriculture 154

Table 4-5: Sectoral Wages, 1966 and 1975 155Table 4-6: Shadow Wages for Skilled Labor Drawn from

Various Sectors of Origin 165Table 4-7: Estimates of the Proportions of Workers Drawn

from Migrant Employment Pf 168Table 4-8: Sensitivity of the Accounting Ratio for Skilled

Labor to Estimated Social Values of Income Transfer andProportion of Foreign Workers 169

Table 4-9: Distribution of Rural Household "Income Claims"

by Source 174Table 4-10: A Conversion Ratio for Agricultural Production 176Table 4-11: The Resource Cost of Unskilled Workers Changing

Occupations 180Table 4-12: Welfare Gains to an Agricultral Worker Changing

Occupations 180Table 4-13: Proportions of Workers Drawn into Formal Sector

Employment 186Table 4-14: Shadow Wage Rates for Urban Unskilled Labor 189Table 4-15: Shadow Wage Rates for Rural Unskilled Labor 190Table 4-16: Estimated Shadow Wages and Accounting Ratios

for Rural and Urban Unskilled Labor 191Figure 4-1: Impact of an Increase in Wages on the Labor Market 193Table A4-1: Estimated Biases in the Shadow Wage When Rural

Wages are Bid Up 201

Chapter 1: Introduction and Summary

1.1 Concepts and Assumptions

This paper presents estimates of shadow, or as we shall frequently

call them, accounting prices for goods and factors of production in Egypt. In

this chapter we briefly introduce the methodology which provides the framework

for our estimates and discuss the major results. Chapters 2 to 4 provide

detailed information on the data, assumptions and methods employed in our work.

Shadow prices may differ from prices observed in the market because

of non-competitive behavior, externalities, and distortions introduced by

government policy. In Egypt, as in many developing economies, policy induced

distortions are perhaps the most pervasive and at the same time the most

complex cause of divergence between market and shadow prices. In these

circumstances market signals may provide an inadequate guide for investment

planning and project appraisal, and the need for a consistent set of prices

which reflect the resource costs and social benefits of a proposed course of

action becomes apparent.

The general procedure used to estimate the shadow price of a given

resource is to determine the change in social welfare which occurs as a result

of withdrawing one unit of the good or factor from its existing employment in

the economy. This "welfare accounting" approach implies that accounting

prices depend on both the objectives of the country and on the economic

environment within which the marginal changes take place.

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There exist in the literature two basic approaches to the social

valuation of resources. The first argues that shadow prices should be defined

solely with respect to the obj c-time-o-f-economic-elfficiency. Other objectives

are recognized but the use of policies to achieve those objectives is

generally perceived as having an economic cost valued at efficiency prices.

An alternative approach is to build into shadow price estimates the weights

attached to various national goals. Benefits accruing to different income

groups, for example, may be assigned different-values taking into account the

objective of altering the income distribution, or savings may be valued

differently from consumption in circumstances where there are constraints on

achieving the desired level of investment and growth.

The approach adopted here is to provide-estimates of accounting

f prices based both on the efficiency criterion and on a limited set of othergoals. In many instances, for example in evaluating the shadow prices of

commodities, the two sets of prices are nearly identical. There are, however,

some important parameters such as the shadow wage rate where efficiency prices

and social accounting prices may diverge significantly. In an economy like

Egypt's, where there is a long and extensive history of interventions by the

government designed to alter the distribution of income among contemporaries,

the need to have a consistent set of prices which reflect as closely as

possible the social gains and losses associated with changes in the

distribution of income is apparent. In the absence of such a set of prices,

it is impossible, for example, to arrive at a meaningful judgement concerning

the costs and benefits of the program of consumer subsidies.

If there are historical policy-imposed distortions in the economic

system, the estimation of shadow prices will vary depending on whether these

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distortions are expected to be removed. In calculating "first-best" shadow

prices one has to assume that all government imposed distortions will be

eliminated except insofar as they contribute to the optimal allocation of

resources. In this sense "shadow pricing" amounts to predicting the market

prices which would prevail when policies have been changed. "Second-best"

shadow prices, on the other hand, assume that existing non-optimal policies

will remain in effect during the period of the analysis. This is equivalent

to deriving the first-order conditions for welfare maximization with market

distortions acting as constraints.

We have in general assumed that the economic environment in Egypt

will not alter radically in the next few years, and the shadow prices we

estimate reflect the taxes, subsidies and other interventions prevailing in

the period 1979-1981,. although where there is evidence of changing policies,

we have attempted to take into account the emerging trend. This should not be

interpreted as implying that we view existing policies as necessary or

permanent; indeed; as we shall indicate below, our shadow prices provide

substantial information that can be used as a basis for designing policies to

remove many of the existing price distortions.

Given these assumptions, if all goods are (potentially) tradable, the

efficiency price (or opportunity cost) of-any commodity or factor is given by

the decline in national income expressed in terms of world prices which occurs

as a result of withdrawing the resource from alternative uses. 1/

1/ There are, of course, a number of restrictive assumptions including theabsence of quantative trade restrictions and monopoly power ininternational trade which must be met, but these may be relaxed at thecost of complicating somewhat the welfare accounting process. We deal in

greater detail with these issues in Chapter 2.

The justification for this valuation, rather than using domestic prices that

reflect consumers' marginal preferences, is that as long as the ratio of

domestic market prices to world prices is constant, consumer prices are

invariant with respect to changes in the allocation of resources. In other

words, it is possible to deal with the productive sphere of the economy

without having to worry about changes in the consumption sphere. Welfare

depends only on the level of purchasing power over the world's goods and

services and can be measured by national income denominated in world prices.

Because of the possibility of trade at fiscal world prices, resources should

be allocated so as to maximize production expressed in these world prices.

In social pricing changes in the incomes of various groups in the

society become relevant. Social benefits must be expressed in terms of a

common unit of account or numeraire. Any commodity or factor may be chosen

for this purpose - in the efficiency pricing criterion discussed above, we

have implicitly chosen foreign exchange as the unit of account - but once it

is chosen all values must consistently be expressed in terms of the numeraire.

In this paper, we follow the now well established practice of valuing

all commodities and factors in terms of their impact on uncommitted foreign

exchange in the hands of the Egyptian government. 1/ Thus we retain as the

basis of our welfare accounting system the use of international prices, but we

add the additional consideration that incomes at international prices accruing

to various groups in the society may be more or less valuable than uncommitted

foreign exchange in the hands of the government. The social price of a

1/ This is the Little and Mirrlees (1974) unit of account.

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commodity is, therefore, equal to the efficiency price plus an adjustment for

the distributional impact of altering the existing allocation of resources.

(See Squire and van der Tak (1976)).

Social pricing will bias project selection according to the value

judgements implicit in the adjustments made to reflect social objectives.

First, we simply attempt to establish the value of average private consumption

relative to uncommitted social income. This value depends on the uses to

which the government puts its income and on the change in the value of average

consumption resulting from these uses. In cases where the value of public

income exceeds the value assigned to average consumption, social prices

reflect the objective of increasing uncommitted public income. The accounting

prices which we estimate based on adjustments for changes in the levels of

public sector and average private sector incomes we have called "extended

efficiency prices". Secondly, we have considered the case in which welfare

weights are assigned to the incomes of various classes of private individuals.

Hence, it is not only the distribution between public sector income and

private consumption which matters, but also the distribution of private sector

income among individuals. In this system of shadow prices, it is possible for

the welfare weights assigned to some classes of individuals to exceed the

value of public sector income, and the shadow prices derived from these

weights reflect the objective of increasing the incomes of certain classes of

private individuals relative to both their contemporaries and to public sector

income. We have called the set of accounting prices based on this set of

objectives "social accounting prices".

Not all commodities are traded, however. It is the presence of

non-traded goods that constitutes the real challenge to shadow pricing.

Because the price for non-tradables is set in the local market, changes in the

-6

supply of a non-traded commodity can affect domestic consumer prices.

Moreover, as a result of market imperfections or policy induced distortions

(for example indirect taxes), the marginal value of non-traded goods to

consumers may differ from their marginal production cost. This divergence

does not create problems in the case of traded goods because their supply can-

always be increased at a fixed world price. In the case of non-tradables,

however, it is important to know whether an incremental unit of the good is

obtained by an increase in production, by depriving other users, or by a

combination of the two. Depending on which of the three cases applies, the

shadow price of such goods may be the demand price (marginal social benefit),

the supply price (marginal social cost), or may lie between the two.

There are no fully satisfactory solutions to dealing with these

complications short of trying to build a full empirical general equilibrium

model of the economy. We have generally assumed that incremental changes in

the demand for non-traded goods are met by an increase in supply, and that the

per unit cost of production is constant. The result of these two simplifying

assumptions is to allow us to approximate the shadow price of a non-traded

good by its marginal social cost of production. Moreover, because the

long-run supply curve is horizontal shadow prices are again independent of the

structure of domestic preferences. This in turn allows us to express the

marginal social cost of production of a non-traded commodity in terms of the

costs of the inputs which are needed for its production. Some of these inputs

will be traded commodities that can be valued at world prices. Others will be

non-traded inputs and finally there are, of course, primary inputs in the form

of capital, land and labor. Wherever we encounter a non-traded input in this

chain, we decompose the cost of producing it until finally we are left with

-7

only primary_fa-aco.r_ costs and traded input costs. In this way the

international prices of traded commodities determine the efficiency prices of

tradables and primary inputs which in turn determine the efficiency prices of

non-tradables. Extended efficiency prices and social accounting prices of

non-tradables differ from their efficiency prices only insofar as changes in

the output of non-tradables affect the distribution of incomes between the

public sector and various private individuals.

Our welfare accounting approach to the estimation of factor shadow

prices is essentially partial equilibrium in nature. In general equilibrium

consumption and production of most goods would be expected to change as a

result of withdrawing a unit of any resource from the rest of the economy.

Estimating these changes in a world of many commodities would be a formidable

task. One alternative is to work with a limited number of aggregate commodity

groups, such as imports, exports and non-tradables. The conditions for

aggregation, however, are very stringent and the possibility of estimating

operationally useful shadow price parameters from such an aggregate approach

is quite limited.

A more practical alternative is to investigate the activities from

which the factor is likely to be withdrawn in order to estimate the change in

national income measured in terms of the unit of account which would occur as

a result of withdrawing the factor from its alternative employment. This

procedure requires considerable knowledge of how the relevant product and

factor markets work, and to the extent that the government is directly

involved in allocating resources, it also requires an understanding of how its

decisions are likely to be made. This is the approach which we have adopted

to estimate the social opportunity cost of such factors of production as

skilled and unskilled labor and capital.

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1.2 Method

If the benefits and cost of projects are to be consistently and

efficiently weighed up according to the principles outlined above, they must

be expressed in terms of a common unit of account. What we have done in the

remainder of this paper is to show the methods by which we express the

accounting prices of many commodities and factors of production in terms of

our unit of account which is uncommitted foreign exchange in the hands of the

Egyptian government. By foreign exchange we mean currency which is

convertable into any other. For conveience, we shall express foreign exchange

in terms of its Egyptian Pound equivalent, but we are still referring to

foreign exchange and could express our shadow prices in dollars or any other

foreign currency. 1/ We do not assume that all benefits and costs of a

project take the form of actual increases or decreases in the foreign exchange

reserves of the public sector. Rather we attempt to express the actual

benefits and costs in terms of equivalent value to such increases or decreases.

Our results could be expressed either as absolute accounting prices

or as the ratio of accounting prices to market prices (accounting ratios).

Although we give a few absolute accounting prices, for example, the shadow

wage and the accounting rate of interest, all of our results are expressed as

accounting ratios as these are generally more useful in giving an overall view

of the structure of price distortions in the economy.

(a) Valuing Commodities

Given our assumptions,-the social value of commodities is equal to the

value at international prices of delivering them to a representative project.

1/ In the case of multiple exchange rates it is important to choose a

consistent accounting rule for the conversion of "border pounds" into

foreign currency values. A discussion of these issues and our accounting

rules is presented in Section 2.2 below.

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For tradable goods, this consists of the world price of the commodity plus the

value at international prices of the port charges, transportation and handling

required to deliver it to the user. In order to find the equivalent value at

international prices of non-tradables, given our assumption of constant

marginal costs, we decompose costs of production into tradable inputs,

non-tradable inputs and the costs of a class of inputs which we shall define

as "primary inputs", for example, labor and foreign exchange. We know the

shadow prices of the traded commodities used as inputs; further, we can break

down the non-tradable inputs into their traded, non-traded, and primary input

cost components. If we move through several rounds of analysis in this

fashion, we can reduce the social cost of any commodity to its equivalent cost

in terms of tradable commodities (foreign exchange) and primary inputs. This

is simply an application of input-output analysis. The shadow price of the

commodity is then given by the sum of the shadow value of traded inputs plus

the shadow value of the primary inputs.

The problem then reduces to estimating the shadow prices of primary

inputs. Unfortunately, the shadow prices of primary inputs themselves depend

on changes in national income (or public sector income) denominated in terms

of foreign exchange, so that they depend ultimately on the shadow prices of

commodities. The solution to this simultaneity problem is simple in

principle; all we need to do is to build a model which will simultaneously

provide the shadow prices of commodities and factors. In practice it is

difficult to implement in a world of many goods and factors.

The main device which we have used is first to express the cost of

any commodity as the sum of its direct plus indirect primary input costs (at

market prices). Because all production functions are linear, the total

(direct plus indirect) primary input content of all commodities may be

determined by the solution to a large number of simultaneous linear equations

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(see Chapter 2). We then make rough estimates of the accounting-ratios for

the primary inputs, and multiply the total primary input costs by these

accounting ratios. This gives us corresponding accounting ratios for

commodities. We then use these preliminary accounting ratios for commodities

to arrive at better estimates of the accounting ratios for primary inputs and

by iteration arrive at a mutually consistant. set of accounting ratios for

everything.

The essentials of the method are illustrated in Table 1-1. Consider

a project which uses I.E 100 worth of packaging materials which are imported as

an input. The customs duty on these is 30 percent, assuming that no special

rebate is allowed, and the port handling, transportation, and handling margins

are as listed in the table. By our input-output method, we may convert these

direct inputs into the direct plus indirect primary input cost coefficients

listed in column (2). We then multiply the total primary input cost

coefficients by their respective accounting ratios and arrive at a weighted

average accounting ratio of .811. The total cost of packaging materials to

the project is therefore LE 81 at border prices.

Several points may be noted. The accounting ratio for foreign

exchange is simply 1.00 since this is our unit of account. The accounting

ratios for taxes, and subsidies are zero, since these are simply transfers

within the public sector. The accounting ratios for capital inputs reflect

their foreign exchange costs; those for labor reflect the estimated change in

national income evaluated at border prices which would occur as a result of

diverting a unit of labor from its existing allocation, expressed as a

percentage of the market wage.

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Once we have the accounting ratios for a large number of goods and

services we need not always increase the size of our input-output table to

find an accounting ratio for a single new commodity. If the accounting ratios

Table 1-1: Calculating the Accounting Ratio for a Commodity

Cost Component Proportion of Accounting Accounting Cost

Delivered Price Ratios Coefficients

Direct Only

Import Value CIF .663 .1.000 .663Duty .198 .000 .000Ports & Harbor Charges .017 1.307 .022Transport .042 1.354 .057Wholesale Distribution .080 .857 .069

1.000 .811

Direct Plus Indirect

Foreign Exchange .735 1.000 .735Skilled Labor .017 1.000 .017Urban Unskilled Labor .011 .454 .005Unskilled Rural Labor .000 .560 .000Capital: Buildings .018 1.450 .026Capital; Machinery - .013 .965 .013Capital: Vehicles .017 .910- .015Extra Incomes to Private Sector .002 .000 .000Non-Traded Agriculture .000 1.000 .000Taxes/Public Income .219 .000 .000Subsidies -.031 .000 .000

1.001 .811

for all of the inputs to the commodity are known, the direct only cost

coefficients may be combined with the appropriate commodity accounting ratios

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to provide an estimate of the accounting ratio of the new good or service. As

an illustration we include the estimated direct-only accounting ratio for

packaging materials in Table 1-1. The two accounting ratios are of course

identical.

The choice of primary inputs is to some extent a matter of

convenience. Our list is given in Table 1-2. Ultimately we wish to express

everything in terms of P1, costs in terms of the unit of account, and PlO and

Pll transfers within the public sector (social surplus), so these must be

included. In between, we put items which cannot be easily expressed as linear

combinations of other accounting ratios -- for example labor, and non-traded

agricultural products -- or about whose values we are particularly uncertain

(to facilitate sensitivity analysis) -- e.g. extra incomes of the private

sector -- , and we include capital inputs for the convenience of knowing the

direct plus indirect social cost of capital per unit of output. Our list

includes all of the important items for which the problem of weighting

benefits in social pricing arises. It is therefore relatively easy for

someone who would like to try alternative weights to work out the effects of

taking a different weighting scheme.

(b) Valuing Factors of Production

The same principles which governed our estimates of accounting prices

for commodities apply to our estimates of the accounting prices for factors of

production. In a proper cost benefit analysis there are no capital inputs per

se. All inputs and outputs are dated with respect to time, and a rate of

discount is used to make them comensurable. The rate of discount appropriate

to our analysis is that which reflects the rate of fall in the welfare value

of the numeraire over time. For efficiency pricing this is the marginal

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productivity of public sector investment at international prices. In social

pricing, it is the Accounting Rate of Interest (ARI), the rate of decline in

the welfare value of public sector income dg,ominated in terms of foreign

exchange. In an economy in full capital market'-equilibrium, and with the

desired income distribution, the two rates of d'is6ount will be equal and will

equal the consumption discount rate. Where constraints exist on the

distribution of income or on the allocation of national income between

consumption and savings these discount rates will differ. The relationship

among them and estimates of their likely magnitudes are further discussed in

Chapter 3. In general it is expected that the Accounting Rate of Interest

will lie below the marginal productivity of capital at border prices and above

the Consumption Rate of Interest. We have found this to be the case in Egypt.

The shadow wage is the change in the numeraire value of national

income which occurs when a marginal worker is taken from his existing

employment and placed in a project created job. It consists of three

elements: (i) the efficiency cost of labor which is the decline in national

income expressed in border prices which occurs as a result of withdrawing the

worker from his previous employment (the value of his marginal product at

border prices); (ii) the cost of providing the resources to meet the increased

consumption of the worker and his household arising out of any excess of wages

in his new employment over those in his previous employment; (iii) the social

value assigned to the benefit accruing to the worker and his household as a

result of the increase in household income. Efficiency prices consider only

element (i) of the shadow wage. For extended efficiency prices and social

accounting prices we must also estimate elements (ii) and (iii). This is done

in the second half of Chapter 3 and applied to the problem of determining the

shadow wage in Chapter 4.

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Figure 1-1: Distribution of Accounting Ratios

Non-Tradables

Median 1.213

20

10

0

Median .965 Imports

40

20

Exports

20Median .982

10

All Values

Frequency

I Median .993

60

40

20

0 .

0.42 0.64 1.26 1.68 2.10 2.53 2.95 3.37 3.79 4.21 4.6353.05 5.47 5.89 6.32 6.74 7.167.5 Las iInterval Value.

- 15 -

1.3 The Main Results and Some Implications

The main results of our analysis are summarized in Table 1-2 and in

Figure 1-1. Table 1-2 presents accounting ratios for primary inputs and for a

number of categories of expenditure, as well as the values of a number of

distributional parameters which are intermediate inputs into the estimation of

social accounting prices. Figure 1-1 summarizes the frequency distributions

of accounting ratios for the'130 commodities included in the study and for

important subsets of these commodities.

The most obvious point which'emerges is that the median accounting

ratio is close to one. Those familiar with other studies of (border)

accounting prices or effective protection in developing countries may find

this result striking. In most countries, protection of a wide range of

tradable consumer and intermediate goods results in accounting ratios for.

tradable commodities which are below unity, often by a wide margin. The

median of our sample of 94 traded commodities is .97, and fully 43 percent of

the accounting ratios for tradables exceed one. Since non-traded goods are

linear combinations of tradables and primary inputs it is not very surprising

to find that their accounting ratios are also close to and often exceed unity.

What is the source of this shadow pricing phenomenon in Egypt? Since

the opening of the Egyptian economy in 1973, the government has tried to

insulate certain consumer goods and producer intermediates from changes in

world prices and in the nominal exchange rate via a system of price controls

and subsidies. Among these commodities are domestically consumed petroleum

products, basic agricultural staples, including wheat and other food grains,

oils, sugar and meat, locally produced and imported intermediate products such

as steel reinforcing rods, cement, and other construction materials, and

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consumer products produced by the public enterprises including shoes,

clothing, and cotton cloth. Various rationing schemes have been implemented

to control excess demand in the markets for these commodities and prices have

not been allowed to increase in line with international prices.

At the same time, agricultural policy has permitted the coexistance

of implicit taxes via fixed producer prices set at levels below the import and

export parity prices of agricultural commodities combined with subsidies on

major agricultural inputs. One consequence of this structure of subsidies and

taxes has been to make the accounting ratios for a large number of

agricultural inputs and outputs greater than one. A possible exception to

this rule is the accounting ratio for extra long staple cotton. Our analysis

in Chapter Appendix 2-2 indicates that the farmgate price of extra long staple

cotton, a product over which Egypt exercises monopoly power, may lie above its

marginal export revenue, although our best estimate of the accounting ratio is

about 1.17.

The overall impact of the system of taxes and subsidies is apparent

from Figure 1-1. The median of our full distribution of 130 commodities is

.99. If this is typical of the central tendency of the distribution of

accounting ratios for all commodities in Egypt (including those whose

accounting ratios we have failed to estimate) it indicates that, on average,

there is little overvaluation of the Egyptian currency resulting from the

structure of nominal protection. In other words, the shadow exchange rate for

the Egyptian economy lies very close to the official exchange rate. This

result is a consequence of the existing structure of taxes and subsidies in

Egypt. Since the shadow exchange rate in the Little-Mirrlees sense is simply

a'summary measure of the relationship between world prices and domestic

prices, our finding that it is close to the official rate (that is that the

standard conversion factor is close to one) indicates that the distortionary

effects of import duties, export taxes and consumer subsidies approximately

cancel out in the aggregate. If the existing structure of protection were to

be eliminated and domestic prices were permitted to adjust to their border

price equivalents, there would be about as many domestic prices that would

rise as there would be prices that would decline in the absence of any

adjustment in the nominal exchange rate. It is likely then that there would

be very little need for an exchange rate adjustment to compensate for the

change in the pattern of taxes and subsidies. This result contrasts with the

more usual estimates of standard conversion factors which are less than

unity. In those cases prior to any nominal exchange rate adjustment the

prices of most goods would decline to their international equivalents. The

nominal exchange rate would then increase to restore equilibrium in the goods

market.

It is important to note here that the exchange rate adjustment

discussed with respect to changes in the structure of protection is a

comparative static one, reflecting changes in the levels of tariffs, subsidies

and price controls. Our accounting ratios fail to provide any information on

the equally important dynamic question of possible exchange rate adjustments

in response to long-term changes in the availability of external resources.

Because Egypt derives a significant portion of it foreign exchange from such

"exogenous" sources as rents paid on petroleum exports and the Suez Canal as

well as from workers' remittances, changes in the availability of these

resources, for example arising from exhaustion of petroleum reserves, may

- 18 -

result in the need for an adjustment of the exchange rate. Any resulting

change in the relative prices of traded and non-traded goods would need to be

reflected in our shadow pricing system. This problem of possible shifts in

long-term resource availabilities is considered in a paper which will appear

as a companion to this study. 1/

Focusing on the median, however, tends to obscure important sectoral

variations in the structure of relative accounting and market prices in

Egypt. There is great variability in the accounting ratios. The standard

deviation of the scatter of 130 commodities is 1.70 and exceeds the mean by

ten percent. Clearly, the process of administrative price determination in

Egypt has resulted in extreme variability in the relationship between market

prices and opportunity costs. Thus, any summary measure of the pattern of

price distinctions such as the standard conversion factor or the shadow

exchange rate marks important sectoral variations in the relationship between

accounting prices and market.prices.

These general observations are borne out by a more detailed

examination of certain subsets of commodities. The median value for exports

is .98 which exceeds slightly that for importables of .96. In both cases, the

standard deviation is less than the mean, indicating that the distributions

are somewhat more compact than the overall distribution.

The closeness of the median accounting ratios for importables and

exportables indicates that the expected gains from shifting resources within

the traded goods sector from import competing to export production are likely

to be small. Reductions in the output of one sector carry a social cost which

is almost precisely offset by the social gains from the increase in the other

1/ See K. Dervis, R. Martin, S. van Wijnbergen: An Optimal Growth Model for

Egypt: Issues in Investment Allocation, Shadow Pricing and Oil

Extraction. World Bank, (forthcoming).

- 19 -

sector' s output. The median values do mask substantial variations in

individual accounting ratios, however, and therefore fail to provide

sufficiently accurate measures of the opportunity costs of individual

commodities. Proposed investments in the traded goods sector should be

appraised individually. Summary conversion factors are inadequate guides to

the social costs and benefits of any particular investment. Non-traded goods

and services are more closely grouped (coefficient of variation .54) which

reflects the fact that they are the weighted averages of a large number of

items. Both the mean and the median of the distribution of non-traded goods,

however, exceed one by a substantial margin (1.33 and 1.21, respectively).

When we recall that the accounting ratio for a non-traded good is the ratio of

its marginal social cost of production to the domestic market price, the

impact of the system of subsidies on intermediate goods and on the

relationship between market and social profitability becomes apparent. Those

activities which intensively use such non-traded goods and services as

electricity, construction, and road and rail transport receive substantial

implicit subsidies relative to the opportunity cost of providing those

inputs. If the accounting ratio applicable to their output is close to the

median value of one, it is quite likely that profits at market prices will

exceed social profits. Moreover, the fact that private costs are below social

costs for these items may encourage excessive substitution of these inputs for

others relative to the optimum input proportions at social accounting prices. 1/

1/ It is perhaps useful to re-emphasize here that our accounting ratios fornon-traded goods are supply prices and hence are appropriate to evaluatingthe social cost of an input. They do not provide the accounting valueappropriate to the output of a project producing the non-tradable. Thisis set by the demand price for-the commodity converted into equivalentvalue in terms of the unit of account

- 20 -

Table 1-2: The Main Accounting Ratios

Primary Inputs Efficiency Extended SocialPrices Efficiency Accounting

Prices Prices

P1 Foreign Exchange 1.00 1.00 1.00

P2 Skilled Labor 1.08 1.08 1.12P3 Urban (Formal Sector) Unskilled Labor .46 .76 .40P4 Rural (Formal Sector) Unskilled Labor .56 .65 .22P5 Capital: Buildings 1.45 1.45 1.45P6 Capital: Machinery .97 .97 .97P7 Capital: Vehicles .91 .91 .91

P8 Extra Incomes of Private Sector 0.00 0.00 0.00

P9 Non-Traded Agriculture 1.00 1.00 1.00

PlO Taxes/Public Sector Surplus 0.00 0.00 0.00

Pll Subsidies 0.00 0.00 0.00

Others:

Consumption & SavingsUrban Average Consumption .000 1.118 1.118Urban High Income Consumption .000 1.098 1.098Urban Low Income Consumption .000 1.219 1.219Rural Average Consumption .000 1.070 1.070Private Sector Savings .000 .600 .600

Conversion FactorsStandard Conversion Factor (SCF) .965 .965 .965

Gross Fixed InvestmentCapital Stock 1.200 1.200 1.200Capital Rental 1.170 1.170 1.170

Intermediate Goods .980 .980 .980Cotton Exports (Extra Long Staple) .837 .837 .837

Rates of DiscountAccounting Rate of Interest (ARI) - 6.0 6.0Consumption Rate of Interest (ARI) - 5.5 5.5Marginal Productivity of Capital

at Border Prices (q) 10.0 - -

Distribution WeightsElasticity of Marginal Valuation

of Income (n) - - 1.0

Value of Public Sector Income(Relative to Average UrbanPer Capita Consumption) (v) - 1.2 1.2

Average Welfare Weight for UrbanHouseholds Taken at Random - - 1.1

Average Welfare Weight for Rural

Households Taken at Random - - 1.9

Urban Critical Consumption Level - - 73.5Rural Critical Consumption Level - - 84.3

- 21 -

The relationship between the median accounting ratios for non-traded

goods and the standard conversion factor has an important implication for

judgements concerning the existing allocation of resources between tradables

and non-tradables. The marginal social benefit accruing from the production

of a non-traded good is measured by domestic willingness to pay converted into

the numeraire. A first approximation to willingness to pay in terms of the

unit of account is given by the product of the domestic price and the standard

conversion factor. 1/ Because the standard conversion factor is close to one,

the domestic price is a fairly good approximation of marginal social benefit.

We know from our estimates of accounting ratios for non-traded goods that

marginal social costs exceed marginal private costs for the typical non-traded

good in Egypt. Hence, at the margin, social costs exceed social benefits for

the typical non-traded activity. If the existing structure of taxes and

subsidies were removed, the supply curve for non-tradables would shift upward

and we would expect a rise in the domestic price of non-tradables and a

reduction in their output. Thus relative to a distortion free environment,

there is over production of non-tradables at the expense of traded goods

producing activities.

A similar argument may be advanced concerning petroleum products sold

domestically. The median accounting ratio for these products is 5.88. This

means that for each pound spent on petroleum products in Egypt, the

opportunity cost in terms of foreign exchange earnings foregone is

approximately six pounds. It is difficult to find a more dramatic example of

1/ We could achieve greater precision by employing a demand price conversionfactor appropriate to the non-traded commodity in question.

- 22 -

the divergence, between market and accounting prices. Proposed investments

which are intensiye in the use of petroleum products will tend to use them

excessively relative-to appropriate factor proportions at accounting prices

and will have higher levels of private than social profitability.

The most striking aspect of the accounting ratios for organized

sector labor is the great difference in the ratio of the shadow wage to the

market wage for skilled and unskilled labor. The shadow wage for skilled

labor exceeds the market wage, while that for unskilled labor is between

one-half and three fourths of the market wage depending on the nature of the

weighting scheme used to evaluate distributional benefits. These differences

reflect the nature of the market for skilled and unskilled labor in Egypt.

Substantial migration of workers in skilled jobs to other Arab countries has

resulted in significant tightening of the market for skilled labor. The

marginal cost in terms of foregone remittances of reducing external migration

by one skilled worker exceeds the domestic wage; hence, the accounting ratio

for skilled workers drawn from the pool of potential migrants exceeds one.

Interestingly, the accounting ratio for skilled workers drawn from alternative

employment within Egypt is also close to one at efficiency prices and extended

efficiency prices. This reflects the fact that wages in the market for

skilled labor approximate the marginal value product of labor at market

prices. Since the standard conversion factor is close to one, the market wage

is a good estimate of the marginal value product at accounting prices.

Because there is no slack in the market for skilled labor, any

increase in the domestic demand for skilled workers should give rise to

bidding up of the skilled wage. This will result in a transfer of income from

consumers and producers of commodities intensive in the use of skilled labor

- 23 -

to skilled workers. We have estimated that on average consumers of the

products of skilled workers are less well off than skilled workers

themselves. Thus, any bidding up of wages generates a welfare cost which is

reflected in our estimate of the social accounting wage. At social accounting

prices, the sum of output foregone pLus the welfare cost of the bidding up of

wages exceeds the market wage and, surprisingly, the opportunity cost of

foregone migrants.

Since the shadow wage for skilled labor is a weighted average of the

opportunity cost of foregone migrants and of skilled workers drawn from other

employment within Egypt, it must inevitably lie close to the market wage.

Given our most reasonable assumptions concerning the proportions of workers

drawn from each source, the accounting ratio for skilled labor exceeds one.

Turning to the market for unskilled labor, we find that although

there has been some tightening in the agricultural labor market, there remains

a substantial differential-between the earnings of a fully employed

agricultural laborer and the annual wage paid to unskilled workers in full

time employment in the public sector or private, formal-sector enterprise.

Given the competitive nature of the agricultural labor market, the annual wage

provides a reasonable estimate of the marginal value product of labor at

market prices. We believe that the accouting ratio applicable to this

estimate of opportunity cost is rather more than one, but it is not

sufficiently high to offset the rural-urban wage differential. Moreover,

because we believe that in Egypt, unlike most developing countries, there is

no significant difference in rural and urban costs of living, the higher wages

in formal sector employment commit the society to a substantial cost in terms

of the unit of account of providing for the increased consumption of the

- 24 -

worker and his household. At extended efficiency prices, this resource cost

is not fully offset by our estimate of the welfare gain; society would have

been better off if the committed consumption could have been retained as

public sector income. At social accounting prices, the welfare gain to the

household of the higher income almost precisely offsets the resource cost.

Thus the efficiency wage and the social accounting wage are approximately

equal. It is important to recall here that the accounting ratios for

unskilled labor apply only to full time employment in the urban or rural

formal sector. They should not be misinterpreted to imply that shadow wages

are lower than actual wages throughout the economy. Accounting ratios for

other types of employment and alternate wage rates could be worked out given

the data and methods in Chapter 3.

Given any of our accounting prices for unskilled labor, the

implications of the relationship between market and accounting prices are

clear. Market prices in Egypt discourage the adoption of labor intensive

techniques relative to the optimum choice of technique at accounting prices.

They encourage the substitution of skilled labor and capital for unskilled

labor and tend to raise the private profitability of enterprises which are

intensive in the use of skilled labor and capital above social returns.

Finally, we consider briefly the implications of our estimates of

discount rates. Our best guess for the consumption rate of interest of 5.5

percent per year reflects quite moderate assumptions about the decline in

social welfare resulting from marginal increases in income (the elasticity of

the marginal valuation of income) and a pure rate time preference of one

percent. On the other hand, it is also based on an assumption of sustained

growth of per capita income of between 4 and 5 percent in the 1980's,

reflecting our assessment of Egypt's growth potential and moderate optimism

about the pace of policy reform. Our consumption discount rate is high,

- 25 -

therefore, because when incomes are growing rapidly maginal increases in the

future ought to be worth relatively less than the same increase in the present.

The consumption rate of interest, however, is not the appropriate

rate of discount to use in project evaluation. Our numeraire is uncommitted

public income denominated in foreign exchange, not consumption. Thus, the

rate of discount appropriate to projects evaluated at shadow prices is the

Accounting Rate of Interest (ARI), which may be expressed as the sum of the

CRI and the rate of change in the value of uncommitted public income relative

to average per capita consumption. In Chapter 3, we give our reasuns for

selecting 6 percent as the best estimate of the ARI.

With the Accounting Rate of Interest set at 6 percent and projects

evaluated in social prices, it is likely that more projects will be approved

than if the Bank's usual 10 percent cut-off rule is used for projects

appraised using only efficiency prices. Also, projects which have long

gestation periods and yield benefits far into the future will have a better

chance to be selected for implementation. We believe that policies which

shift resources in the public sector away from commitments to consumption

towards investment are desirable and hence, that the Accounting Rate of

Interest advocated is reasonable in light of Egypt's goals and constraints.

While we believe 6 percent to be a reasonable discount rate to govern Egypt's

investment program, it is of course a separate question whether the Bank

should use the same discount rate for its own projects. While it can be

argued that the Bank should limit itself to the "best" projects (in terms of

the ERR) it should also be stressed that use of higher discount rates biases

the selection process against projects with long gestation lags. Given that

the Bank is the institution providing loans with the longest maturities, these

may be the types of projects for which Bank financing may be most appropriate.

- 26 -

The main lesson to be drawn from our estimates of accounting prices

is that in Egypt, as in many countries,.private profits provide an inadequate

indicator of the social profitaility of investment and of potential areas for

efficient competition in export or import markets. In Egypt, however, the

great variety and large number of interventions in product markets, and the

resulting great variability in the distribution of accounting ratios, means

that simple adjustments of market rates of return for general patterns of

distortions are also impossible. In economies, for example, where the typical

accounting ratio is less than one and the distribution is relatively compact,

it is almost uniformly true that projects producing exports for which the

international elasticity of demand is high and purchasing inputs on the

domestic market will have higher rates of return at accounting prices than at

market prices. If such projects are commercially viable, they are socially

desirable. In Egypt no such rule of thumb applies and each project must be

evaluated to determine its social profitability. This is due in large part to

the fact that Egyptian relative prices are seriously out of alignment with

international relative prices. It is, therefore, clear that in the longer

term there will be substantial social benefits to policies which seek to

adjust the pattern of domestic relative prices to reflect economic opportunity

costs. This will permit a greater concordance between commercial viability

and economic efficiency and thus assist in achieving an efficient allocation

of investment.

- 27 -

Chapter 2: Accounting Ratios for Commodities

This chapter outlines the methodology, data, and assumptions employed

in estimating the shadow prices, accounting ratios and factor cost

coefficients of more than one hundred goods in Egypt. It consists of four

sections. The first section describes the manner in which the production and

distribution costs of commodity inputs are transformed into their

direct-plus-indirect factor costs and thence into shadow prices. The second

section consists of discussion of the data and assumptions used in making the

estimates of the cost composition of tradable and non tradable goods. The

final two sections provide estimates of conversion factors for a number of

homogenous expenditure categories -- e.g. consumption, savings, investment and

the standard conversion factor -- which are required for future analysis.

2.1 The Valuation of Commodity Inputs

The method of estimating accounting prices followed in this paper is

an adaptation of a procedure which is now generally accepted in the literature

on social cost benefit analysis. 1/ The market prices of goods and services

are divided into their foreign exchange and domestic cost components; these

are then valued in terms of the numeraire (unit of account) and summed to give

the accounting or shadow price of the commodity. It is also possible to

describe the shadow price structure in terms of ratios of the shadow prices of

1/ See for example Scott, McArthur and Newbery (1976), Page (1976) or

Ray (1980).

- 28 -

commodities to their market prices. When data are given in terms of domestic

currency values rather than in terms of physical quantities this formulation -

entitled the "accounting ratio" is particularly convenient.

To estimate the marginal social cost of a commodity we begin by

distinguishing between two classes of inputs into its production, goods and

services and primary factors. Primary factors are inputs which have their

accounting prices determined outside the goods market - for example foreign

exchange, labor, and capital -- or which represent transfers of income -- for

example taxes/subsidies and incomes accruing to private individuals. The

choice of primary factors is somewhat arbitrary. Our list, along with

estimates of the accounting ratios applicable to each input, is contained in

Table 2-1. Ultimately we wish to express the costs/benefits of any commodity

in terms of P1, foreign exchange. The intervening inputs are designated

either because we wish to be able to test the sensitivity of our estimated

accounting ratio to assumptions made concerning their accounting prices or as

a matter of convenience in having the total (direct plus indirect) content of

the item for some of our analytical work. Thus, unlike other studies of this

type, we distinguish taxes and subsidies as separate input items in order to

trace the direct plus indirect effect of consumer subsidies on commodity

prices. Similarly, because we shall wish to use as a cost-benefit criterion

the DRC or resource cost ratio, capital inputs - buildings, machinery and

vehicles - are included as primary factors, rather than as direct commodity

inputs. Our list includes all of the important items for which the problem of

weighing benefits arises. Thus it is relatively simple to trace the impact of

alternative assumptions concerning the weights assigned on the system of

social prices.

- 29 -

Table 2-1: Accounting Ratios for Factors of Production in Egypt

Primary Factor Input Accounting RatioEfficiency Extended Social

Prices Efficiency AccountingPrices Prices

P1 Foreign Exchange 1.000 1.000 1.000

P2 Skilled Labor 1.080 1.080 1.120

P3 Urban Unskilled Labor .456 .760 .395

P4 Rural Unskilled Labor .560 .653 .224

P5 Capital Buildings 1.650 1.650 1.650

P6 Capital Machinery .965 .965 .965

P7 Capital Vehicles .910 .910 .910

P8 Extra Incomes of PrivateSector 0.000 0.000 0.000

P9 Non-Traded Agriculture 1.000 1.000 1.000

P10 Taxes/Public Sector Surplus 0.000 0.000 0.000

Pll Subsidies 0.000 0.000 0.000

- 30 -

The market price of an input is transformed into its shadow price in

two stages. First, the direct factor costs and costs of the commodity inputs

involved in supplying one LE of the good are estimated. For example, the

costs of supplying an imported input such as machinery spare parts to the

final purchaser will consist of the direct foreign exchange cost (cif value),

tariffs, transportation, port handling and the distributor's margin. The cost

composition of a non-traded good can be found in a similar manner.

In the second stage of the analysis the direct plus indirect factor

cost content of supplying the commodity is estimated by tracing the factor

cost of supplying the intermediate inputs into the production of the commodity

in question. The sum of the direct factor inputs and those used indirectly in

providing intermediate inputs are then multiplied by the relevant accounting

prices to determine the shadow price of the good or service.

The similarity of the method to input-output analysis is apparent,

but the construction of the input-output matrix for the economy proceeds along

somewhat different lines. The input-output accounting tableau appropriate for

this method appears in Figure 2.1. Those familiar with orthodox input-output

tables will recognize some important departures from the standard

presentation. First, goods are divided into the categories tradable and

non-tradable; and domestic activities sub-matrices are reported for each. In

accordance with the standard efficiency pricing methodology, tradable

activities are treated as if the marginal source of supply is represented by

changes in the demand for importables and/or the supply of exportables.

Import competing and export producing activities are dropped from the

input-output table and replaced by the transport and distribution and trade

and taxes sub-matrices which summarize the direct marginal social cost content

(at domestic market prices) of a unit increase in final demand.

- 31 -

FIGURE 2-1:

Modified Input-Output Tableau forAccounting Price Estimates

A MATRIX (nxn)

Tl ... TmINl N.n

Tradable Activities Non-Tradable Activities

-0- Tradable Inputs intoI Non-tradable Production

Tm

NI

-0- I Non-Traded Activities

Transport and Distribution Transport and Distribution

P Matrix! pxn)

Foreign Exchange and Domestic Value AddedTaxes Matrix Matrix

Pp,

- 32 -

For non-traded activities the Leontief column consists of four

components: (a) a tradable content vector, (b) a domestic activities vector,

(c) a transport and distribution vector, and (d) a value added vector.

Tradable inputs into non-traded activities are treated symmetrically with

tradable deliveries to final demand, since at the margin tradable imports have

their accounting prices fixed on the international market. Thus, the only

domestic activities rows which provide inputs into non-tradables are other

non-tradable activities.

The primary factors matrices show the foreign exchange and tax

content of tradable commodities (the trade and taxes sub-matrix) and the value

added content of non-tradable activities. The sum of any column across both

commodities and factors is LE ;.00 at market prices.

Let us denote the two input value matrices in Figure 2.1 as:

A = (a..) a square matrix (nxn) in which each of the a.. shows

the direct input of commodity i per unit of commodity j.

P = (P j) a rectangular matrix (pn) which shows the direct primary

factor inputs into the delivery of one LE of the good at market

prices.

Let the accounting ratio for each primary factor be defined as r (s =

1,...P) and the commodity accounting ratios by f. (j = 1,.. .n). Then in

matrix notation

f = Af + Pr (1)

in which f and r are the vectors of commodity and primary input accounting

ratios respectively. This yields

-A PF = (I-A) Pr = Pr (2)

- 33 -

where P = (I-A) P, the matrix of total direct plus indirect requirements of

primary inputs. Clearly, if we have estimates of the primary input accounting

ratios, the commodity accounting ratios follow quite simply, once the A and P

matrices have been specified. Since the parameter estimates of some of the

primary factor accounting ratios depend themselves on the commodity accounting

ratios - for example the shadow wage rate - it is necessary to follow an

iterative procedure. First, reasonable but arbitrary values are assigned to

the primary input categories and preliminary estimates of commodity accounting

ratios are derived. These are then used to estimate improved values of the

factor accounting prices and the process is repeated. Convergence to a

reasonably stable set of values can normally be achieved in two to three

iterations.

The estimates of direct and total factor costs and the accounting

ratios derived from them apply to the period 1979/80, although in some cases

it was necessary to refer to data from earlier years to provide a picture of

the cost composition of certain non-traded activities. The estimated

accounting ratios for the commodities evaluated by the above method are

presented in Table 2-2.

Table 2-2: Accounting Ratios by Category/Egypt

Tradable Goods

I TI Aluminum 1.0612 2 Busses 0.7373 3 Cement 2.1854 4 Chemicals (industrial)(subs.) 2.1585 5 Chemicals (inorganic) 0.9596 6 Chemicals (organic) 0.9427 7 Electric Machinery 0.9658 8 Electrical Distribution Machinery 0.8309 9 Electrical Motors 0.849

- 34 -

10 10 Fittings and Fixtures 0.85211 11 Gloss Products 0.94912 12 Iron and Steel Products 0.93713 13 Iron and Steel Building Materials (subs.) 2.35814 14 Iron and Steel 0.92815 15 Jute Yarn 0.84616 16 Jute Bags 0.74617 17 Machinery (metal working) 0.96518 18 Machinery (textiles) 0.96519 19 Machinery (office) 0.76820 20 Machinery Spare Parts 0.96521 21 Metals (fellous) 0.96522 22 Metals (non-ferrous) 0.99823 23 Metal Products 0.89924 24 Paints and Pigments 0.91125 25 Paper and Printing 0.95126 26 Paper (subs.) 1.76927 27 Paper Products 0.78628 28 Packaging Materials 0.80629 29 Plastics 0.81030 30 Rubber (crude) 0.97531 31 Rubber Products 0.78832 32 Tires and Tubes 0.81833 33 Tobacco (unmfg.) 0.90434 34 Telecommunications Equipment 0.87035 35 Trucks and Lorries 0.91036 36 Wood (crude) 0.99437 37 Wood Products 0.97538 38 Vehicle Spares 0.868

Agricultural Inputs and Outputs

39 Al Agricultural Machinery 1.15940 2 Agricultural Machinery Spares 1.02141 3 Agricultural Implements 0.99242 4 Bags 1.28043 5 Fertilizer (wtd average) 1.66344 6 Pesticides 1.97645 7 Seeds 1.14946 8 Maize 1.31347 9 Onions 4.25948 10 Rice 2.04349 11 Soy Beans 0.99250 12 Sugar 0.96951 13 Wheat 1.591

Petroleum Products

52 PP1 Crude Oil 1.01053 2 Diesel 6.751

54 3 Fuel Oil 15.29955 4 Gas Oil 6.265

- 35 -

56 PP5 Kerosene 5.88357 6 Naptha 4.43858 7 Petrol 1.527

Urban Consumer Goods (Tradable)

59 Ul Beef (rationed) 1.97860 2 Beef (non-rationed) 1.00761 3 Butagas (LPG) 4.82262 4 Coffee 0.67963 5 Clothing 1.10664 6 Consumer Durables 0.50165 7 Edible Fats 1.22166 8 Fish 0.96967 9 Fruit 0.65868 10 Footwear 0.97369 11 Lentils 1.66670 12 Maize 1.79771 13 Milk and Products 0.96872 14 Medicines and hygiene 0.93973 15 Passenger Automobiles 0.57174 16 Rice 5.40775 17 Sesame 0.92976 18 Soap and Detergents 0.82177 19 Sugar (rationed) 1.20278 20 Sugar (non-rationed) 0.48379 21 Tea 0.40180 22 Textiles (non-rationed) 0.97081 23 Tobacco Procuts 0.38382 24 Vegetables 0.91983 25 Vegetable Oil (rationed) 5.22984 26 Vegetable Oil (non-rationed) 2.59985 27 Wheat 3.51786 28 Wheat Flour 1.250

Rural Consumer Goods

87 RI Lentils 0.97188 2 Maize (non-subsidized) 0.92789 3 Meat (non-rationed) 1.16390 4 Rice (non-subsidized) 1.79991 5 Sesame 1.04292 6 Sugar (non-rationed) 0.53693 7 Vegetable Oil (non-rationed) 2.48794 8 Wheat (non-subsidized) 1.520

Non-Traded Goods

95 N1 Animal Fodder 1.08596 2 Bread Baking 1.15697 3 Banking and Insurance 0.328

- 36 -

98 N4 Beverages 0.73199 5 Biscuits and Confectionery 1.058

100 6 Building and Construction 1.669

101 7 Building Materials 3.773102 8 Cotton Cloth (rationed) 2.985

103 9 Cigarettes 0.619104 10 Electricity 3.321

105 11 Entertainment and Culture 0.779106 12 Food Packing 0.947

107 13 Food Distribution 1.237108 14 Garments (subsidized) 1.112

109 15 Grain Milling 1.592

110 16 Housing (rural) 1.626

111 17 Housing (urban - low and middle income) 1.569

112 18 Housing (urban - high income) 1.535113 19 Milk Products 1.266

114 20 Meat Processing 0.886

115 21 Miscellaneous Office Services 0.862

116 22 Personal Services 0.958

117 23 Port and Harbor Charges 1.315118 24 Printing and Publishing 1.236119 25 Rail Transport (passengers) MC 1.199120 26 Rail Transport (goods) MC 1.213

121 27 Rail Transport (price) MC 0.000

122 28 Retail Distribution 0.711123 29 Road Maintenance 1.423

124 30 Road Transport (passenger) 1.270125 31 Road Transport (goods) 1.365

126 32 Services NES 1.627

127 33 Telecommunications 0.972128 34 Transport (wto png) 1.343

129 35 Vehicle Repair 0.909

130 36 Wholesale Distribution 0.798

The 130 commodities in Table 2-2 are divided into six major groups -

tradable intermediates, agricultural inputs and outputs, petroleum products,

tradable urban consumer goods, tradable rural consumer goods, and

non-tradables. Our coverage of commodities includes all of the major SITC

three digit categories in Egypt's external trade statistics, major consumer

goods, and all of the non-tradable sectors represented in the 1977

input-output table. Thus the frequency distribution of accounting ratios in

Table 2-2 is quite representative of the overall relationship between

accounting and market prices in the Egyptian economy.

- 37 -

A summary measure of the "typical" accounting ratio is the median of

the distribution of all 130 commodities which is .993. The mean is 1.549

indicating the effect of a number of commodities with extremely high ratios of

the accounting price to the market price. There are relatively few

commodities with low accounting ratios in our distribution, and these are

consumer goods which are typically heavily taxed, tobacco, coffee, tea and

alcohol. Because of the heavy subsidization of many consumer items, the

median accounting ratio for tradable consumer goods is .970. The median of

the distribution of petroleum products is 5.88 indicating the magnitude of the

subsidies to petroleum products. Subsidies and production taxes in the

agricultural sector are similarly indicated by the median of the distribution

of agricultural inputs and outputs of 1.28. The system of subsidies also

works its way through the structure of production and exerts a major influence

on the social marginal cost of non-traded commodities. Non-traded goods in

our sample have a median accounting ratio of 1.21, thus for the typical

non-traded good the accounting price exceeds its market price by approximately

21 percent.

Overall the picture which emerges is of a distribution of accounting

ratios characterized by high variance and a large incidence of values

exceeding unity. There are few heavily protected sectors of the Egyptian

economy, and in contrast to many developing countries there are a substantial

number of activities in which pricing policy has suppressed the domestic

market price below the shadow price. The most notable of these sectors is

petroleum, but accounting prices exceeding unity are also found in agriculture

and among subsidized urban consumer goods.

- 38 -

Before turning to a detailed discussion of data and the methods used

to establish the input structures of the commodities listed in Table 2-2, it

may be useful to review briefly a number of general issues which affect the

appropriateness of our methodology. These are the degree of tradability,

increasing returns to scale, variable relationships between international and

domestic prices, and inelastic world supply and demand. These topics also

introduce the important issues of the time perspective of the analysis and the

degree to which individual project analysts should undertake supplementary

shadow price estimates in addition to those presented here.

(a) The Degree of Tradability

A crucial underpinning of the border price rule on which our system

of accounting prices is based is that potentially tradable goods are in fact

traded at the margin. In the absence of that assumption -- s.ay for example

because of fixed import quotas or heterogeneity of products -- changes in the

domestic supply of or demand for potentially tradable commodities may result

in changes in their domestic price with no effect on the trade balance. In

such circumstances accounting ratios based on the relationship between border

and domestic prices will not provide a correct estimate of marginal welfare

change and, hence, of the marginal social cost/benefit associated with the

commodity. The cost-benefit analyst has essentially two options in dealing

with commodities for which the degree of tradability is uncertain. The first

is to treat all potentially tradable commodities as traded on the rationale

that it is likely that for minor changes in final demand imposed by the

project, quotas or other quantative interventions will be adjusted upward to

reflect the increased demand. The alternative is to treat such commodities as

non-traded goods. It is then possible to analyze their social costs of

- 39 -

production in the manner described above, or in the case of commodities which

are in inelastic domestic supply to estimate the changes in producer's and

consumer's surplus which occur as a consequence of a marginal change in supply

or demand. Clearly the second alternative involves substantially more work

for the project analyst and introduces a greater margin for error. Therefore

most cost benefit studies have, wherever possible, treated tradables as fully

traded. We shall follow that approach here, but with several important

exceptions. These are primarily in the area of subsized and rationed consumer

goods, notably textiles and clothing, where the level of product quality is

substantially lower than the minimum standard in international trade. Thus

although these items fall into a category which is potentially tradable, they

are in fact non-traded goods, and we shall detail the assumptions made

concerning their social cost in the notes on specific industries below.

(b) Constant Costs vs Variable Returns to Scale

The input-output method outlined above implicitly assumes that the

separate items making up the marginal social cost of a commodity vary linearly

with the quantity of the good demanded. If this were not so, the A and P

matrices would vary with the scale of demand. This is not precisely the same

thing as assuming constancy of average costs, since the accounting prices are

applicable only to marginal changes in supply or demand. Where large changes

in the availability of an item are contemplated the project analyst must, as

always, carefully consider the possible changes in social costs associated

with non-marginal changes, and the accounting ratios presented here would not

in general be applicable. Otherwise the constancy of the A and P matrices

implies constancy of marginal social costs. Allowances for variable returns

to scale may be made by allowing variations in the a.. and p . overii Si

- 40 -

different intervals of output. In practice this can be done only to a limited

extent. Moreover, given our limited knowledge of returns to scale in the

non-traded goods sectors of the Egyptian economy, any such adjustments would

be largely arbitrary, and we have therefore chosen not to make them. The

marginal social cost coefficients in our input-output structure represent the

best information we have on the cost composition of those activities.

(c) Variable Relationships Between International and Domestic Prices

Wherever domestic prices are admihistratively set, as for example is

the case with fixed producer and consumer prices, the relationship between

domestic and international prices may vary over time with changes in either

price. 1/ This has rather vexing consequences for accounting ratios based

upon the relationship between the market and shadow price of a commodity taken

at one particular moment. Although the appropriate accounting price remains

the border price, when the ratio of prices changes, the accounting ratio must

also change. In the case of agricultural commodities which exhibit

considerable year to year variations in international prices, the presence of

fixed domestic prices could imply almost continuous updating of accounting

ratios. In general, the economist estimating a set of shadow prices must use

his judgement concerning the medium term relationship beteen domestic and

foreign prices. In the Egyptian context whete there have been substantial

changes in domestic prices of price controlled traded commodities since 1979

l/ Obviously the presence of quantative restrictions is another example of a

variable relationship between world and domestic prices, since changes in

domestic demand or supply will alter the quota premium of the commodity.

- 41 -

we have in general focused on the relationship between these domestic prices

which, given past practice, may be expected to prevail for several years and

the "normal" world price as represented by the average of the past several

years prices. These accounting ratios should remain relatively stable over

the next few years, but major movements in either price would require revision

of the input-output value coefficients and the accounting ratios.

(d) Inelastic World Supply or Demand

Cases in which a country faces less than perfectly elastic foreign

supply or demand curves for a commodity pose a slight complication in the

estimation of accounting ratios, but can be allowed for within the general

approach by adjusting the input coefficients to reflect the marginal export

revenue or marginal import cost of the commodity. Social pricing exercises

will also require that the change in producer and consumer incomes resulting

from the price change be evaluated. For Egypt the major commodity market in

which the quantity exported could have a significant impact on the world price

is that for long staple cotton. Thus we devote some attention to working out

the plausible value of the marginal export revenue from cotton.

It should be clear from the foregoing discussion that the general

system of estimating shadow prices is quite flexible with regard to its

ability to accommodate various institutional and policy constraints which

affect the relationship between market and social prices.- The implementation

of these procedures, however, in order to calculate a basic set of shadow

prices for an economy such as Egypt, is a fairly laborious and time consuming

1/ Two levels of aggregation are represented by the "trade data approach" ofSquire and van der Tak (1975) and the input-output approach advocated bySchohl (1979).

- 42 -

task. This is because the construction of the A and P matrices requires

detailed analyses of the markets for commodities, a project which can use

almost unlimited amounts of information. In view of the alternative methods

available for estimating more aggregated national parameters in cost-benefit

studies what are the advantages of a more detailed approach? From the point

of view of the present study we would argue that there are three important

gains from taking the greater time required for a highly detailed shadow

pricing exercise:

(i) It requires a careful examination of the workings of many commodity

markets and industries and thus generates valuable information about

the economic factors underlying the present situation. This is of

particular value in an economy like Egypt where administered pricing

decisions impinge at both the producer and consumer margins in the

markets for many commodities. Our approach allows us to trace the

impact of these interventions through a number of interconnected

markets.

(ii) Because we wish to apply our accounting prices to an examination of

comparative advantage and international competitiveness in several

Egyptian industries, quite a wide array of accounting prices is

required, and it is convenient to estimate them within the context of

a general shadow pricing exercise.

(iii) The work, once completed, can be updated relatively easily to reflect

changes in the policy environment. Once the impact of a policy

change on the coefficients of the A and P matrices has been worked

out, it is simple to trace the impact of these changes on the full

set of accounting ratios.

- 43 -

Thus we have attempted to work with as wide a range of items as

possible within the resources available. By distinguishing between various

types of commodities - e.g. types of transport, agricultural products,

petroleum products, etc. - we are able to consider in detail the ways in which

government pricing and taxation policies are affecting the incentive structure

of the economy relative to what might be desirable in view of the structure of

social costs and benefits.

2.2 Exchange Rate Changes and Multiple Exchange Rates

Recall that we have chosen to express all values of commodities and

factors of production in terms of constant 1979 "border Egyptian Pounds" -

that is Egyptian pounds freely convertible at the average nominal exchange

rate prevailing in 1979. If one wished to switch from border pounds to

dollars as the unit of account it is simple to divide the accounting value by

the nominal exchange rate. Either unit of account provides a consistent

welfare index differing only by a scalar value.

Since 1979, however, two changes have occurred in the exchange rate

regime which must be addressed. First, there has been a marked widening in

the exchange rates offered in each of the three segments of the Egyptian

foreign exchange market - the "central bank pool", the "commercial bank pool",

and the "free" market financing own exchange imports. In 1979, transactions

in the commercial bank and central bank pools both took place at a rate of

.70 LE to the dollar, and those on the "free" market took place at rates not

exceeding .78. By 1981, although the central bank rate remained at .70, the

commercial bank rate had increased to .84 and the parallel market rate had

increased to around 1.00. Hence, the weighted average nominal exchange rate

has increased to .80. Thus, the period from 1979 to 1981 was marked by a

shift from an essentially unified to a multiple exchange rate regime and by a

- 44 -

nominal depreciation of the Egyptian pound. How do these two actions affect

our estimates of accounting prices and accounting ratios?

Let us first consider the question of a nominal devaluation. The

change in the exchange rate will have no impact on the world price of tradable

commodities (denominated in terms of foreign currency) for which Egypt is a

price taker. Domestic prices will rise by the amount of the devaluation but

relative traded goods prices will be unaffected. Accounting ratios for traded

goods will also be unaffected. To see this, consider the case of a tradable

commodity which is subject to an ad valorem tariff = (l+t). The accounting

price denominated in dollars is P and in terms of border pound is P R,

where R is the nominal average rate of exchange. The domestic price is P R T

and the accounting ratio is therefore:

f. = P R/P RT = 1/T. (3)

The level of the nominal exchange rate is irrelevant to the shadow price of

the traded commodity and to its accounting ratio. It nevertheless remains

true that because a nominal value has changed (in this case R) we have to

deflate to constant 1979 prices if we wish to compare real resource costs in

the two periods. If our unit of account is dollars and dollar denominated

world prices are unchanged this may be accomplished simply by dividing border

pounds in each period by the nominal average exchange rate prevailing in that

period. If we wish to retain border pounds of constant purchasing power as

the unit of account then we must deflate the nominal border pounds in each

period by a discount factor equal to Dt = R79 / Rt;(t = 79,.. .N).

-45 -

Either approach provides a consistent index of the real resource cost of a

traded commodity. 1/

A similar argument applies to the accounting prices and accounting

ratios applicable to non-traded goods, as long as the devaluation is nominal

and not real. A nominal devaluation implies that non-traded goods prices rise

in the same proportion as the adjustment in the exchange rate and that

therefore the relative price of traded and non-traded goods remains constant.

With constant relative prices, the structure of production is invariant to the

change in the exchange rate; hence the input-output structure on which

non-traded goods shadow prices are based remains unchanged as do the shadow

price and accounting ratio.

If the devaluation is real, in the sense that the relative prices of

tradable and non-tradable goods change after the devaluation, the effect of

the exchange rate adjustment is more complex. The relative price change will

1/ To illustrate this consider the following simple example. A project uses

100 units of an input in both 1979 and 1981 with a constant world price of

US $1.00. The commodity is subject to a tariff of 10 percent ad valorem.

The effect of the exchange rate adjustment may be seen from the following

table:

Year Units Pw Accounting Value R Value in Domestic AccountingUS $ Border LE Value Ratio

1979 100 1 100 .70 70 77 .909

1981 100 1 100 .80 80 88 .909

It is clear from the table that the real resource cost of the input -- its

accounting value in US dollars is unchanged between the two periods, as is

the accounting ratio. In moving from domestic market values to accounting

values one would first multiply by the accounting ratio to arrive at

current border pounds. To arrive at 1979 US dollar values one would

divide by the nominal exchange rate (R). To value commodities in border

pounds of constant purchasing power one would multiply the 1981 current

border value by the discount factor 70/80 = .875. Both techniques yield

the correct answer that the real resource cost of the input is unchanged

between the two periods.

- 46 -

alter the input-output coefficients on which the shadow pricing system is

based and will also change the estimates of the marginal social products of

labor and capital. A real exchange rate adjustment therefore alters the

accounting ratios applicable to non-tradables and, hence, affects the overall

distribution of accounting ratios in the economy. Predicting the net effect

of this adjustment on the accounting price system is quite difficult. 1/ In

the case of Egypt, we do not believe that the adjustment in the exchange rate

between 1979 and 1981 reflects a real exchange rate adjustment. Indeed,

increases in non-traded goods prices may have led the exchange rate,

suggesting that the nominal change from .70 to .82 reflects adjustment in the

foreign exchange market to maintain constancy of the real exchange rate.

The shift from a unified exchange rate regime to a multiple exchange

rates poses somewhat different problems. In Egypt access to various elements

of the foreign exchange market is determined by the ownership of the

enterprise as well as by the type of good. Thus, it is possible for a single

commodity to be imported at three different rates of exchange depending on the

final user or importer. The exchange rate system, therefore, operates like a

system of indirect taxes and subsidies. Enterprises with access to the

central bank pool receive an implicit subsidy on imports entering at the rate

of .70, but pay an implicit tax on exports receiving the same rate, relative

to the commercial bank and parallel market rates. A similar, although

converse argument, applies to firms importing and exporting exclusively at the

parallel rate. Differences in the exchange rates represent transfers between

1/ Very little work has been done on predicting the impact of a real exchangerate adjustment on a system of shadow prices. See Little and Mirrlees

(1976) and Ray (1982).

- 47 -

suppliers and users of foreign exchange, rather than variations in the real

resource costs of commodities supplied to various categories of users.

If the exchange rates were specific to commodities it would be

possible to handle the implicit tax/subsidy element of the multiple exchange

rate system in a symetric fashion to that applied to trade taxes and

subsidies. One would choose one exchange rate as a base and show deviations

in the market price border price relationship due to different exchange rates

as taxes or subsidies. Because in Egypt the exchange rate may differ for

differing commodity-user pairings we have adopted a slightly different

approach. We choose as a base border Egyptian pounds convertable at a rate of

.70 in 1981. (Note that this is equivalent to constant price 1979 border

Egyptian pounds and was, therefore, chosen for convenience.) We can then

specify two "exchange rate accounting ratios", EAR's, which allow us to

convert from border LE at the commercial or parallel rate to border LE at the

central bank rate. To find the accounting value of a traded commodity whose

price is denominated in terms of domestic currency in 1981, we multiply by

both the commodity accounting ratio and the exchange rate accounting ratio to

arrive at the resource cost in terms of border pounds convertible at the

central bank rate. This value in turn may be converted into dollars at the

central bank rate if desired.

The purpose of making this adjustment is very similar to the

rationale for expressing values in terms of constant purchasing power. We

wish to reflect the ultimate impact on the trade balance of a change in

expenditure at domestic prices. Consider the commodity discussed above with

world price P , tariff rate T and accounting ratio f. The domestic price

is variously P, = P RT < P= P RcT - P. P R f , depending1 w 2 w 3 w

- 48 -

on the exchange market to which the purchaser has access, where R, R and

R are the exchange rates in the central bank, commercial bank, and free

market pools respectively. Since the world price is constant, border pound

prices must also reflect the constancy of the opportunity cost of the good.

Define the exchange rate accounting ratios EAR = R/Rc and EAR =

fR/Rf. The accounting value of the commodity in border pounds (central bank

rate) may be found by:

P f = P f EAR = P f EAR = P RT(1/T) = P R T(1/T)(R/Rc) = (4)lj 2i 3j w

P R Tf(l/T)(R/R ),w

which obviously differs only by a scalar, R, from the world price P . Hence

the effective accounting ratio for any commodity-user pair consists of the

product of the commodity accounting ratio f. and the exchange rate

accounting ratio EAR (i = c,f). The exchange rate accounting ratios are

central bank rate, 1.00, commercial bank rate, .70/.84 = .833, and parallel

market rate, .70/1.00 = .70. Note that when the exchange rate accounting

ratios are applied there is no need for a further adjustment to arrive at 1979

border pound since the exchange rate is equal in both periods. 1/

2.3 Data and Assumptions

Estimation of accounting ratios by the methods described above

requires a substantial amount of information on the composition of commodity

and factor inputs used in the production and supply of goods and services. We

1/ For the project analyst whose accounts are given mainly in US dollars analternative approach is to convert the central bank border price values of

non-traded goods and labor given in this paper to dollar values using therate of .70. Either approach provides a consistent index of social valueand the choice is dictated largely by convenience.

- 49 -

have drawn our estimates of input-output coefficients from several statistical

sources of varying reliability. Inevitably some of the data are not as recent

as one would desire, and given the major structural changes in the Egyptian

economy in the past several years, this represents a limitation which should

be corrected as additional information becomes available.

The cost composition breakdowns for goods and services contained in

Table 2-2 appear in Appendix 2-1. Here we shall focus on the general sources

of data employed and highlight major assumptions and methods of deriving the

input coefficients. Two major references are available on the structure of

production in Egypt. The first and most comprehensive is the 1977

input-output table. The second is the production accounts of public sector

enterprises for which the last year available is 1979. Transport and

distribution margins may be imputed from both of these sources for several

categories of traded goods, and they provide the best information available on

the cost structure of non-traded activities. In general we have used the

public sector production accounts as our principal source supplemented by the

input-output table.

The accounting ratios estimated in this study, except in the case of

items entering into rural or urban consumption, are applicable to producer

prices. These are more appropriate for empirical studies of industrial

comparative advantage and have the additional advantage of requiring fewer

assumptions to be made regarding distribution margins.

2.3.1 The Cost Composition of Traded Goods

Cost breakdowns for more than eighty tradable goods are presented in

the Appendix tables. These goods fall into two categories, consumer goods

used in estimating the consumption conversion ratio and producer goods which

- 50 -

are significant inputs into domestic Egyptian industries. Data for the cost

analysis were drawn from published sources and from some unpublished

Government of Egypt memoranda.

Wherever possible an attempt was made to determine the cost

composition of an importable by direct comparison of cif, wholesale and retail

prices. In most instances, however, aggregation problems made direct

comparison of unit prices uncertain, and in the case of some producers goods

market prices were unavailable. Thus for approximately half of the traded

goods analyzed a border price estimate was derived from the external trade

statistics. Estimated duty rates, port handling charges, transport costs, and

distributor's margins were added to the border price to arrive at an estimate

of the final delivered costs. In other instances, principally for

non-agricultural consumer goods, it was more convenient to work backward from

the market price.

Duty rates for 1979/80 were compiled on the basis of unpublished data

provided by the Department of Customs and Excise. The compilations included

estimates of both statutory rates and actual collections. Where substantial

differences existed between the two figures, the ad valorem equivalent of the

actual collections was used as the relevant rate. If several duty rates were

applicable to items within a single category of tradable goods -- e.g.,

industrial chemicals -- a weighted average duty was estimated for the category

using the 1979 levels of imports.

Information on excise and other indirect taxes and on price

differentials charged by public sector distribution agencies were taken from

the public sector accounts and several additional unpublished sources. 1/

1/ Principally el Edel (1980).

- 51 -

For traded agricultural commodities transport and distribution margins and the

implicit subsidy for urban consumer goods were taken from two recent

agricultural price policy studies carried out by the Bank. 1/

Port handling costs were estimated from per ton handling charges at

Alexandria Harbour. Where these data did not exist we attempted to impute

"typical!' handling margins from comparable categories of goods.

Road and rail transport costs were available from data provided in

the Egypt National Transport Study (Netherlands Engineering Consultants

(1981)). The various volumes of this report provided estimates of ton/mile

charges for major commodity groups by both rail and lorry.

Perhaps the weakest link in our analysis of the cost composition of

tradables is in the distribution margins imputed on the basis of data from the

input-output table and the public sector accounts. In the absence of a survey

of distributive trades, these represent the best information available; but

the estimates could be considerably improved. Average retail and wholesale

margins derived from these sources were 19.0 and 16.8 percent respectively

which seem a bit high by comparison with other countries, especially with

respect to Egypt's relatively compact spacial distribution. We have

nevertheless employed these margins in the absence of alternative information.

There were several tradable activities which required special

consideration. Notes on these specific industries are found in Appendix 2-1.

1/ Cuddihy (1980) and World Bank (1981a)

- 52 -

2.2.2 Non-Traded Goods and Services

Cost breakdowns for forty non-traded goods and services are presented

in the Appendix tables. These are the major activities which are either

(i) important inputs into industrial production or (ii) major components of

rural and urban consumption. The principal sources of information on the

non-traded sector were the 1977 input-output table and the public sector

production accounts. These were supplemented by sector studies in

transportation and limited personal interviews. Although none of the sources

offered exhaustive information on all activities the estimates derived from

them should prove sufficiently accurate for the estimation of accounting

prices. In the remainder of this chapter we deal generally with the problems

encountered in estimating the input-output coefficients for non-traded

industries and direct specific remarks to industries where the estimates are

unusual or uncertain.

The cost coefficients for most non-traded activities are based on the

long run average cost of production. It was assumed that the industries

operated under conditions of constant marginal costs over the range of output

involved in the estimates. Hence, average Leontief type production

coefficients are appropriate for the evaluation of marginal social costs of

production. 1/ An exception to this general rule was made in the case of

railway transportation, for which evidence indicated that economies of scale

were significant, and that 1979-80 market prices differed from marginal costs.

1/ An alternative approach would have been to assume a plausible value forthe divergence between marginal and average costs for industries in which

economies of scale were believed to be significant. Data on potentialeconomies of scale in Egyptian industries are unavailable, however.

Rather than use estimates derived from data on other countries it was felt

appropriate to assume generally constant costs.

- 53 -

By assuming all costs to be variable, possible benefits from

increased utilization of industrial capacity resulting from project induced

increases in demand are ignored. Excess capacity in Egypt occurred most

frequently in those import substitution industries which are treated here as

tradable goods. Non-tradable activities which provide direct inputs into the

manufacturing sector are generally services, and output may reasonably be

assumed to keep pace with increases in demand. Thus, as a rule, the use of

long run average costs should provide accurate estimates of the marginal

social cost of non-traded goods. An exception to the general procedure was

made in the case of certain quota restricted inputs into Egyptian

manufacturing. The assumptions made regarding the marginal social cost of

these industries are dealt with in the notes on specific activities.

The Allocation of Wages and Salaries

The distribution of labor costs between payments to skilled labor and

payments to unskilled labor has important implications for the final estimates

of resource costs, since the opportunity costs of skilled and unskilled

workers differ significantly. The division between skilled and unskilled

labor is in fact a division between labor which is assumed to be fully

employed in the economy and labor which is either unemployed or

underemployed. Skilled labor is labor which is assumed to be engaged in

occupations where the market wage represents the private opportunity cost of

the worker. The distinction between skilled and unskilled workers requires

that the latter category include all workers whose jobs require limited or no

on-the-job training. Such "semi-skilled" occupations as machine paced

operatives or drivers ought to be counted as unskilled labor, since these

occupations can be readily filled with limited training.

- 54 -

The nature of the data provided on non-traded activities made a high

degree of approximation and some arbitrary classifications necessary in making

the allocation of labor costs. For approximately half of the non-traded

activities examined an estimated breakdown between payments to skilled and

unskilled labor was available. 1/ For the remaining activities the principle

sources of data on wage payments were the Public Sector Enterprise Accounts

and the ILO (1981) labor force study. The public sector accounts provided

information on the distribution of wages and salaries between production and

other (technical, managerial, and clerical) workers. In cases where this was

the only information available, all production workers were allotted to the

unskilled category while other employees were considered skilled. Where

possible, data from the public enterprise accounts were supplemented by

reference to the ILO report. All unskilled labor in industrial non-tradable

activities was assumed to be urban unskilled labor. Although this assumption

is not strictly correct for such activities as road transportation and

distributive trades where rural enterprises are important components of the

industry, it was impossible to estimate the relevant proportions of rural and

urban workers in these activities.

The Treatment of Indirect Capital Inputs

To estimate the indirect inputs of capital into a project it is

necessary to know something about the size and composition of the capital

stocks of industries supplying inputs into the project under evaluation. It

is also necessary to convert capital inputs whose economic lives extend over

more than a single period into current inputs without distorting the resulting

estimates of accounting prices.

1/ These were industries covered by the author's personal interviews or by

other firm level returns.

- 55 -

The approach adopted in this study was to identify three primary

input categories of capital -- buildings, machinery, and vehicles. Estimates

of the annual inputs of capital services provided by each of these three

categories of assets were computed for each non-traded activity. The

procedure for estimating the annual input of capital services at market prices

was quite simple. An annuity factor based on the marginal product of capital

and an assumed economic life of the capital input was applied to the estimated

value of the capital stock of the asset. This annuity gave the annual

equivalent of the depreciation and return to capital at market prices, and was

entered as a direct primary factor cost of the activity employing the capital

input. In this manner, cost coefficients for capital inputs were derived for

each non-traded activity. As our best estimate of the marginal productivity

of capital at market prices we employ 10 percent (net of tax). Ideally, it

would have been desirable to estimate the annual input of working capital for

firms in addition to the input of fixed capital. Unfortunately, information

on the level of working capital existed only for distributive trades; thus

working capital was excluded from all cost estimates except those for

wholesaling and retailing.

Information existed on the size and composition of the capital stock

for 15 of the 40 non-traded activities analyzed. The estimated values,

however, referred to years ranging from 1976 through 1980. To deal with these

estimates in the simplest manner possible it was assumed that the percentage

composition of capital costs in total costs in the reference year was the same

as in 1979-80. For the remaining industries the only information on capital

costs was an estimate of value added minus wages and salaries. This figure

presumably includes interest, depreciation, profits, and direct taxes. In

- 56 -

order to provide an approximate distribution of capital costs among the three

categories of domestic capital inputs an estimated breakdown of aggregate

figures was made on the basis of the average composition of assets for firms

in Egypt. The average composition of assets for firms was determined from

information on the composition of investment contained in the 1978 plan (World

Bank (1981b)). The percentage of each asset category in the total was

multiplied by its annuity factor to provide an estimate of the percentage

composition of capital costs in gross profits.

Miscellaneous-Costs and Extra Capitalists' Incomes

These two input categories are elements in the cost structure of a

limited number of non-traded activities. If extra incomes accrue to owners of

activities supplying inputs into a project under analysis, these extra incomes

should be counted as indirect costs of employing the non-traded good. While

it is not difficult to estimate the value of direct extra capitalists' incomes

resulting from:.an investment, the limited data available on supplying

industries made the estimation of extra capitalists' incomes in non-traded

activities supply inputs very uncertain. In general, therefore, it was

assumed that extra incomes did not accrue to the private owners of non-traded

activities. Any discrepancy between the estimated long run average costs of

production (including a normal return to capital) and the value of output was

assumed to consist of miscellaneous costs which were not included in the

initial cost estimate. The implication of the procedure adopted is that the

net of tax return available to investors in Egypt is close to a real rate of

10 percent. We shall argue in Chapter 3 that this assumption is quite

reasonable.

- 57 -

There were several industries in which our estimates were

particularly uncertain or in which special assumptions which departed from the

general scheme outlined above were required. These activities are discussed

in Appendix 2-1.

2.4 Household Income and Expenditure: Conversion Factors for Consumption and

Savings

Consumption Conversion Factors

Before we can proceed to estimate the accounting prices of factors of

production it is necessary to construct accounting ratios for marginal

increases in consumption by various income categories. These consumption

conversion factors will be used in Chapters 3 and 4 when we attempt to

estimate the cost in terms of the unit of account of policies which increase

the level of consumption by various households at market prices. Since

consumer expenditure represents an important commitment of resources, we

devote considerable attention to establishing the value of a unit increase in

consumption at accounting prices. The value of a unit increase in consumption

at market prices in terms of the numeraire depends upon the commodity

composition of marginal consumer expenditure. Only one reasonably reliable

source of data on consumer expenditure exists for rural and urban households

in Egypt, the Household Expenditure Survey 1974-75. The expenditure survey

covers 3000 households in rural and urban areas and represents the only

comprehensive source of expenditure data by income class for Egypt in the

1970's.

In principle, our estimates should apply to marginal increases in

consumption and therefore require the use of marginal expenditure weights.

Lacking estimates of expenditure elasticities, we have been compelled to work

with the average weights from the expenditure survey. This introduces one

important potential source of bias on our estimates of consumption conversion

- 58 -

ratios. Incomes have grown rapidly in Egypt since 1975, and it is reasonable

to expect that, particularly in urban areas, the expenditure weights for

agricultural commodities and subsidized basic consumer goods may have declined

somewhat from the 1974/75 levels. Because of the high accounting ratios

applicable to subsidized urban consumer goods, this may cause our estimates of

consumption conversion ratios to overstate the accounting cost of average

urban consumption somewhat.

The categories for which consumption conversion ratios were

calculated cover average rural and urban consumption plus high and low income

conversion ratios for urban consumers. The lower limit for high income

households was taken as LE 1000 per annum in 1974/75, which roughly defines

the upper decile of all urban households by income. The upper limit for low

income households was taken as LE 200 per annum which defines roughly the

bottom three deciles of the urban household distribution. In our general

analysis we shall use the conversion ratios applicable to average

consumption. It is useful, however, both for the appraisal of specific

projects and policies and for the insights which can be gained into the

existing tax and subsidy structure to supplement these with the conversion

factors for specific groups of households.

The expenditure distributions and the resulting estimates of

conversion ratios are presented in Tables 2-3 and 2-4. The most striking

results are the differences between rural and urban conversion ratios and the

magnitude of the conversion ratio for average urban consumption. For each LE

100 increase in average urban consumption the commitment of foreign exchange

convertable at the official rate is LE 111. An increase in average rural

consumption on the other hand commits the economy to only LE 107 for each LE

100 in expenditure at market prices. The effects of the current policy of

heavily subsidizing urban consumption are readily apparent in these numbers.

- 59 -

Evaluating Household Savings

The conversion factor for savings of wage recipients will depend on

the form in which increases in wealth are held. Because little evidence

exists on the asset choice of households in Egypt, a simple model for

determining the social cost of several forms of assets is developed, and

plausible values for the parameters are used to provide an approximate.

estimate of the accounting ratio for savings. 1/

If the savings of an average worker's household increase by one LE

(i.e., if household income increases by the reciprocal of the marginal

propensity to save), the household is assumed to hold its increased wealth in

one of three forms, as an increase in the level of cash balances, as a deposit

in the banking system, or as an investment in housing, agriculture or casual

sector activities (e.g. small scale enterprise or petty trading). 2/

1/ The 1974/75 expenditure survey contains no information on householdsavings behavior or on the asset composition of households.

2/ This simplified description of asset choice may not be altogetherincorrect for Egyptian workers' households. Land is not among assetsacquired by workers. Direct investment in industrial enterprises is alsonot a feasible alternative for most workers. Deposits in the bankingsystem, especially in the government-owned savings and commercial banks,are a form in which workers' households choose to hold their savings, andanecdotal evidence suggests there is substantial investment in agricultureby urban workers and by migrant laborers via remittances. Casual sectoractivities remain an important source of employment (although perhaps notof income) for other members of fully employed workers' households, and itseems worthwhile to include the alternative despite the absence of data.

- 60 -

Table 2-3: Accounting Ratios for Urban Consumption

Expenditure Weights 1974/75Expenditure Category Average Low Income High Income Acc. Ratio

- 200) ( 1000)

Grain and Carbohydrate .098 .182 .069 1.76

Dry Beans .015 .026 .009 1.30

Vegetables .044 .063 .031 0.92

Fruits .036 .030 .037 0.66

Meat .101 .099 .103 1.49

Fish .022 .022 .019 0.97

Milk and Eggs .050 .042 .052 0.97

Oils and Fats .041 .050 .031 1.37

Sugar and Sweets .029 .039 .023 0.84

Misc. Food .036 .059 .027 0.54

Tea and Coffee .016 .024 .012 0.54

Other Beverages .022 .007 .028 0.73

Textiles and Clothing .132 .063 .143 1.02

Housing, Fuel and Light .129 .166 .110 1.65

Furniture .036 .025 .047 0.97

Medical Care and Medicine .018 .010 .022 0.88

Transport and Communications .038 .010 .072 1.27

Education .020 .002 .034 0.86

Culture and Entertainment .013 .001 .022 0.86

Other .103 .079 .110 0.50

Consumption Conversion Factor 1.118 1.219 1.098

- 61 -

Table 2-4: Accounting Ratio for Rural Consumption

Expenditure Category Expenditure Weight Accounting Ratio

Grains and Carbohydrate .187 1.350

Dry Beans .023 .980

Vegetables .044 .920

Fruits .029 .660

Meat .111 1.163

Fish .018 .970Milk and Eggs .043 .970

Oils and Fats .058 1.300

Sugar and Sweets .038 .536

Misc. Food .022 .536

Tea and Coffee .024 .540Other Beverages .010 .730Textiles and Clothing .124 1.020

Housing Fuel Light .098 1.626Furniture .034 .970

Health and Hygiene .010 .880Transport and Communications .030 1.270

Education .010 .860

Culture and Entertainment .004 .860

Other .083 .500

Consumption Conversion Factor 1.070

- 62 -

The average saver is assumed to be infinitely lived and does not dissave.

Thus, his additional savings represent a permanent increase in the stock of

wealth and are not drawn down at a later point in life-cycle of the household

to finance consumption. 1/ The social cost of each type of asset is

separately estimated, and the social cost of savings in general may then be

found by weighting the social cost of each asset by its proportion of the

typical savers portfolio.

The social cost of an increase in cash holdings is most easily

estimated. Given the assumptions, the increase in cash balances held by the

household is permanent. Because the saver is not expected to draw down these

cash holdings at any future date to finance further consumption or the

purchase of alternative forms of assets, the social cost is zero.

Assets held in the form of investments in the banking system in

agriculture or in the casual sector represent an addition to the stock of

capital. If the unit of savings is invested in capital goods with a market

1/ The assumption of an infinitely lived saver, although not essential forthe analysis, greatly simplifies the algebra. It is consistent with alife-cycle savings hypothesis in which the amount of household incomeallocated to consumption over the life cycle of each cohort is equal tothe resources accruing to the household over its lifetime. In such amodel, households in each cohort first save and then dissave to maintain apreferred level of consumption. It has been shown that in the presence ofsteady population growth and/or growth of income, the saving andwealth-income ratio will remain constant for all cohorts taken together.Thus, the infinitely lived saver represents the average over all cohortsin the population, and if the conditions of steady growth of population orincome are approximately fulfilled, he will not dissave and his savingsand wealth-income ratios will remain constant, as hypothesized. SeeF. Modigliani, "The Life Cycle Hypothesis of Saving, The Demand for Wealthand the Supply of Capital", Social Research, 33, No.2, pp. 160-217.

- 63 -

value of K , the accounting cost of the unit of investment is equal to

fkK , where fk is the accounting ratio applicable to capital goods of

the type purchased. The investment generates an annual stream of income at

accounting prices determined by the social rate of return on the investment

activity. If the investment is in the public sector, as for example, when the

increase in savings is held in the banking system, the social return is

assumed equal to the accounting rate of interest. 1/ Hence, the annual social

income from the investment in period t is RfkKt at accounting prices when

R is the accounting rate of interest. If the assets are privately held they

are assumed to earn a real rate of return of r per cent per annum at market

prices. The annual stream of social income produced by the private casual

sector investment may be found by multiplying the annual returns at market

prices by an accounting factor for gross profits, fp. The accounting ratio

for gross profits is the ratio of value added at world prices less wages

evaluated at the shadow wage rate to value added less wages at market prices.

The act of saving and investment by the household entitles it to an

annual income equal to the return on the asset at market prices. Deposits

held in the banking system are assumed to earn a real rate of return of i per

cent per annum; the annual income from the investment is, therefore, iKt.

Investments in casual sector activities earn an annual return of rKt. The

household is assumed to consume a portion of the increase in income and to

1/ This is clearly true for government-owned banks which hold the bulk of

workers' savings. Privately-owned banks may also be assumed to lend to

the government from marginal increase in funds.

- 64 -

save the remainder in the same ratio for other forms of income. 1/ Thus, in

any year the distribution of consumption and savings out of interest income

from the initial unit of savings is given by:

iK t(c + s) c + s = 1 (3)

Savings out of interest income are assumed to be reinvested in the banking

system. If the rates of interest and the marginal propensity to save are

assumed constant over time, wealth and government investment out of the

initial unit of savings grow at a rate:

K = K (I + si)t (4)t 0

The social cost of the consumption and investment out of interest in any year

is given by:

ct = iK t(cfc+ sf k. (5)

where fc is the conversion ratio applicable to the consumption of the

household. If savings are invested in agriculture or casual sector activities

consumption and savings out of the return to the investment may be found in a

similar manner. Adding the simplifying assumption that all savings are plowed

back into the same activity, the social cost of consumption and investment in

year t arising out of the return to the initial investment is given by:

Ct = rK t(f cc + f ks) (6)

The social cost of unit of savings held as bank deposits in year 0 is

given by the accounting cost of the investment in year zero less the present

discounted value of the returns to the investment plus the present value of

1/ Direct taxes are ignored because the savers whose accounting ratio we aretrying to estimate escape the direct tax net. Because the accountingratio for taxes is zero, it would be possible to include tax payments inthe derivation of the accounting ratio for savings of workers withoutdifficulty.

- 65 -

the social cost of the additional consumption and investment out of interest

income:

f = K f - E (Rf K - C )/(l + R) (7)d O k t k t t

The social cost of a unit of savings held as assets in 'casual sector

investments is similarly given by:

fd KOfk i (rf Kt -C)(l+R)t (8)

Setting Ko = 1 and substituting from above, the accounting ratio for savings

held on bank deposits may be expressed as:

fd fk (Rf- cif - sif )/(R - si) (9)d k k c k

and for other investments as:

fd k- (rf p- crf srfk )/(R - sr). (10)

Empirical values for savings held as bank deposits and in casual

sector investments are presented in Table 2-5. In column 1 a unit of savings

is assumed to be held as deposits in the banking system. Sources of the

estimated parameter values are given in the notes accompanying the table. The

accounting ratio for bank deposits is quite robust with reference to

reasonable changes in the parameter values. Stipulating that all interest

income is consumed raises the accounting ratio only slightly to .160.

Allowing the accounting rate of interest to increase to 10 percent results in

a fall in the accounting ratio to .102.

Estimated parameter values for only three casual sector activities

are applied to the model. The activities considered are petty trading,

housing and small scale enterprise which are probably the most important uses

of investible funds in the casual sector.

- 66

Table 2-5: Accounting Ratios for Savings of Households

Parameter Basic Deposits Casual Sector Agriculture Housing

fk 1.200 1.000 1.274 1.569fp .900 1.710 .717R .06 .06 .06 .06c .90 .90 .90 .90s .10 .10 .10 .10r .05 .10 .12i .01fc 1.11 1.11 1.11 1.11fd .036 1.181 .107 1.882

Notes: The accounting ratio for fk is based on the accounting ratiofor the average composition of capital stock. The real rate ofreturn on bank deposits is assumed to be 1.0 percent. Depositrates vary from 9-15 percent in nominal terms. With expectedinflation between 12 and 15 percent real rates of interest mayrange from -6 to 3.0 percent. Real rates of return to casualsector investments discussed in text.

Table 2-6: Alternative Values of the Accounting Ratiofor Household Savings

Case Case Case Case AccountingType of Asset 1 2 3 4 Ratio

Cash Balances .300 .333 .200 0.000Deposits .300 .333 .200 .036Petty Trading .133 .333 .333 .200 1.181Agriculture .133 .333 .200 .107Housing .133 .333 .200 1.882fs .432 .441 1.020 .641

Sources: Table 2-5

Distribution of assets by type discussed in text.

- 67 -

The set of parameter values in Column 2 refers to savings which are

held as a permanent increase in the capital stocks of the casual sector. The

accounting ratio, fk5 is a simple average of consumption items frequently

manufactured and sold by the casual sector in Egypt. In estimating fp it

was assumed that implicit "wage costs" of the self-employed trader represented

75 percent of value added in petty trading and that market traders purchase no

inputs other than items in their inventory. Thus the accounting ratio for

output and purchased inputs was .96, the accounting ratio for labor inputs was

taken as .77, and fp was estimated at .90.

The most difficult of.the parameters to estimate was the rate of

return to petty trading activities. No careful study of the casual sector has

yet been undertaken. The limited evidence available indicates that rates of

return to small scale manufacturing and petty trading may be quite low.

Incomes of petty traders are among the lowest of all occupational groups and

frequently small scale manufacturing is undertaken by workers queueing or

formal sector or migrant labor employment. In Table 2-5 it was assumed that

the marginal rate of return to investments in the casual sector was 5.0

percent per annum. Because this was only a guess, alternate rates of return

of 2.0 percent and 8.0 percent were also tried, with corresponding accounting

ratios of 1.08 and 1.26 respectively. If the assumption that savings are

ploughed back into the activity is abandoned and replaced by an assumption

that all profits are consumed by the household, the accounting ratio rises to

1.20. Not surprisingly, the accounting ratio for assets held in this form

substantially exceeds the accounting ratio for deposits held in the banking

system. Because the rate of return in casual sector activities is assumed to

be much lower than the accounting rate of interest, the social cost of the

investment and the increase in consumption made possible by the investment are

- 68 -

not offset by the additions to uncommitted social income which would arise

from an investment in the public sector. If the parameters presented in Table

2.5 are approximately correct, it appears that the government of Egypt could

increase the social return to savings of workers by increasing the incentives

to hold assets as deposits in the banking system rather than as investments in

casual sector activities.

Column 3 refers to the case in which the unit of savings is invested

in agriculture. For simplicity the agricultural investment is assumed to take

the form of an increase in working capital which will be spent on additional

implements or seeds. An approximate accounting ratio, fk' is given by an

average of the accounting ratios for agricultural products and hardware. The

value of fp and the rate of return are estimated from Cuddihy (1980) and

World Bank (1981).

The investment is assumed to be in marginal food crop agricultural

activities, either on urban plots by the worker and his household or by

relatives in the rural sector to whom the worker remits a portion of his

income. The accounting ratio fp is set equal to 1.71. Again the rate of

return is the most difficult parameter to estimate. Internal rates of return

for food crops range from below zero to more than 50 percent. Since the

agricultural investment in question is assumed to be marginal, it is likely

that the return will be at the lower end of this very broad range. As a

tentative estimate r is set equal to .10. The estimate is highly uncertain

and, therefore, alternative values of .05 and .15 were also tried. Estimates

of the accounting ratio for savings invested in agriculture ranged from .677

to -.073, with a preferred value of .107.

- 69 -

The final asset choice considered is investment in housing

construction. Studies of urbanization in Egypt indicate that construction of

a house either in the city or in their native villages is an important use of

savings of urban residents. For investments of this type data are again quite

limited. The cost breakdowns for housing construction permitted an estimate

of fk and fp. The rate of return to housing construction was placed at

12 percent in the absence of evidence on actual returns. Because much of the

investment in housing occurs in response to the desire to establish a home in

a rural village, it does not seem unreasonable to believe that the rates of

return on such investments may be lower than the very high rates of return to

urban housing. Given the assumptions, the cost qf a unit of savings held in

the form of an investment in housing is equal to 1.88.

The aggregate accounting ratio for savings of workers is made up of

the weighted average of the accounting ratios for each of the asset choices

considered. Again lack of data severely limits the accuracy of the estimated

accounting ratio. The distribution of savings among assets held has not been

analyzed for any class of Egyptian households. For this reason alternative

accounting ratios are worked out in Table 2-6 on the basis of several

plausible assumptions concerning the composition of savings. The range of

results -- from 1.02 to .43 -- indicates that the accounting ratio for savings

is quite sensitive to assumptions regarding portfolio composition. In the

absence of better information the accounting ratio for savings is set equal to

.60, which is near the lower end of the range, reflecting an assumption that

about 30 percent of the portfolio is held in the form of cash balances and

deposits.

- 70 -

2.5 Conversion Ratios for Other Expenditure Categories

In this section we present estimates of summary parameters which may

be useful in providing rough estimates of the shadow cost of several

categories of expenditure. We shall calculate the standard conversion factor

and conversion factors for intermediate and capital goods.

(a) The Standard Conversion Factor

The standard conversion factor is useful in converting the market

value of minor non-traded items into their equivalent value at border prices,

and it may be used to express the results of changes in consumer and producer

surplus in terms of the numeraire. It also provides a summary measure of the

relationship in the economy between shadow prices and market prices and, under

certain simplifying assumptions, can be thought of as the ratio of the market

exchange rate to the shadow exchange rate. 1/ Given the large number of goods

for which we have estimated accounting ratios, the best estimate of the

standard conversion factor is provided by the median of the frequency

distribution of an appropriately selected set of tradable and non-tradable

commodities. The median of the full distribution of 130 commodities is .993.

This may slightly overstate the standard conversion factor because we have

included a large number of petroleum products in our sample, and, hence, the

full sample may overrepresent commodities which are highly subsidized. An

alternative estimate is provided by taking the median of the sets of tradable

inputs (T1-38), urban consumption goods (Ul-28) and non-tradables (Nl-36).

The estimate of the SCF is .960, which is very similar to our first estimate.

1/ On this point see Scott (1974) or Little and Mirrless (1974).

- 71 -

We therefore take as our best estimate of the standard conversion factor a

value of .965, which is also the median of the distribution of the 75 major

tradable and non-tradable commodities in our sample.

(b) A Conversion Factor for Investment

The conversion factor for investment is useful in cases where the

only estimate of the capital cost of an inp'pt consists of a single value

figure for total investment or of the'residual of value added minus wages. In

such circumstances,,the social cost of the capital input may be estimated by

combining information on the average distribution of investment by type (eg.

buildings, machinery etc.) and the accounting ratios for investment goods. We

present two conversion factors for capital inputs. The first is applicable to

total investment expressed in LE. The second is the accounting ratio for

rental of capital and is applicable to annualized capital cost data such as

value added minus wages. It is found by taking the annual amortization of the

capital stock by type at' the Accounting Rate of Interest as weights and

applying the relevant conversion ratios. Results of the estimates are set out

in Table 2-7. Because the accounting ratio for building and construction

exceeds unity by a large margin the accounting ratios for investment are also

generally above one.

(c) A Conversion Factor for Intermediate Goods

We present a summary measure of the accounting ratio for intermediate

goods for reasons similar to those applicable to the conversion factor for

investment. In some circumstances, miscellaneous intermediates may be lumped

together as a cost item and may, therefore, require a general conversion

factor. This accounting ratio should not be used in circumstances when

individual cost items are specified. We take as our estimate of the

accounting ratio for intermediates the median of the distribution of tradables

- 72 -

(Tl-38), agricultural inputs and outputs (Al-13) and non-tradables (Nl-36)

which is .980. Clearly we would not go far wrong in using the standard

conversion factor to value miscellaneous intermediate inputs.

Table 2-7: Conversion Factors for Investment

Weight in Weight in AccountingInvestment Annual RatioExpenditure Capital Rental

ManufacturingLand & Buildings 27.8 24.4 1.67Machinery & Equipment 60.7 66.1 .97Services 11.5 9.5 .86

Conversion Factor 1.15 1.13

Transport & CommunicationsLand & Buildings 26.0 20.7 1.67Machinery & Equipment 62.4 70.6 .90

Services 11.6 8.7 .86

Conversion Factor 1.10 1.06

Other ServicesLand & Buildings 45.0 40.8 1.67

Machinery & Equipment 45.7 51.3 .86

Services 9.3 7.9 .86

Conversion Factor 1.22 1.19

Gross Fixed InvestmentLand & Buildings 38.1 34.1 1.67

Machinery & Equipment 51.6 57.2 .92

Services 10.3 8.7 .86Conversion Factor 1.20 1.17

Notes: Investment weights are from World Bank (1981b)Rental Weights computed from Column (1) weights are ARI .08

Economic Lifetimes, Buildings = 40, Machinery = 20, Services 00

- 73 -

Appendix 2-1: Cost Coefficients for Commodities in Egypt

The cost breakdowns for 130 commodities in Egypt are presented in

this appendix. These cost breakdowns are the precentage of the delivered cost

of a commodity at market prices made up of other commodity inputs and primary

inputs. The list of commodities and primary inputs is in Table A2-1-1. Cost

coefficients are presented in Table A2-1-2. To find the cost breakdown of any

commodity, find its identification number in Table A2-2-1. For example, the

identification number for textile machinery is 18. Commodity cost

coefficients are then given by the second entries corresponding to that

identification number. Thus, 18, 117 gives the port charges coefficient for

textile machinery. Primary input cost coefficients are also available in the

P matrix. To find these values, locate the column corresponding to the item

identification number. Primary input cost contents are given by the row

values 1-11. The total direct primary input cost is given by row 12.

Total (direct plus indirect) cost coefficients are available in Table

A2-1-3, the P matrix. In this case the matrix is transposed. Commodities are

listed as rows; primary input coefficients are listed as columns. To find the

total primary input coefficients for any commodity, locate the relevant row

and read across all columns.

Notes on Specific Industries

(a) Subsidized Producer Goods

A number of producer goods including cement, building materials,

steel reinforcing rods, and certain industrial chemicals are both produced in

Egypt and imported. These commodities are distributed through public sector

- 74 -

FIGURE A2-1:

Shadow Price Determination in Segmented Commodity Markets

£~~~Lt ~ ~ ~ /

C _'~~~~~~~~~~~~C

Pp S'- x \7 I

s / IA

- 75 -

authorities and are sold at subsidized prices. In certain cases, however,

there is a price differential charged between imported and domestic sources of

supply and the domestic production is sold at a rationed price below that of

the competing import. The nature of the market for these commodities is

illustrated in Figure A2-1. The domestic demand curve is represented by DD.

Domestic supply is given by SS which is displaced downward by production

subsidies to S'S'. Production is given by OA which is sold at a price of

PD. If the public sector marketing authority fills remaining domestic

demand at PD by imports AB, a per unit subsidy of PWPD is implied and

the appropriate accounting ratio is Pw /P . If on the other hand the

supply authority allows the domestic price on the imported commodity to rise

to PW (while rationing the domestically produced quantity) import demand

declines to AB'; and the appropriate accounting ratio is 1.0. Note that in

both cases the appropriate accounting price is the world price, but that the

ratio of the accounting price to the domestic price changes in response to the

behavior of the marketing authorities. The presence of a production subsidy

is irrelevant to the determination of the accounting price since in both cases

the incremental change in demand is met by changes in the volume of imports.

We have in general estimated two sets of accounting ratios for these products:

one based on the assumption that the supply authority charges a uniform price

for the commodity and the other based on the assumption that the subsidized

domestic price is charged only to limited categories of users with the

consequence that market prices for the non-rationed segment of the market have

as their basis the import price of the commodity. In general we shall use the

latter accounting ratio except in the case of cement in which the former set

of assumptions applies.

- 76 -

(b) Cement

Cement has shifted from an exportable to an importable in recent

years, and Egypt has embarked on a major investment campaign which should

permit local production to fill domestic demand within ten years. In this

study cement has been treated as an importable with a CIF price based on the

normal level of interntional prices, since in recent years there have been

substantial year to year variations in the international price. As we noted

above, cement is sold at a control price below the import parity price by the

Ministry of Housing and Reconstruction, thus its accounting ratio exceeds 1.0.

(c) Fertilizer

Fertilizer is a second industrial sector in which it is possible that

a reversal of trade flows may take place in the medium term. Although at

present Egypt is a net importer of fertilizer, there are sufficient planned

investments in capacity expansion to achieve self-sufficiency, and possibly to

generate an exportable surplus. Experience suggests that the investment

program may slip somewhat. Hence fertilizers are treated in this report as

importables, but major increases in domestic supply could call for a revision

of the direction of trade assumption.

(d) Textiles and Clothing

Product heterogeneity represents the principal impediment to accurate

shadow pricing in the textile sector. Egypt is a major exporter of cotton

textiles which are its principal manufactured export. There are however some

segments of the textile industry which produce wholly non-traded varieties of

cloth, and the high incidence of trade in textiles with bilateral payments

trading partners makes it difficult to establish the appropriate international

price for much of the sector's traded output. We have,adopted the following

simplified approach to the textiles sector. Rationed cloth which is of a

- 7 7 -

standard below that entering international trade has been treated as a

non-tradable. Cotton yarn and non-rationed cloth are treated as exportable

with a "normal" international price based on their unit values in trade with

the industrialized countries. Unit prices for trade with the eastern bloc are

not employed.

Clothing is a mixed sector as well. There are limited exports of

clothing, again largely to the non-OECD countries, which coexist with limited

imports of clothing for the urban high-income consumer. The bulk of output,

though, is the nontraded product of small scale enterprises. We have

considered two categories of clothing, importable and non-traded.

It is important to recall that although these accounting ratios are

sufficient to establish the accounting costs of rural and urban consumption

and to provide some rough indication of the relative social returns to textile

production, appraisal of textile projects would require substantially more

detailed analysis of the proposed output of the project. The aggregate

accounting ratios for the textiles sector should be used with caution.

(e) Subsidized Agricultural Products

As we noted in section 2.1 above, the major problem with subsidized

agricultural products is that the relationship between domestic prices and

international prices may fluctuate greatly over time. The accounting ratios

which we have employed are based on mean international prices for the period

1977-80 and on the 1980 levels of producer and consumer prices. These

relative values should remain roughly constant in the short to medium term,

but any major change in either the international price or the administered

domestic price will require a revision of the accounting ratio. We have

provided three sets of accounting ratios for agricultural commodities - one

- 78 -

each for rural and urban consumption and one for farm output - based on the

relationship of the domestic price to the international price.

(f) Cotton

Cotton is the only commodity in which Egypt faces a less than

perfectly elastic demand curve for its exports. The appropriate accounting

ratio is therefore based on the marginal export revenue rather than the

average FOB price. In Appendix 2-2 we derive an accounting ratio for cotton

and explore the sensitivity of our estimates to alternative estimates of the

elasticity of demand for long staple cotton.

(g) Petroleum Products

Petroleum is the largest single Egyptian export by value, and

domestically produced petroleum products play a major role in determining the

social cost of such important non-traded activities as transport and

electrical generation. The significance of these products in our analysis is

greatly increased by the fact that all of them sell at domestic prices which

are far below the export parity price. The presence of major implicit

subsidies in the market for domestic petroleum products raises no major

problems with the method of analysis, beyond our previously mentioned caveat

regarding potential variability in the relationship between domestic and

international prices, though it raises extremely important policy issues. For

each product the implicit subsidy to consumption may be estimated by working

back from the domestic price imputing transport and distribution margins and

thereby arriving at the ex-factory value. This may then be compared with the

border price. Our estimates of implicit subsidies and accounting ratios are

taken from the Petroleum Products Pricing Study (Pierce, Whitman (1981)) and

refer to the period 1979/80. Major changes either in domestic or

international prices would have to be reflected in revised accounting ratios

- 79 -

for the products concerned. The magnitude of the price differential is quite

stunning. Accounting ratios for major petroleum products range between 2.0

and 15.0.

Natural gas pricing presents a special problem in that if the volume of

gas production becomes sufficiently great, gas will shift from being a traded

to a non-traded good. For the purposes of our analysis we have assumed that

natural gas is substitutable for fuel oil and have priced it at the thermal

equivalent of the fuel oil replaced. This is a valid assumption in the medium

term and gives us about $4.50 per Mcf in 1980 prices. In the longer run

natural gas production may exceed the scope for replacement of petroleum

products. At that point its shadow price is set by its marginal value product

at border prices which may be expected to lie between the thermal equivalent

of fuel oil replaced and the liquified natural gas (LNG) net back. For

further discussion of these issues and an estimate of the longer run shadow

price of natural gas see Dervis, Martin and van Wijnbergen (1982).

(h) Rail Transport

Rail Transport was the only nontraded activity in which we had

empirical evidence of economies of scale. Moreover the National Transport

Study indicated that there was great variability in the price marginal cost

margin by type or rail cargo, with the bulk of cargo transported at rates

substantially below marginal cost. For this reason several accounting ratios

for rail transport are estimated. The principal accounting ratio is that

applicable to marginal cost and gives the resource cost at shadow prices of

providing one LE of rail services. The other accounting ratios represent the

price-marginal cost relationship for various important categories of goods and

vary only in the amount of the implicit subsidy provided by the rate structure.

- 80 -

(i) Road Transport

Road transport which is both a public and private sector activity

receives an implicit subsidy from the government to the extent that public

expenditures on construction and maintenance are not recovered by user

charges. Although we have not been able to obtain reliable estimates of road

construction expenditures in a form satisfactory to allow their inclusion in

long run marginal costs, we have included road maintenance expenditure in the

marginal social cost of providing road transport services. When this item is

included in the estimates of marginal social cost they show a net direct

subsidy of 11 percent of revenue.

(j) Electricity

The principal issue 'lere is the extent to which the accounting ratio

for electrical generation should reflect the long run average costs of the

integrated grid, including hydroelectric power. The electricity sector has

largely used the full capacity of the generating facilities of the Aswan High

Dam, and substantial current demand is being met by thermal power generation.

Thus, we have assumed that marginal increases in electricity demand will be

met by increased thermal output in the medium term. The marginal social cost

of production for thermal generation is estimated to be LE .0464/KwH ($.0663)

border pounds in 1980.

There are a few large users in the Egyptian public sector which

receive electricity at rates as low as LE 0.0035/KwH. Our accounting ratio,

however, should apply to the "typical" marginal user of electricial power. We

have therefore used a market price of LE .014/KwH that reflects the cost to

the "typical" incremental user. The total net subsidy coefficient allowing

for direct and indirect input requirements of subsidized inputs, is 2.32.

This means that for each LE 100 spent on electrical power generation there is

- 81 -

a social loss of LE 232 in forgone government revenue. The implicit subsidies

are clearly reflected in the accounting ratio for electricity of 3.321 which

is not quite as high as that of petroleum products, but which substantially

exceeds the conversion factors for capital and intermediate goods. In terms

of the choice between more or less energy intensive techniques or products it

is clear that current tariffs, even excluding some "outliers" such as Kima

(fertilizer) and Nag Hammadi (aluminum), provide a very poor guide to relative

social costs.

(k) Distributive Trades

Wholesale and retail distribution are particularly difficult sectors

due to the absence of data on the private sector. We have relied entirely on

the public sector accounts for estimates of the cost structure of distribution

activities. In the case of distribution, it was necessary to estimate the

cost of holding stocks, since interest on working capital is a major cost item

for these activities. In the absence of better information, we have assumed

that stocks represent about 15 percent of turnover in both wholesaling and

retailing, which implies that interest on working capital accounts for 10

percent of total costs. Since these stocks consist of the various products

being distributed, the social cost of holding them depends on the accounting

price of the product concerned. This is a case, therefore, of a situation

where increased demand for a product as an input into a project leads to a

further increase in demand to maintain the desired level of stocks. To allow

for this, we assume that for each good in which wholesale or retail

distribution is an input, 10 percent of these inputs are inputs of the good

itself and adjust the input-output coefficients accordingly. This has the

effect of reducing the apparent distribution margin and increasing the foreign

exchange and tax/subsidy coefficients from their unadjusted levels. Given the

- 82 -

distribution margins involved, the corrections are not quantitively very

important -- less than two percent of total costs -- but the adjustment was

not difficult so we made it.

(1) Non-Traded-Agricultural Commodities

Items subsumed under this heading include vegetables, berseem, some

food grains, staple starches and fresh fish. An increase in demand for these

products may lead to a rise in the market price and to: (i) an increase in the

production of these commodities either as a result of increased effort by

producers or at the expense of other agricultural output which is tradable;

(ii) a shift by consumers from consumption of these products to substitutes;

and (iii) a transfer of income from consumers to producers of non-traded

agricultural products. items (i) and (ii) comprise the social cost of the

increase in the demand for non-traded agricultural goods. Item (iii) may

represent a cost or a benefit depending on the welfare weights attached to the

incomes of producers and-consumers.

It is possible to devote great time and energy to the estimates of

plausible values for these three elements, however, the payoff for our present

purposes would be rather small. Hence, we have assumed that all of the

increase in output will arise at the expense reduced output of tradable

agricultural crops. The marginal social cost of production is therefore found

by taking as input coefficients the proportions in total sown acreage of the

principal tradable agricultural commodities. This procedure ignores elements

(ii) and (iii) above, and any detailed use of accounting prices to evaluate

agricultural projects would require a more careful examination of the social

costs and benefits of non-traded agricultural production.

- 83 -

Table 2-2: Accounting Ratios by Category/Egypt

Tradable Goods

1 TI Aluminum2 2 Busses3 3 Cement4 4 Chemicals (industrial)(subs.)5 5 Chemicals (inorganic)6 6 Chemicals (organic)7 7 Electric Machinery8 8 Electrical Distribution Machinery9 9 Electrical Motors10 10 Fittings and Fixtures11 11 Gloss Products12 12 Iron and Steel Products13 13 Iron and Steel Building Materials (subs.)14 14 Iron and Steel15 15 Jute Yarn16 16 Jute Bags17 17 Machinery (metal working)18 18 Machinery (textiles)19 19 Machinery (office)20 20 Machinery Spare Parts21 21 Metals (fellous)22 22 Metals (non-ferrous)23 23 Metal Products24 24 Paints and Pigments25 25 Paper and Printing26 26 Paper (subs.)27 27 Paper Products28 28 Packaging Materials29 29 Plastics30 30 Rubber (crude)31 31 Rubber Products32 32 Tires and Tubes33 33 Tobacco (unmfg.)34 34 Telecommunications Equipment35 35 Trucks and Lorries36 36 Wood (crude)37 37 Wood Products38 38 Vehicle Spares

Agricultural Inputs and Outputs

39 Al Agricultural Machinery40 2 Agricultural Machinery Spares41 3 Agricultural Implements42 4 Bags43 5 Fertilizer (wtd average)44 6 Pesticides45 7 Seeds

- 84 -

46 8 Maize47 9 Onions48 10 Rice49 11 Soy Beans50 12 Sugar-51 13 Wheat

Petroleum Products

52 PP1 Crude Oil53 2 Diesel54 3 Fuel Oil55 4 Gas Oil56 PP5 Kerosene57 6 Naptha58 7 Petrol

Urban Consumer Goods (Tradable)

59 Ul Beef (rationed)60 2 Beef (non-rationed)61 3 Butagas (LPG)62 4 Coffee63 5 Clothing64 6 Consumer Durables65 7 Edible Fats66 8 Fish67 9 Fruit68 10 Footwear69 11 Lentils70 12 Maize71 13 Milk and Products72 14 Medicines and hygiene73 15 Passenger Automobiles74 16 Rice75 17 Sesame76 18 Soap and Detergents77 19 Sugar (rationed)78 20 Sugar (non-rationed)79 21 Tea80 22 Textiles (non-rationed)81 23 Tobacco Procuts82 24 Vegetables83 25 Vegetable Oil (rationed)84 26 Vegetable Oil (non-rationed)85 27 Wheat86 28 Wheat Flour

Rural Consumer Goods

87 RI Lentils88 2 Maize (non-subsidized)89 3 Meat (non-rationed)

- 85 -

90 4 Rice (non-subsidized)91 5 Sesame92 6 Sugar (non-rationed)93 7 Vegetable Oil (non-rationed)94 8 Wheat (non-subsidized)

Non-Traded Goods

95 NI Animal Fodder96 2 Bread Baking97 3 Banking and Insurance98 4 Beverages99 5 Biscuits and Confectionery100 6 Building and Construction101 7 Building Materials102 8 Cotton Cloth (rationed)103 9 Cigarettes104 10 Electricity105 11 Entertainment and Culture106 12 Food Packing107 13 Food Distribution108 14 Garments (subsidized)109 15 Grain Milling110 16 Housing (rural)111 17 Housing (urban - low and middle income)112 18 Housing (urban - high income)113 19 Milk Products114 20 Meat Processing115 21 Miscellaneous Office Services116 22 Personal Services117 23 Port and Harbor Charges118 24 Printing and Publishing119 25 Rail Transport (passengers) MC120 26 Rail Transport (goods) MC121 27 Rail Transport (price) MC122 28 Retail Distribution123 29 Road Maintenance124 30 Road Transport (passenger)125 31 Road Transport (goods)126 32 Services NES127 33 Telecommunications128 34 Transport (wto png)129 35 Vehicle Repair130 36 Wholesale Distribution

- 86 -

Table A2-1-2: Cost Coefficientsfor Commodities in ERgpt

1 I 1.000 I 117 0.054 1 128 0.054 1 130 -0.0612 2 1.000 2 117 -0.013 2 130 -0.129 3 3 1.0003 117 -0.094 3 125 -0.219 3 130 -0.250 4 4 1.0004 117 -0.049 4 130 -0.081 5 5 1.000 5 117 -0.0205 130 -0.110 6 6 1.000 6 117 -0.020 6 130 -0.1197 7 1.000 7 117 -0.020 7 130 -0.118 8 8 1.0008 117 -0.038 8 130 -0.100 9 9 1.000 9 117 -0.0389 130 -0.100 10 10 1.000 10 117 -0.045 10 130 -0.085

11 11 1.000 II 117 -0.042 II 130 -0.110 12 12 1.00012 117 -0.040 12 128 -0.044 12 130 -0.066 13 13 1.00013 117 -0.100 13 128 -0.111 13 130 -0.167 14 14 1.00014 117 -0.066 14 130 -0.072 15 15 1.000 15 117 -0.03515 130 -0.102 16 16 1.000 16 117 -0.038 16 130 -0.10017 17 1.000 17 117 -0.020 17 130 -0.118 18 18 1.00018 117 -0.020 18 130 -0.118 19 19 1.000 19 117 -0.02119 130 -0.128 20 20 1.000 20 117 -0.020 20 130 -0.11821 21 1.000 21 117 -0.066 21 130 -0.072 22 22 1.00022 117 -0.055 22 130 -0.084 23 23 1.000 23 117 -0.01723 130 -0.106 24 24 1.000 24 117 -0.046 24 130 -0.09225 25 1.000 25 117 -0.036 25 130 -0.103 26 26 1.00026 117 -0.056 26 130 -0.162 27 27 1.000 27 117 -0.02527 130 -0.105 28 28 1.000 28 117 -0.017 28 128 -0.04228 130 -0.080 29 29 1.000 29 117 -0.019 29 130 -0.11130 30 1.000 30 117 -0.038 30 130 -0.100 31 31 1.00031 117 -0.029 .31 130 -0.101 32 32 1.000 32 117 -0.01332 128 -0.039 32 130 -0.090 .33 33 1.000 33 117 -0.05033 130 -0.088 34 34 1.000 34 117 -0.020 34 130 -0.11835 35 1.000 35 117 -0.013 35 130 -0.129 36 36 1.00036 117 -0.042 36 130 -0.096 37 37 1.000 37 117 -0.03837 130 -0.100 38 38 i.000 38 117 -0.012 38 130 -0.13039 39 1.000 39 117 -0.077 39 128 -0.135 39 130 -0.13440 40 1.000 40 117 -0.068 40 128 -0.068 40 130 -0.12041 41 1.000 41 117 -0.040 41 122 -0.070 41 128 -0.04041 130 -0.070 42 42 1.000 42 117 -0.033 42 130 -0.18243 43 1.000 43 117 -0.050 43 120 -0.096 43 121 0.06443 122 -0.064 43 128 -0.047 43 130 -0.147 44 44 1.00044 117 -0.055 44 122 -0.110 44 128 -0.050 44 130 -0.13045 45 1.000 45 117 -0.045 45 122 -0.085 45 128 -0.05045 130 -0.075 46 46 1.000 47 47 1.000 48 48 1.00049 49 1.000 50 50 1.000 51 51 1.000 52 52 1.00052 117 -0.021 52 128 -0.021 52 130 -0.020 53 53 1.00053 117 0.098 53 128 0.098 53 130 -0.557 54 54 1.00054 117 0.400 54 128 0.400 54 130 -0.320 55 55 1.00055 117 0.085 55 128 0.085 55 130 -0.484 56 56 l.00056 117 0.079 56 128 0.079 56 130 -0.113 57 57 1.00057 117 0.059 57 128 0.059 57 130 -0.376 58 58 1.00058 117 0.018 58 128 0.018 58 130 -0.178 59 59 1.00059 107 -0.115 59 114 -0.058 59 117 -0.031 59 130 -0.05960 60 1.000 60 107 -0.046 60 114 -0.023 60 117 -0.01260 130 -0.023 61 61 1.000 61 117 -0.020 61 122 -0.08561 130 -0.085 62 62 1.000 62 117 -0.001 62 122 -0.00562 130 -0.005 63 63 1.000 63 117 0.021 63 122 -0.08563 130 0.065 64 64 1.000 64 117 -0.040 64 122 -0.10564 130 -0.080 65 65 1.000 65 107 -0.010 65 117 -0.00565 130 -0.010 66 66 1.000 66 117 -0.031 66 122 -0.084

- 87 -

Table A2-1-2 -(Cont.)

66 130 -0.084 67 67 1.000 67 117 -0.030 67 122 -0.08067 130 -0.070 68 68 i.000 68 117 0.025 68 122 -0.11168 130 0.065 69 69 1.000 69 117 -0.0610 69 122 -0.04469 130 -0.045 70 70 1.000 70 117 -0.017 70 122 -0.05070 130 -0.055 71 71 1.000 71 117 -0.031 71 122 -0.08471 130 -0.084 72 72 1.000 72 117 -0.0i0 72 122 -0.06072 130 -0.045 73 73 1.000 73 117--0.045 73 122 -0.11573 130 -0.082 74 74 1.000 74 117 0.033 74 122 -0.15374 128 0.066 74 130 0.153 75 75 1.000 75 117 -0.00375 122 -0.015 75 130 -0.015 76 76 1.000 76 117 -0.03076 122 -0.085 76 130 -0.070 77 77 1.000 77 107 -0.02477 117 -0.010 77 120 -0.035 77 121 0.016 77 130 -0.02478 78 1.000 78 107 -0.010 78 117 -0.004 78 120 -0.00878 121 0.003 78 130 -0.010 79 79 1.000 79 107 -0.00579 117 -0.001 79 130 -0.005 80 80 1.000 80 117 0.03080 122 -0.112 80 130 0.060 81 81 1.000 81 117 -0.03381 122 -0.090 81 130 -0.082 82 82 1.000 82 117 -0.03082 122 -0.080 82 130 -0.070 83 83 1.000 83 117 -0.02083 122 -0.044 83 130 -0.044 8A'48'41TI000 84117 -0.0i0

84~T22-0.2 2 84130 j -0.022 8585 1.000 85 107 -0.12485 117 -0.041 85 120 -0.062 85 121 0.012 85 130 -0.07486 86 i.000 86 107 -0.044 86 117 -0.015 86 130 -0.05387 87 1.000 87 117 -0.003 87 122 -0.014 87 125 -0.02087 130 -0.014 88 88 1.000 88 117 -0.008 88 122 -0.02788 125 -0.048 89 89 i.000 89 117 -0.010 89 122 -0.01089 128 -0.024 89 130 -0.020 90 90 1.000 90 117 0.01190 122 -0.051 90 128 0.022 90 130 0.051 91 91 1.00091 117 -0.003 91 122 -0.013 91 128 -0.019 91 130 -0.01392 92 1.000 92 117 -0.004 92 120 -0.074 92 121 0.03492 122 -0.010 93 93 1.000 93 117 -0.010 93 122 -0.02093 128 -0.091 93 130 -0.020 94 94 1.000 94 117 -0.01094 120 -0.075 94 121 0.044 94 122 -0.051 94 130 -0.02095 28 -0.150 95 49 -0.023 95 54 -0.012 95 78 -0.03295 95 1.000 95 115 -0.020 96 28 -0.085 96 65 -0.05096 86 -0.380 96 96 1.000 96 104 -0.020 96 115 -0.02096 125 -0.021 97 19 -0.069 97 26 -0.070 97 97 i.00097 104 -0.010 97 115 -0.016 98 5 -0.013 98 6 -0.05998 20 -0.007 98 23 -0.095 98 27 -0.019 98 28 -0.03498 54 -0.007 98 78 -0.201 98 98 1.000 98 115 -0.03099 20 -0.054 99 28 -0.i77 99 54 -0.01i 99 71 -0.05199 78 -0.i14 99 86 -0.068 99 99 1.000 99 104 -0.00899 115 -0.008 100 3 -0.159 100 13 -0.113 100 23 -0.025

100 37 -0.025 100 52 -0.010 100 54 -0.008 100 55 -0.010100 100 1.000 100 101 -0.026 100 104 -0.001 100 125 -0.005100 126 -0.193 101 20 -0.050 101 28 -0.034 101 54 -0.139101 55 -0.065 101 101 1.000 101 104 -0.010 101 120 -0.402101 121 0.317 101 126 -0.113 101 129 -0.065 102 6 -0.010102 54 -0.015 102 102 1.00.0 102 104 -0.011 102 115 -0.100102 128 -0.089 103 27 -0.045 103 28 -0.040 103 33 -0.165103 54 -0.010 103 103 1.000 103 115 -0.025 104 5 -0.004104 8 -0.007 104 14 -0.002 104 20 -0.002 104 53 -0.006104 54 -0.155 104 55 -0.008 104 57 -0.002 104 101 -0.004104 104 1.000 104 115 -0.039 104 125 -0.015 105 104 -0.014105 lOS 1.000 105 115 -0.119 106 6 -0.020 106 20 -0.045106 22 -0.079 106 26 -0.217 106 29 -0.020 106 60 -0.025106 66 -0.119 106 67 -0.029 106 77 -0.058 106 104 -0.010106 106 1.000 106 iuS -0.025 107 16 -0.050 107 27-0.125107 28 -0.100 107 53 -0.025 107 104 -0.005 107 107 1.000

- 88 -

Table A2-1-2 (Cont.)

107 115 -0.100 107 120 -0.115 107 121 0.085 107 125 -0.118107 126 -0.122 108 5 -0.069 108 20 -0.020 108 28 -0.019108 29 -0.021 108 80 -0.051 108 108 1.000 108 115 -0.027109 54 -0.035 109 104 -0.050 109 109 1.000 109 115 -0.040109 125 -0.060 110 3 -0.104 110 10 -0.040 110 13 -0.130110 23 -0.011 110 24 -0.012 110 37 -0.059 110 101 -0.130110 110 1.000 110 115 -0.013 110 126 -0.030 111 3 -0.088111 10 -0.043 111 13 -0.142 Il1 23 -0.014 111 24 -0.013111 37 -0.077 Ili 101 -O,Iil Ill I1 1.000 111 115 -0.017111 126 -0.030 112 3 -0.056 112 10 -0.063 112 13 -0.113112 23 -0.030 112 24 -0.017 112 37 -0.094 112 101 -0.128112 112 1.000 112 115 -0.020 112 126 -0.030 113 28 -0.183113 104 -0.037 113 113 1.000 113 115 -0.039 113 125 -0.024113 126 -0.040 114 28 -0.053 114 104 -0.035 114 114 1.000114 115 -0.045 114 125 -0.059 114 126 -0.032 115 19 -0.111115 97 -0.210 115 104 -0.012 115 115 1.000 115 116 -0.111115 118 -0.111 115 127 -0.333 116 116 1.000 117 20 -0.060117 55 -0.070 117 104 -0.011 117 115 -0.100 117 117 1.000118 5 -0.065 118 20 -0.050 118 25 -0.352 118 104 -0.025118 115 -0.069 118 118 1.000 118 127 -0.030 118 128 -0.030119 3 -0.041 119 7 -0.041 119 12 -0.087 119 22 -0.001119 23 -0.011 119 36 -0.007 119 55 -0.038 119 101 -0.003119 119 1.000 120 3 -0.051 120 7 -0.050 120 12 -0.108120 22 -0.002 120 23 -0.013 120 36 -0.008 120 55 -0.037120 101 -0.004 120 120 1.000 121 121 -1.000 122 27 -0.069122 28 -0.069 122 104 -0.005 122 115 -0.040 122 122 1.000122 125 -0.056 123 3 -0.050 123 12 -0.045 123 23 -0.011123 52 -0.232 123 55 -0.065 123 101 -0.025 123 115 -0.010123 123 1.000 124 32 -0.141 124 38 -0.202 124 53 -0.020124 55 -0.023 124 58 -0.011 124 115 -0.042 124 123 -0.089124 124 1.000 124 129 -0.040 125 32 -0.206 125 38 -0.090125 53 -0.010 125 55 -0.043 125 58 -0.027 125 115 -0.065125 123 -0.141 125 125 1.000 125 129 -0.113 126 4 -0.031126 5 -0.022 126 6 -0.021 126 7 -0.015 126 12 -0.006126 20 -0.003 126 23 -0.006 126 27 -0.041 126 36 -0.021126 53 -0.020 126 54 -0.021 126 55 -0.020 126 58 -0.020126 59 -0.032 126 62 -0.011 126 65 -0.011 126 66 -0.013126 67 -0.021 126 71 -0.050 126 80 -0.004 126 96 -0.051126 98 -0.002 126 104 -0.022 126 106 -0.069 126 115 -0.025126 118 -0.007 126 126 1.000 126 127 -0.035 126 128 -0.064127 20 -0.060 127 104 -0.011 127 115 -0.100 127 127 1.000128 120 -0.143 128 125 -0.857 128 128 1.000 129 32 -0.053129 38 -0.512 129 104 -0.005 129 115 -0.065 129 129 1.000130 27 -0.073 130 28 -0.074 130 115 -0.077 130 128 -0.088130 130 1.000 0 0 0.000 0 0 0.000 0 0 0.000

Table A2-1-2: Direct Primary Input(Cont.) Coefficients for Commodities

PRIMARY INPUTS-EGYPT(11,130) 1979

COLUMN 1 2 3 4 5 6 7 8 9 10

ROW1 1.156 0.617 1.563 2.029 0.845 0.821 0.845 0.700 0.719 0.7252 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.0003 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.0004 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.0005 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000

6 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.0007 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.0008 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.0009 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000

10 0.000 0.241 0.000 0.000 0.025 0.040 0.017 0.162 0.143 0.14511 -0.109 0.000 -1.125 -1.159 0.000 0.000 0.000 0.000 0.000 0.00012 1.047 0.858 0.438 0.870 0.870 0.861 0.862 0.862 0.862 0.870

COLUMN ii 12 13 14 15 16 17 18 19 20 c

ROW1 0.806 0.773 1.944 0.784 0.719 0.616 0.845 0.845 0.638 0.8452 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.0003 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.0004 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000

5 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.0006 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.0007 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.0008 0.000 0.000 0.000 0.000 0 .000 0.000 0.000 0.000 0.000 0.0009 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000

10 0.042 0.078 0.000 0.078 0.144 0.246 0.017 0.017 0.213 0.01711 0.000 0.000 -1.322 0.000 0.000 0.000 0.000 0.000 0.000 0.00012 0.848 0.851 0.622 0.862 0.863 0.862 0.862 0.862 0.851 0.862

Table A2-1-2 (Cont.)

PRIMARY INPUTS-EGYPT(tI,130) 1979

COLUMN 21 22 23 24 25 26 27 28 29 30

ROW1 0.821 0.859 0.792 0.777 0.821 1.566 0.669 0.663 0.696 0.8452 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.0003 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.0004 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.0005 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.0006 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.0007 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.0008 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.0009 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000

10 0.041 0.002 0.085 0.085 0.041 0.078 0.201 0.198 0.174 0.0171i 0.000 0.000 0.000 0.000 0.000 -0.861 0.000 0.000 0.000 0.00012 0.862 0.861 0.877 0.862 0.862 0.783 0.870 0.861 0.870 0.862

COLUMN 31 32 33 34 35 36 37 38 39 40

ROW1 0.669 0.677 0.768 0.750 0.790 0.862 0.845 0.748 0.769 0.7442 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.0003 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.0004 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.0005 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.0006 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.0007 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.0008 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.0009 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000

10 0.201 0.181 0.094 0.113 0.069 0.000 0.017 0.111 0.000 0.000il 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 -0.115 0.00012 0.870 0.858 0.862 0.863 0.859 0.862 0.862 0.859 0.654 0.744

Table A2-1-2 (Cont.)

PRIMARY INPUTS-EGYPT(11,130) 1979

COLUMN 41 42 43 44 45 46 47 48 49 50

ROW1 0.780 1.091 1.255 1.655 0.902 1.313 4.259 2.043 0.992 0.9692 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.0003 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.0004 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.0005 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.0006 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.0007 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.0008 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.0009 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000

10 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.008 0.031II 0.000 -0.306 -0.595 -1.000 -0.157 -0.313 -3.259 -1.043 0.000 0.00012 0.780 0.785 0.660 0.655 0.745 1.000 1.000 1.000 1.000 1.000

COLUMN 51 52 53 54 55 56 57 58 59 60

ROW1 1.591 0.938 6.567 16.107 6.105 6.003 4.295 1.433 1.697 0.679 v

2 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 13 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.0004 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.0005 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.0006 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.0007 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.0008 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.0009 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.21710 0.000 0.000 0.000 0.000 0.000 0.396 0.000 0.226 0.000 0.00011 -0.591 0.000 -5.928 -14.627 -5.419 -5.354 -3.553 -0.801 -0.960 0.00012 1.000 0.938 0.639 1.480 0.686 1.045 0.742 0.858 0.737 0.896

Table A2-1-2 (Cont.)

PRIMARY INPUTS-EGYPT(11,130) 1979

COLUMN 61 62 63 64 65 66 67 68 69 70

ROW1 4.667 0.670 1.125 0.310 1.194 0.801 0.506 0.979 1.586 1.6952 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.0003 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.0004 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.0005 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.0006 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.0007 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.0008 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.0009 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.00010 0.000 0.320 0.000 0.465 0.000 0.000 0.314 0.000 0.000 0.00011 -3.857 0.000 -0.124 0.000 -0.219 0.000 0.000 0.000 -0.685 -0.81712 0.810 0.990 1.001 0.775 0.975 0.801 0.820 0.979 0.901 0.878

COLUMN 71 72 73 74 75 76 77 78 79 so

ROW1 0.800 0.847 0.365 5.552 0.902 0.665 1.098 0.448 0.390 0.9782 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.0003 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.0004 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.0005 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.0006 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.0007 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000a 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.0009 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.00010 0.001 0.038 0.393 0.000 0.064 0.150 0.000 0.523 0.599 0.00011 0.000 0.000 0.000 -4.451 0.000 0.000 -0.175 0.000 0.000 0.00012 0.801 0.885 0.758 1.101 0.966 0.815 0.923 0.971 0.989 0.978

Table A2-1-2 (Cont.)

PRIMARY INPUTS-EGYPT(11.130) 1979

COLUMN 81 82 83 84 85 86 87 88 89 90

ROW1 0.210 0.767 5.136 2.553 3.175 1.134 0.919 0.832 1.095 1.8472 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.0003 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.0004 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.0005 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.0006 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.0007 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.0008 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.086 0.000 0.0009 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000

10 0.585 0.053 0.000 0.000 0.000 0.000 0.029 0.000 0.000 0.00011 0.000 0.(o0 -4.244 -1.607 -2.464 -0.246 0.000 0.000 -0.159 -0.81412 0.795 0.-20 0.892 0.946 0.711 6.888 0.948 0.918 0.936 1.033

COLUMN 91 92 93 94 95 96 97 98 99 100

ROW1 0.993 0.434 2.321 1.364 0.000 0.000 0.000 0.000 0.000 0.000 X2 0.000 0.000 0.000 0.000 0.080 0.162 0.088 0.046 0.085 0.1293 0.000 0.000 0.000 0.000 0.045 0.162 0.010 0.045 0.043 0.0494 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.0005 0.000 0.000 0.000 0.000 0.045 0.032 0.002 0.026 0.040 0.0606 0.000 0.000 0.000 0.000 0.231 0.076 0.010 0.153 0.213 0.1117 0.000 0.000 0.000 0.000 0.060 0.051 0.005 0.057 0.059 0.0768 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.0009 0.000 0.000 0.000 0.000 0.302 0.000 0.000 0.000 0.069 0.00010 0.000 0.512 0.000 0.000 0.000 0.000 0.720 0.208 0.000 0.000i1 -0.041 0.000 -1.462 -0.474 0.000 -0.059 0.000 0.000 0.000 0.00012 0.952 0.946 0.859 0.890 0.763 0.424 0.835 0.535 0.509 0.425

Table A2-1-2 (Cont.)

PRIMARY INPUTS-EGYPT(11,130) 1979

COLUMN 101 102 103 104 105 106 107 108 109 110

ROW1 0.000 1.682 0.000 0.000 0.000 0.000 0.000 0.522 0.000 0.0002 0.100 0.301 0.060 0.060 0.163 0.053 0.069 0.090 0.121 0.1343 0.099 0.301 0.031 0.019 0.090 0.052 0.060 0.091 0.095 0.1724 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.0005 0.040 0.054 0.025 0.450 0.290 0.055 0.023 0.052 0.210 0.0336 0.120 0.232 0.102 0.222 0.051 0.137 0.085 0.167 0.329 0.0887 0.080 0.007 0.030 0.005 0.047 0.031 0.037 0.033 0.060 0.0448 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.0009 0.000 0.004 0.000 0.000 0.000 0.025 0.000 0.000 0.000 0.00010 0.000 0.000 0.467 0.000 0.226 0.000 0.051 0.000 0.000 0.00011 0.000 -1.807 0.000 0.000 0.000 0.000 0.000 -0.162 0.000 0.00012 0.439 0.774 0.715 0.756 0.867 0.353 0.325 0.793 0.815 0.471

COLUMN III 112 113 114 115 116 117 118 119 120

ROW1 0.000 0.000 0.000 0.000 0.000 0.000 0.019 0.000 0.000 0.0002 0.132 0.125 0.054 0.215 0.112 0.400 0.063 0.210 0.153 0.141 .3 0.167 0.160 0.056 0.098 0.000 0.250 0.240 0.100 0.153 0.1414 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.0005 0.033 0.033 0.037 0.061 0.000 0.300 0.198 0.101 0.132 0.1486 0.089 0.087 0.189 0.162 0.000 0.050 0.132 0.180 0.298 0.2677 0.044 0.044 0.061 0.071 0.000 0.000 0.080 0.030 0.036 0.0308 0.000 0.000 0.000 0.169 0.000 0.000 0.000 0.000 0.000 0.0009 0.000 0.000 0.501 0.000 0.000 0.000 0.000 0.000 0.000 0.00010 0.000 0.000 0.000 0.000 0.000 0.000 0.017 0.000 0.000 0.00011 0.000 0.000 -0.222 0.000 0.000 0.000 0.000 -0.242 0.000 0.00012 0.465 0.449 0.676 0.776 0.112 1.000 0.749 0.379 0.772 0.727

Table A2-1-2 Cont.)

PRIMARY INPUTS-EGYPT(11,130) 1979

COLUMN 121 122 123 124 125 126 127 128 129 130

ROWI 0.000 0.000 0.000 0.000 0.000 0.000 0.099 0.000 0.130 0.1802 0.000 0.187 0.138 0.043 0.048 0.098 0.270 0.000 0.120 0.0903 0.000 0.100 0.069 0.100 0.100 0.085 0.050 0.000 0.000 0.0004 0.000 0.000 0.069 0.000 0.000 0.000 0.000 0.000 0.000 0.0005 0.000 0.123 0.076 0.089 0.069 0.071 0.198 0.000 0.042 0.0966 0.000 0.037 0.120 0.065 0.040 0.040 0.132 0.000 0.057 0.0607 0.000 0.056 0.090 0.235 0.160 0.042 0.080 0.000 0.015 0.0908 0.000 0.091 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.0199 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000

10 0.000 0.167 0.000 0.000 0.000 0,000 0.000 0.000 0.000 0.15311 -1.000 0.000 0.000 -0.100 -0.112 0.000 0.000 0.000 0.000 0.00012 -1.000 0.761 0.562 0.432 0.305 0.336 0.829 0.000 0.364 0.688

I

- 96 -

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Table A2-1-3 (Cont.)

PRIMARY INPUTS-TRANSPOSED

COLUMN I 2 3 4 5 6 7 8 9 10 1

ROW49 0.992 0.000 0.00.0 0.000 0-000 0.000 0.000 0.000 0.000 0.008 0.00050 0.969 0.000) 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.031 0.00051 1.591 0.000 0.000 0.000 0.000 0.000 o.ooo 0.000 o.ooo 0.000 -. 952 0.973 0.007 0.008 0.000 0.009 0.007 0.007 0.000 0.000 0.007 -. 253 6.647 0.049 -0.026 0.000 0.034 0.019 0.036 0.011 0.000 0.103 -5.87054 15.698 -0.047 -0.141 -0.003 -0.095 -0.075 -0.066 o.oos o.ooo 0.015 -14.289955 6.174 0.043 -0.023 0.000 0.029 0.016 0.032 0.009 0.000 0.090 -5.36956 5.941 -0.003 -0.027 -0.001 -0.013 -0.011 -0.008 0.002 0.000 0.409 -5.29057 4.358 0.035 -0.015 0.000D 0.025 0.014 0.026 0.007 0.000 0.071 -3.52058 1.476 0.019 -0.004 0.000 0.015 0.009 O.Ois 0.003 0.000 0.261 -0.79459 i.830 0.042 0.028 0.000 0.029 0.037 0.023 0.011 0.000 0.033 -1.03560 0.732 0.017 0.011 0.000 0-012 0.015 0.009 0.004 0.217 0.013 -0.03061 4.725 0.030 0.016 0.000 0.026 0.014 0.017 0.009 0.000 0.036 -3.67462 0.673 0.002 0.001 0.000 0.002 O.001 0.001 0.001 0.000 0.322 -0.00163 i.103 0.007 0.003 0.000 -0.001 -0.004 -0.003 0.006 0.000 0.003 -0.11664 0.380 0.036 0.023 0.000 .0.033 0.017 0.020 0.011 0. 000 0.506 -0.02665 1.208 0.003 0.003 0.000 0.003 0.003 0.002 0.000 0.000 0.004 -0.22666 0.864 0.031 0.018 0.000 0.028 0.015 0.018 0.009 0.000 0.037 -0.02167 0.563 0.028 0.017 0.000 0.026 0.014 0.016 0.009 0.000 0.347 -0.02068 0.959 0.012 0.005 0.000 0.002 -0.003 -0.002 0.009 0.000 0.009 0.00869 1.616 0.016 0.008 0.000 0.014 0.007 0.009 0.005 0.000 0.019 -0.69470 1.734 0.019 0.011 0.000 0.017 0.009 0.011 0.QQ6 0.000 0.023 -0.82971 0.863 0.031 0.018 0.000O 0.028 0.015 O.O18 0.00-,9 0.000 0.038 -0.02172 0.880 0.019 0.010 0.000 0.016 0.008 0.010 0. ~Qt 0.000 0.060 -0.00973 0.441 0.039 0.025 0.000 0.036 0.018 0.021 0.012 0.000 0.436 -0.02874 5.452 0.00o1 -0.002 -0.001 -0.012 -0.016 -0.020 0.011 0.000 -0.007 -4.40575 0.912 0.005 0.003 0.000 0.005 0.002 0.003 0.qO2 0.000 0.070 -0.00376 0.723 0.030 0. 018 0.000 0.027 0.0i4 0.016 0.009 0.OQO 0.184 -0.0207 7 1.147 0.0i3 0.011 0.000 0.013 0.016 0.007 q. 001I 0.cqb 0.010 -0.21778 0.465 0.004 0.003 0.000 0.004 0.005 0.003 0.000 O.Goo 0.527 -0.01279 0.396 0.002 0.001 ). 000 0.001 0.001 .0.001 0.000 0. OO_Q 0.601 -0.003 .80 0.958 0.013 0.004 0.000 0.002 -0.004 -0.001 0.009 0.000 0.010 0.01081 0.275 0.032 0.019 0.000 0.029 0.015 0.018 0.010 0.000 0.623 -0.02282 0.824 0.028 0.017 0.000 0.026 0.014 0.016 0.009 0.000 0.086 -0.02083 5.171 0.017 0.010 0.000 0.016 0.008 0.010 0.005 0.000 0.019 -4.25784 2.671 .0.008 0.005 0.000 0.008 0.004 0.005 0.002 0.000 0.010 -1.61385 3.343 0.042 0.034 0.000 0.038 0.047 0.024 0.002 0.000 0.038 -2.56986 1.193 0.015 0.010 0.000 0.013 0.013 0.011 0.001 0.000 0.019 -0.27487 0.944 0.007 0.005 0.000 0.006 0.004 0.007 0.002 0.000 0.037 -0.01388 0.880 0.012 0.011 0.000 0.011 0.006 0.012 0.089 0.000 0.010 -0.02989 1.128 0.008 0.007 0.000 0.009 0.006 0.008 0.001 0.000 0.009 -0. 17690 I.B14 0.000 -0.001 0.000 -0.004 -0.005 -0.007 0.004 0.000 -0.002 -0.79991 1.016 0.007 0.005 0.000 0.006 0.004 0.006 0.001 0.000 0.007 -0.05392 0.475 0.014 0.013 0.000 0.014 0.021 0.004 0.001 0.000 0.516 -0.05793 2.407 0.019 0.016 0.001 0.018 0.014 0.020 0.002 0.000 0.016 -1.511

94 ~~1.423 0.025 0.019 0.000 0.023 0.026 0.010 0.005 0.000 0.017 -0.54795 0.342 0.088 0.046 0.000 0.049 0.234 0.063 0.000 0.302 0.054 -0.17896 0.650 0.179 0.170 0.000 0.052 0.090 0.061 0.001 0.000 0.032 -0.236

Table A2-1-3 (Cont.)

PRIMARY INPUTS-TRANSPOSED

COLUMN 1 2 3 4 5 6 7 8 9 10

ROW97 O.194 0.097 0.013 0.000 0.012 0.016 O.O8 0.000 0.000 0.748 -O 08898 0.400 0.059 0.048 0.000 0.034 0.159 0.061 0.001 0.000 0.347 -0.10999 0.552 0.095 0.046 0.000 0.051 0.220 0.064 0.001 0.069 0.106 -0.204

100 1.089 0.180 0.087 0.001 0.104 0.146 0.110 0.002 0.000 0.035 -O754101 3.046 0.185 0.150 0.000 0.115 0.237 0.099 0.002 0.000 0.039 -2 873102 2.050 0.343 0.316 0.001 0.081 0.251 0.025 0.000 0.004 0.028 -2.099103 0.363 0.071 0.034 0.000 0.032 0.107 0.034 0.001 0.000 0.510 -0151104 2.579 0.068 0.002 0.000 0.443 0.216 0.000 0.001 0.000 0.015 -2.323105 0.069 0.201 0.097 0.000 0.312 0.064 0.051 0.000 0.000 0.250 -0.044106 0.542 0.073 0.061 0.000 0.075 0.150 0.041 0.002 0.030 0.077 -0.052107 0.695 0.155 0.112 0.001 0.088 0.149 0.080 0.001 0.000 0.157 -0.439108 0.688 O.101 0.094 0.000 0.058 0.171 0.036 0.001 0.000 0.018 -0166109 0.738 0.142 0.100 0.000 0.240 0.345 0.070 0.000 0.000 0.015 -0.651110 1.013 0.181 0.208 0.000 0.070 0.134 0.075 0.002 0.000 0.035 -0.718I1I 0.974 0.177 0.200 0.000 0.068 0.131 0.073 0.002 0.000 0.036 -0.661112 0.952 0.171 0.194 0.000 0.068 0.131 0.072 0.001 0.000 0.040 -0.629113 0.305 0.080 0.068 0.000 0.069 0.208 0.073 0.000 0.501 0.053 -0.358114 0.226 0.244 0.112 0.001 0.093 0.181 0.087 0.169 0.000 0.028 -0 140115 0.277 0.308 0.063 0.000 0.131 0.083 0.037 0.001 0.000 0.196 -o.097116 0.000 0.400. 0.250 0.000 0.300 0.050 0.000 0.000 0.000 0.000 o.000117 0.561 0.099 0.245 0.000 0.219 0.145 0.087 0.001 0.000 0.046 -0.412178 0.526 0.253 O.114 0.000 0.140 0.205 0.047 0.001 0.000 0.045 -0 331119 0.449 0.160 0.157 0.000 0.139 0.303 0.043 0.001 0.000 0.018 -0.270120 0.494 0.150 0.146 0.000 0.157 0.274 0.038 0.001 0.000 0.022 -0 281121 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 l OOO122 0.170 0.208 0.110 0.001 0.139 0.047 0.070 0.091 0.000 0.211 -0 047123 0.848 0.754 0.077 0.069 0.089 0.133 0.101 0.001 0.000 0.020 -0.493124 0.67i 0.084 O.711 0.006 O.113 0.088 0.254 0.001 0.000 0.077 -0.405125 0.805 0.115 0.117 0.010 0.105 0.077 0.187 0.002 0.000 0.093 0 509126 1.138 0.149 0.110 0.001 . 0.114 0.079 0.068 0.002 0.002 0.058 -0.721127 0.209 0.303 0.057 0.000 0.217 0.143 0.085 0.000 0.000 0.022 -0 036128 0.760 0.120 0.121 0.008 0.112 .10S 0.166 0.001 0.000 0.082 -0 476129 0.612 0.150 0.007 0.000 0.063 0.070 0.026 0.001 0.000 0.09S -0 025130 0.375 0.127 0.017 0.001 0.119 0.077 0.110 0.019 0.000 0.208 -0.053

- 99 -

Appendix 2-2: An Accounting Price for Cotton

The accounting price for cotton is an important parameter both for

appraisal of agricutural projects and as an element in establishing the social

value of the marginal product of labor in agriculture. Egypt is a major world

producer of cotton, supplying more than 50 percent of world demand for extra

long staple on average since the 1950's. Because of this high share of the

world cotton market, it is inappropriate to treat the world demand for Egypt's

cotton exports as infinitely elastic.

Marginal export revenue may be derived from estimates of two sets of

parameters, the expected future world market price of cotton and the price

elasticity of demand for Egyptian cotton exports. It is possible to use a

simple residual demand model to derive an estimate of the elasticity of demand

for Egypt's cotton exports from data on the world elasticity of demand for

cotton, the supply elasticity of other cotton producers, and Egypt's share in

world cotton output. The demand for Egyptian cotton is viewed as the

difference between world demand, Q , and the supply of the rest of the

world, Q .Q = Q -Q . On the basis of this relationship, the

elasticity of demand for Egyptian cotton may be written n e =

(n -e s )/s9, where n and nw are the price elasticities of demandw r r ee w

for Egyptian exports and world cotton production respectively, e is the

supply elasticity of all other cotton producers taken collectively, and s

and s are the shares of total world production held by Egypt and the rest

of the world.

Empirircal estimates of these paramters are quite uncertain. Recent

research indicates that the long run price elasticity of demand for extra long

staple cotton by the industrial countries is approximately -.65. (World Bank

(1981)). Because Egypt maintains significant marketing agreements with

- 100 -

bilateral payments trading partners, this elasticity may not be appropriate as

a basis for the evaluation of the elasticity of demand for total cotton

exports.

The structure of marketing arrangements in Egypt's principal

competitors (Sudan, Morocco, and Peru) is such that in each case the

government intervenes via marketing arrangements or variable tax levies to set

a producer price, distinct from the world price of cotton. Hence, the

elasticity of supply is composed of the product of the elasticity of the

producer price with respect to the world price and the elasticity of supply

with respect to the producer price. Little is known about either parameter.

Table A2-2-1 presents alternative estimates of the elasticity of

demand for cotton under various assumptions regarding the elasticity of supply

response for the rest of the world and Egypt's share in total extra long

staple production. Egypt's average share in world production fell in the

1970's, and predictions of its future value are difficult. The average share

for the period 1970-1977 was 43 percent. This suggests that, given reasonable

values for the long run elasticity of supply from competitors, the elasticity

of demand facing Egypt is probably in the range of -2 to -3.

Table A2-2-2 explores the sensitivity of the estimated marginal

export revenue for extra long staple cotton to estimates of the export price

FOB and the elasticity of foreign demand. Values for the marginal export

revenue range from LE 400 to LE 666 per ton. We take as our provisional

estimate of the marginal export revenue a value of LE 600 per ton.

There is, however, evidence to suggest that extra long staple cotton

is technically fully substitutable for long staple. Since Egypt is not a

major supplier of long staple to the world market, it may be viewed as a price

taker in the market for long staple substitutes. In 1979 the international

- 101 -

price of long staple was LE 800 FOB, and this price presumably sets a floor

under the extra long staple price. Hence, an alternative estimate of the

marginal export revenue of extra long staple is given by the long staple floor

price of LE 800. There would be, however, some costs associated with

marketing of extra long staple as a long staple substitute, and therefore the

realized marginal revenue would probably lie somewhat below the FOB price.

Table A2-2-1: The Elasticity of Demand for Cotton Exports

Egypt's Share Elasticity of Supply from Rest of Worldin Total Output 0 .5 1.0

.50 -1.30 -1.80 -2.30

.45 -1.44 -2.06 -2.67

.40 -1.63 -2.38 -3.13

Table A2-2-2: Sensitivity Analysis of Marginal Export Revenue

Elasticity of World Price (LE ton)Demand 800 900 1000

-2.00 400 450 500-2.50 480 540 600-3.00 533 600 666

To provide an accounting ratio applicable to the farmgate price we

deduct the costs of transportation and processing. The calculation is set out

in Table A2-2-3. The ratio of the accounting price to the farmgate price lies

in the .920 - 1.41 range. The midpoint of the range is 1.17, which, lacking

further insight into the costs associated with marketing, we choose on our

best estimates.

- 102 -

Table A2-2-3: The Accounting Price for Cotton Exports

Item Market Accounting AccountingValue Ratio Value

Marginal Export Revenue 800 1.000 600Marketing Expenses -38 .862 -33Transport & Handling -60 1.343 -80Ginning Costs -80 1.206 -96Misc. Expenses -45 .323 -14Tax/Subsidy -167 0.000 0Farmgate Price 410 577

Accounting Ratio 1.41

- 103 -

Chapter 3: Discount Rates, The Value of Public Income,

and Consumption Distribution Weights

In this chapter we estimate social pricing parameters for the

distribution of consumption across generations and among contemporaries. The

first of these distributional issues involves estimation of discount rates for

project appraisal. We begin by estimating the marginal productivity of

capital at border prices. This provides us with an important efficiency

pricing parameter and with part of the empirical basis for estimating the

Accounting Rate of Interest (ARI). We then turn to estimates of the

Consumption Rate of Interest (CRI) and the ARI.

The second half of the chapter attempts to establish a weighting

system for the distribution of consumption among contemporaries in Egypt and

employs our estimates of both intertemporal and contemporary income

distribution parameters to establish a likely value for uncommitted public

sector income relative to private consumption. In the course of our work on

estimating distributional weights, we also gain some insights into the likely

social value of Egypt's consumption subsidies and develop some rather striking

estimates of rural-urban price differentials.

The major characteristic of social cost-benefit analysis which

distinguishes it from other methods of project appraisal is the systematic

incorporation of distributional considerations into the estimation of shadow

prices and project rates of return. For some shadow prices - for example the

shadow wage rate - distributional effects can have a major impact on the final

value of the parameter, and estimates of social and efficiency prices may

diverge significantly.

- 104 -

There remains considerable debate as to the relevance of social

pricing in informing operational decisiors. Nevertheless, in an economy like

Egypt which is characterized by several important policy interventions

explicitly designed to alter the distribution of income, any effort to

estimate a consistent set of accounting prices would be seriously deficient

without some attempt to establish a set of distributional weights. This

endeavor yields an additional benefit in that it permits us to evaluate (at

the margin) the efficacy of a number of redistributional policies - food

subsidies and public sector wage and employment policies - at the same time

that they provide information on the Government's implicit judgements

regarding the distribution of income.

3.1 The Marginal Productivity of Capital at Border Prices

The marginal product of capital is the net return earned by a

marginal unit of public investment when all inputs and outputs are valued at

border prices. Thus it represents the marginal rate of transformation between

present and future foreign exchange; its value reflects both the past history

of investment projects within the economy and the likely returns to new

investments. In a well fuctioning capital market with access to foreign

sources of finance it will also reflect the real rates of return to lending or

borrowing on international capital markets. We consider three sources of

evidence on the marginal productivity of capital: macroeconomic evidence from

historical data on the Egyptian economy and the DRM model, microeconomic

evidence on the rates of return at accounting prices to public sector

investment, and data on borrowing and lending on international markets.

- 105 -

(a) Macroeconomic Evidence on the Rate of Return

Procedures for estimating the average return to capital at border

prices from aggregate economic data are well known. 1/ The first method

involves adjustment of the incremental output capital ratio to net out labor's

contribution to output and to convert from market to border prices;

q rA Q a L K] (f /f)(1

where q is the marginal product of capital at border prices, Q, K, and L are

output, capital stock and employment, respectively and f /f is the ratiov k

of the accounting ratio for net output to the accounting ratio for capital.

Our estimates of this approximation to the marginal productivity of capital

are summarized in Table 3-1. Incremental output capital and employment

capital ratios are taken from recent economic reporting for Egypt and from

projections contained in the DRM model. As a proxy for the marginal

productivity of labor we employ the average real wage. The limitations of

this assumption are made abundantly clear in Chapter 4; it is sufficient,

however, given the approximate nature of these estimates.

A second method employs evidence on the share of profits in national

income and the assumption that the underlying structure of production is

Cobb-Douglas with constant returns to scale. In such cases

q MA (f /f) (2)K v k

where a is the elasticity of output with respect to capital. Under perfect

competition and constant returns to scale a may be estimated by taking the

share of capital in national income. Results of this calculation are set out

in Table 3-2.

1/ See for example Squire and van der Tak (1975) or Mashayekhi (1980)

- 106 -

Because there are substantial rents to the resource, the marginal

productivity of capital will be overstated in the macroeconomic accounts

including the petroleum sector. Hence we have chosen the estimate of the

marginal productivity of capital exclusive of the petroleum sector. Our

estimated values of q from these methods lie between .150 and .210.

Limitations of the techniques are obvious, and great reliance should not be

placed on these estimates.

Table 3-1: Estimates of the Marginal Productivityof Capital ICOR Method

Incremental Marginal Incremental

Period Output/Capital Product Employment fv/fk. q

Ratio of Labor Capital Ratio

1974-1979 .265 555 1.5 x 10-4 .90 16.4

1980-1985 .258 654 .98 x 10-4 .90 17.4

1985-1990 .257 712 1.2 x 10-4 .90 15.4

Table 3-2: Estimates of the Marginal Productivityof Capital Share Method

Period Share of Capital Average Product fv/fk q

in National Income of Capital

1974-1979 .476 .492 .90 21.1

1980-1985 .448 .448 .90 18.1

1985-1990 .447 .450 .90 18.1

- 107 -

(b) Microeconomic Evidence on the Rate of Return at Border Prices

Microeconomic evidence at the sector and project levels on the rate

of return to public sector investment may be drawn principally from two

sources. The first is a survey of 22 public sector enterprises conducted by

Professor Heba Handoussa (Handoussa (1980a)) which provides data on rates of

return at border prices and domestic resource costs of foreign exchange based

on cross section data from 1977. The second source is the economic rate of

return estimates from Bank projects in the industrial and agricultural

sector. Neither source is exactly appropriate for our needs, but taken

together they provide an indication of the rates of return at border prices of

a rather broadly based set of public investment projects.

Table 3-3 presents Handoussa's estimated social (border price) rates

of return to investments in six public sector industries. There is one major

problem with the interpretation of these results. Data on the capital stock

of enterprises in her survey refer to book value of assets at historic cost.

Both inflation and depreciation (in a growing company) will tend to make this

an understatement of the replacement cost of productive capital, and hence

will tend to inflate estimates of the rate of return. If we assume that

companies have been investing and growing at a real rate g, that the rate of

inflation in the price of capital goods is p and that the capital stock is

depreciated on historic cost at a rate d, then the ratio of replacement cost

at current prices, K, to book value at historic cost, H, is:

K (g,T)H ~~~~(~~~P~~~d7T ~~~(3)H f(gdp+d,T)

where O (x,T) =T ext dt ex , and T is the age of the oldest

108 -

capital still in use. For public sector manufacturing we take g= .05, d= .085

and p= .08. If the companies. in Handoussa's sample are on average ten years

old, the ratio of replacement cost to book value is approximately 1.92. Thus

in columns 2 and 3 of Table 3-3, we deflate her rates of return by the

reciprocal of this ratio to arrive at rates of return at replacement cost.

These values range from -14.8 percent for metal products to 16.9 percent for

cement.

Table 3-3: Financial and Economic Rates of Returnto Some Public Sector Industrial Investments

Financial Rate Economic RateIndustry of Return of Return flfk

Textiles 18.6 5.2 .20

Clothing 10.0 11.5 1.15

Food Products 10.6 15.4 1.47

Metal Products -22.5 -14.8 .66

Cement 4.9 16.9 3.45

Fertilizer 2.9 11.7 3.98

Source: Handoussa (1980)

Notes: Rates of return deflated to replacement cost rates byequation (3) in text.

- 109 -

Table 3-4: Rates of Return to Public Sector Industry

Financial Rate Economic Rate Percentage WeightIndustrial Group of Return of Return in Total Output

Textiles & Clothing 9.72 9.72 27.7

Food Products 7.77 11.42 10.9

Chemicals 4.19 10.43 18.5

Metals & MetalProducts 2.40 1.53 42.9

Weighted Average 5.34 6.56

It is also possible to use Handoussa's data to estimate the rate of

return to public sector manufacturing as a whole. The relationship between

the financial rate of return and the social rate of return is approximately:

q rf (4)

fk

where fli is the accounting ratio applicable to profits - the ratio of value

added at world prices minus wages at shadow prices to value added minus wages

at market prices - and fk is the accounting ratio for capital goods. Thus

from data provided on financial and social rates of return it is possible to

deduce the ratio f /fk for individual industries. These are listed in

column (3) of Table 3-3. These ratios may then be combined with data on the

average financial rate of return in four major categories of public sector

industry to provide an estimate of the weighted average rate of return to

public sector industrial enterprises. The estimates are contained in Table

3-4, and the average rate of return at border prices for the industrial sector

is approximately 6.6 percent. This rate of return is heavily influenced by

- 110 -

the low level of social profits in the metal products sector which carries a

high weight in total public sector output. It is undoubtedly below the

marginal return at border prices to industrial projects.

Evidence from Bank Staff Appraisal Reports on recent investment

projects indicates that returns to proposed investment activities range from

16-21 percent at border prices. There is undoubtedly a measure of selectivity

bias in the sample, since Bank projects are undoubtedly among the proposed

investments with the highest levels of social profitability, but these data

provide a plausible upper bound for the economic rate of return to marginal

investment projects.

(c) Interest Rates on Foreign Borrowing

If at the margin a country is borrowing from abroad, the marginal

productivity of capital at border prices should at least equal the real rate

of interest on marginal foreign debt. In circumstances where the government

controls substantial revenues denominated in foreign currency, such as oil

revenues in Egypt, it also has the option of holding assets denominated in

dollars rather than undertaking domestic investment. Consistent project

appraisals would reject marginal investments returning less at border prices

than could be earned by holding interest bearing claims on foreigners. Thus,

lending and borrowing rates on the international capital market provide some

additional evidence on the likely medium term value of the marginal

productivity of capital at shadow prices. The Government of Egypt has

borrowed from a number of multilateral and commercial sources in the past, and

presumably will continue to do so. Interest charges on these loans grange from

the 1979-1980 World Bank rate of 10.5 percent to a level 1.25-1.75 percent

above the LIBOR rate. This implies at present an interest rate on new dollar

indebtedness of approximately 20.5 percent. Even this rate may not reflect

the marginal cost of borrowing, since increases in the volume of debt service

tend to push up the margin over the LIBOR rate which Egyptian borrowers have

to pay. The maturity of Eurocurrency loans is also shorter than the maturity

of the investments likely to be financed out of those loans. Thus, the debt

will have to be rolled over at terms which are uncertain. These

considerations suggest that a risk premium might also be incorporated into the

estimated marginal cost of borrowing. Allowing for a risk premium suggests

that the marginal cost of borrowing in nominal terms might be as high as 22-23

percent.

It is important to ask whether this rate represents a viable medium

term estimate of the dollar interest rate. Moreover, borrowing on the

commercial market has been largely limited to short term portfolio management,

and may not represent terms at which the Government is willing to finance

medium and long term capital expenditure. If interest rates are expected to

decline to more traditional levels in the short to medium term, a marginal

nominal cost of 10-15 percent might be more appropriate. From either nominal

rate we must deduct the expected rate of inflation for traded commodities in

dollar terms to arrive at a real rate of interest. Given the importance of

petroleum in Egyptian trade, it is difficult to make a sensible projection of

the rate of inflation. For the purpose of this analysis we will allow 8-12

percent per annum for inflation which suggests a real rate of interest on

foreign borrowing in the range of 2-10 percent. Potential real earnings on.

foreign denominated assets are probably in the range of 3-5 percent.

- 112 -

(d) A Possible Value for q

Our estimates of the marginal productivity of capital at border

prices fall within the rather broad band of 6-20 percent. Any attempt to

narrow this range must rely more on judgement than on evidence, but it seems

unlikely that the rate of return at border prices for the typical marginal

public sector project exceeds 10-12 percent. Indeed our evidence on the past

performance of public sector industry suggests a range of average returns of

from 5-12 percent, and if one excludes investments in basic metals and metal

products the observed rates of return tend to cluster in the interval between

8 and 12 percent. Thus we choose 10 percent as our most likely value for q,

and we employ alternative values of 8 and 12 percent in testing the

sensitivity of several of our parameters.

3.2 The Consumption Rate of Interest

The consumption rate of interest is the rate at which the marginal

valuation on consumption declines over time. As such, it is a policy

parameter designed to insure that the Government's views on the relative

desirability of present as opposed to future consumption are adequately

reflected in the system of social prices. A high consumption rate of interest

implies that the welfare gains from investments yielding a stream of benefits

in the future are heavily discounted and, therefore, favors present

consumption over saving and investment.

As conventionally defined, the consumption rate of interest is the

sum of the pure rate of time preference and the product of the long term rate

of growth of per capita consumption and the elasticity of the marginal utility

of consumption. Of the three components, only the growth rate of real per

capita consumption can be estimated without recourse to an explicit value

judgement.

- 113 -

Our estimates of the real growth of per capita consumption ae taken

from the "base case" scenario of the DRM model for the Egyptian Economy (World

Bank (1980a)). For the period 1982-1990, the DRM projections indicate that

growth rates of total consumption consistent with the existing policy

framework, resource endowment, and investment behavior fall in the range of

5-8 percent per annum.. The mean value of the year to year growth rates for

the entire projection period is 7.2 percent, implying an average growth rate

of per capita consumption of between 4.5 and 5.0 percent. This is not

inconsistent with historical evidence from the 1970's. Egypt sustained a rate

of growth of consumption per head of between 5 and 6 percent at constant

prices between 1975 and 1980.

Of the subjective parameters, the pure rate of time preference is the

one on which we have the least information. The pure rate of time preference

represents the degree of "impatience" of the Government, the extent to which

benefits which occur in the future are discounted simply because they accrue

to future generations. (The possibility that future generations will be

richer and therefore will value marginal additions to income less highly than

the present generation is allowed for by the growth of per capita income and

the elasticity of its marginal valuation.) Other writers on social cost

benefit analysis have suggested plausible values in the range of 0-5 percent.

Given the Egyptian Government's commitment to long term growth and its

apparent willingness to undertake investment projects of long gestation such

as irrigation and land reclamation, it seems likely that the value of the pure

rate of time preference is quite low.

In section 3.5 we present our reasons for setting the elasticity of

the marginal valuation of consumption at one. This value reflects some degree

of concern for equity, but is consistent with the observed behavior of the

Government with regard to horizontal equity among comtemporaries.

- 114 -

Table 3-5 sets out the range of estimates of the consumption rate of

interest. As our best estimate we take the rate of growth of real per capita

consumption as 4.5 percent, the elasticity of the marginal valuation of income

as unity, and the pure rate of time preference as 1.0 percent, yielding a

consumption rate of interest of 5.5 percent.

It is important to note that Egypt's growth performance in the 1970's

and its projected sustained., if somewhat more moderate, growth in the 1980's

are the factors that lead to the relatively high estimate of the consumption

rate of interest. 1/ We have adopted quite modest values of the pure rate of

time preference and the elasticity of the marginal valuation of income.

Higher values of these subjective parameters would raise the CRI accordingly,

with important implications for the accounting rate of interest and ultimately

for the selection of projects.

Table 3-5: Possible Values for the Consumption Rate of Interest

Elasticity of Marginal Rate of Growth of Pure Rate of Time PreferenceValuation of Income Per Capita Consumption 0.0 0.5 1.0

n = 0.5 4.0 2.0 2.5 5.04.5 2.3 2.8 3.85.0 2.5 3.0 4.0

n = 1 4.0 4.0 4.5 5.04.5 4.5 5.0 5.55.0 5.0 5.5 6.0

n = 2 4.0 8.0 8.5 9.04.5 9.0 9.5 10.05.0 10.0 10.5 11.0

1/ Compare for example the rates of 3.0 for Pakistan (Squire et al(1979)) and 4.5 for Turkey (Mashayekhi (1980)). This is a medium termparameter appropriate to the period 1983-88. The CRI is obviouslytime dependent and will vary with the growth path of per capitaconsumption. For a fuller discussion on the time path of the CRI and

estimate of its long term behavior see Dervis, Martin and vanWijnbergen (1982).

- 115 -

3.3 The Accounting Rate of Interest

The accounting rate of interest (ARI) simply measures the rate of

fall in the social value of the numeraire, uncommitted foreign exchange held

by the public sector. It provides the principal intertemporal link in project

appraisal by making it possible to express net benefits (measured in terms of

the unit of account) which occur at different times in comeasurable units.

Ideally, projects should be undertaken until the marginal rate of return on

public sector investments when they are evaluated at social accounting prices

equals the ARI. If the ARI is set too low, too many projects will be

approved; conversely, if it is set too high, there will be underinvestment.

At a full optimum with no constraints on public sector saving and investment

behavior the level of investment will be pushed until the ARI is equal to the

CR1.

In principle, the relationship between the ARI, the CRI and the

marginal productivity of capital is reasonably straightforward. The CR1

measures the rate of decline in the social valuation of average per capita

consumption. The parameter v estimated in section 3.6 measures the social

value of the numeraire relative to average per capita consumption. Hence

- v/v = ARI - CRI (5)

where v/v = (dv/dt)/v. Since the marginal product of capital, q, is a major

determinant of v, under rather stringent assumptions we can use information on

the rate of return to public sector investments at accounting prices and our

estimate of the CRI to arrive at an estimate of the ARI.

If we assume that the marginal allocation of public expenditure

between consumption and investment remains constant, the rate of fall in the

value of public sector income is given by the rate of change in social

- 116 -

valuation of public sector consumption (vc) and investment (v. ):

v/v =.s v. /v. + (l-s) v /v (6)inv inv c c

where s is the share of investment expenditure in total public expenditure.

Further, we shall assume that the Government maintains the value of public

consumption relative to the value of private per capita consumption at the

existing levels discussed in Section 3.6(a); thus Ic/vc = 0. The social

valuation of public sector investment vi falls at a rate equal to the

difference between the rate at which current public investment can be

transformed into future public income and the consumption rate of interest.

Thus: ARI = s (R - CRI) + CRI (7)

where R is the internal rate of return on public sector investment which

depends on q and the length of life of capital investment, T. A set of values

for the ARI is presented in Table 3-6. Three assumed lifetimes for investment

are considered, T = 15, T = 20 and T = , which is tantamount to an

assumption of steady state growth and reinvestment in the public sector.

Table 3-6 reveals the sensitivity of the ARI to the assumed

elasticity of the marginal valuation of income and the marginal productivity

of capital. Elsewhere in this chapter we presented our arguments for the case

that in Egypt .08 q .12 and n = 1.0. This suggests a range for the ARI of

4.7 to 7.0 percent depending on the assumed internal rate of return on public

sector investment.

- 117 -

Table 3-6: Alternative Estimates of the Accounting

Rate of Interest

Accounting Rate of InterestR N 0.5 N = 1.0 N = 2.0

q 8 T = 15 - 2.37 2.84 4.72 8.47T = 20 4.96 3.49 5.36 9.12T = X 8.00 4.25 6.13 9.88

-10 T = 15 5.56 3.64 5.52 9.11T = 20 7.75 4.19 6.06 9.81T = X 10.00 4.75 6.63 10.38

-12 T = 15 8.44 4.36 6.24 9.99T = 20 10.32 4.83 6.71 10.46T = X 12.00 5.25 7.13 10.88

A lower bound for the ARI is surely set by the marginal lending rates

in dollar terms discussed in Section 3.1(c). There we argued that the real

rate of interest on dollar denominated assets was in the range of 3-5

percent. The upper end of this range is consistent with our estimate of the

ARI derived above, but there is some danger that if we select an ARI as low as

say 5.0 percent too many investments projects will be approved. On the other

hand, if we set the ARI at 10 percent this implies a rate of change in v of

4.5 percent per annum which is extremely rapid. 1/

Our evidence is quite consistent in suggesting that 4.0< ARI < 8.0

and we shall therefore take as our best guess a value for the accounting rate

of interst of 6.0 percent. For projects which are very sensitive to the

assumed discount rate, alternative values of 4 and 8 percent should be checked.

1/ An ARI of 10 percent would also imply a rate of increase in the critical

consumption level of 10 percent per year which is very high given past

performance on the growth of per capita consumption. On this point seeScott, Mac Arthur and Newbery (1976) p 43ff.

- 118 -

3.4 Relative Weights for Per Capita Consumption

The methodology of estimating income distribution weights is now

quite well established; (see for example Squire and van der Tak (1975), Scott,

McArthur and Newbery (1976) or Squire, Little and Durdag (1979)). 1/

In order to estimate the social benefit which accrues when a

household receives an increase in disposable income, a number of assumptions

concerning the Egyptian Government's attitude toward increases in the incomes

of private citizens are required. One of the simplest, and most conventional,

of assumptions to make is that planners assign progressively lower marginal

valuations to income as household incomes rise. Most social cost-benefit

studies have employed a marginal valuation function of the form:

U'(Y) = k Yn (8)

where the single parameter n, the elasticity of the marginal valuation of

income, summarizes the degree of egalatarian bias of the Government. By

arbitrarily setting U'(Y) = 1, where Y is the mean level of income, it is

possible to derive the value of the scaling factor k and the relative weights

to be assigned to marginal changes in income at varying levels;

d = U'(Y) = Yn (9)y

Thus, given estimates of the mean level of income Y and the elasticity of the

marginal valuation of income, n, it is possible to derive a consistent set of

welfare weights reflecting the social valuation of marginal changes in private

incomes.

1/ Because many of these concepts are more fully developed in Squire and vander Tak the reader may refer to their work for additional exposition ifdesired.

- 119 -

Because data on incomes by household are lacking in most developing

countries, it has become conventional to work with expenditure surveys and to

use consumption expenditure as a proxy for income. This is the approach which

we have adopted for Egypt as well. Tables 3-7 and 3-8 present the estimated

values of the relative welfare weights assigned to marginal increases in

household incomes by income class for both rural and urban households, based

on the 1974/75 expenditure survey. Interpretation of the tables is

straightforward. Because household size varies with income, we have chosen

household consumption per capita as the appropriate indicator of income

levels. 1/ The positive association of household size with income means that

the household income distribution tends to overstate the inequality of income

and hence the dispersion of the income weights relative to the per capita

distribution. Three possible values of the elasticity of the marginal

valuation of income, n, are listed in the tables. Given that Egypt employs a

progressive income tax system it is doubtful that the appropriate value for n

is less than or equal to 0; for this would imply that the Government places

equal weights on marginal increases in the incomes of all individuals or in

the case of a negative value of n that it values marginal increases in the

incomes of the rich more highly than those accruing to the poor.

The relation between n and the weights assigned to marginal increases

in income is quite clear. With n = .50 the marginal benefit of increasing the

consumption of a household in the lowest income class by one Pound is slightly

1/ It would have been more preferable to work with income per adultequivalent, which would have permitted correction for householdcomposition as well as size, but this is not possible on the basis of the1974/75 survey.

- 120 -

more than three times the marginal benefit of increasing the consumption of a

household in the highest income class. With n = 2 on the other hand, the

welfare weight assigned to the lowest income category is more than 100 times

the weight assigned to the highest. These values probably bound the

appropriate parameter estimate for n in Egypt, and we shall consider below

evidence on its most likely value.

The relative weights summarized in Tables 3-7 and 3-8 apply to gains

(or losses) in income occuring at urban prices. If rural and urban prices

differ, the command over real consumption represented by LE I at urban prices

may differ greatly from that represented by LE 1 at rural prices. Since

Table 3-7: Relative Weights for Marginal Changesin Urban Incomes at Different Income Levels

Income Class Percentage Total Per Capita Expenditure WeightLE Per Annum Households Consumption n = 0.5 n = 1.0 n = 2.0

5-49 0.4 33.0 1.72 2.97 8.8050-74 0.5 45.8 1.46 2.14 4.5775-99 0.9 38.9 1.59 2.52 6.33

100-149 4.0 43.4 1.50 2.26 5.09150-199 5.3 46.7 1.45 2.10 4.41200-249 6.6 48.0 1.43 2.04 4.16250-299 8.9 57.2 1.31 1.71 2.93300-349 8.1 63.7 1.24 1.54 2.36350-399 7.8 64.5 1.23 1.52 2.30400-499 14.7 71.7 1.17 1.37 1.86500-599 12.0 86.9 1.06 1.13 1.27600-799 12.8 104.1 0.97 0.94 0.88800-999 6.9 144.0 0.82 0.68 0.46

1000-1399 6.9 163.7 0.77 0.60 0.361400-1999 3.0 248.4 0.63 0.39 0.152000+ 1.6 337.9 0.54 0.29 0.08

- 121 -

welfare measures in the final analysis should reflect the society's valuation

of the benefits of changed command over a bundle of consumption goods, it is

useful to have a set of absolute welfare indicators expressed in terms of a

constant set of prices. Put another way, if we take the mean level of urban

per capita consumption as a base, C , what is the relative value of a unit

marginal increase in consumption accruing to a rural household with per capita

consumption at rural prices of C ? Such a question is relevant for example

in evaluating the welfare gains and losses of transfers between households in

different sectors.

Table 3-8: Relative Weights for Marginal Changesin Rural Incomes at Different levelsMeaures at Urban Prices

Income Class Percentage Total Per Capita Expenditure Weight

LE Per Annum Households Consumption n = 0.5 n = 1.0 n = 2.0

5-49 2.0 37.3 1.70 2.89 8.3450-74 2.7 32.0 1.83 3.37 11.33

75-99 3.5 29.1 1.92 3.70 13.70

100-149 7.8 34.3 1.77 3.14 9.86

150-199 11.2 38.5 1.67 2.80 7.83

200-249 11.8 42.7 1.60 2.52 6.36

250-299 12.6 45.9 1.53 2.35 5.50

300-349 10.2 49.3 1.48 2.18 4.77

350-399 8.9 55.4 1.39 1.94 3.70

400-499 11.3 61.5 1.32 1.75 3.07

500-599 4.4 69.9 1.24 1.54 2.37

600-799 6.5 81.4 1.15 1.32 1.75

800-999 3.0 98.0 1.05 1.10 1.21

1000-1399 2.4 149.8 0.85 0.72 0.52

1400-1999 1.3 150.8 0.85 0.71 0.51

2000+ 0.5 418.7 0.51 0.26 0.07

N4ote that all values are measured in terms of urban prices. Thus the

expenditure weights measure the relative value of a transfer of LE 0.91 at

rural prices or LE 1.0 at urban prices.

- 122 -

Suppose that the ratio of rural consumer prices to urban prices is p;

then the rural consumption level C is equivalent in real terms to an urban

consumption level of C = Cr/p. The appropriate income weight to be

assigned is therefore d = Ur~~

It is also important to recall that the value of any transfer in

nominal income between the rural and urban sectors of the economy must be

expressed in the same set of constant prices. Consequently, a unit marginal

increase in the income of a rural household has the same value as an increase

of l/p accruing to an urban household. The welfare value of a unit increase

in the income of a rural household with consumption level C expressed in

terms of urban purchasing power is therefore:

i n (10)

Table 3-8 expresses the weights assigned to marginal additions to rural

incomes measured at urban prices. We shall throughout this study measure all

incomes and gains in income at urban prices. Rural-urban price differentials

are discussed in Appendix 3-1.

3.5 A Possible Value for n

Although it is reasonable to assert that the Government of Fgypt may

attach lower value to marginal additions to income for citizens in high income

brackets, it is difficult to establish the precise value of the elasticity of

the marginal valuation of income (n). Certainly, many public policy

statements could lead to the conclusion that the Egyptian Government has a

strongly egalatarian bias. Such assertions are buttressed to an extent by the

system of urban consumption subsidies and by the progressive nature of the

system of direct taxes. The picture is obscured, however, when one considers

the overall incidence of the tax system. Indirect taxes via the system of

- 123 -

agricultural price differentials fall disproportionately on rural households

in the low and middle income range and the overall incidence of rural taxation

crucially depends on the access of rural households to subsidized farm inputs

and consumer goods. (See el Edil (1980) and Korayem (1980)).

Other writers on welfare weights have suggested that a plausible

range for the elasticity of the marginal valuation of income is between 0 and

5. The only "objective" estimate of this elasticity available for Egypt can

be derived from the structure of the income tax system, based on the

assumption that the tax tables reflect the principle of equal marginal

sacrifice. Marginal sacrifice, the welfare loss to an individual due to taxes

collected from an incremental LE 1.00 of income, may be expressed as:

MS. = u(Y.) t. (11)1 1 1

where MS. is the marginal sacrifice of household with income Y., U'(Y.)31 1 1

is the marginal valuation of income for a household with income Y. and t.

is the applicable marginal tax rate. If the Government follows a principal of

equal marginal sacrifice, the MSi are equal for all income intervals i.

Thus, taking the lowest income class subject to direct taxation as a base and

specifying a marginal valuation function of the constant elasticity form in

(8) we may write:

Ms~ kY -n t MS ~-nt

Msb kY -n tb (12)b

Simplifying, taking logarithms, and rearranging terms:

ln(ti/tb) = -n ln(Yb/Yi) (13)

Equation (13) was fit to the Egyptian 1979 tax table by ordinary least

squares. Income was taken as the midpoint of the range applicable to each

- 124 -

(a) The Social Value of Consumption Subsidies

Egypt has a long-standing commitment to a system of consumer

subsidies which is one of the most extensive in the non-centrally planned

economies. The subsidy bill ranged from 8 percent of CDP in 1977 to 11

percent in 1979 and accounted for approximately one third of central

government current expenditure in both years. Major consumption subsidies

exist for a wide range of staple food items including, wheat, corn, bread,

beans, oils, meat and sugar. Subsidizing these commodities represents an

effort by the Government of Egypt to insulate urban consumers from the

effects of rising import prices. In choosing the extent of the subsidy the

Government has made an implicit judgement regarding the value of public

income relative to private sector consumption. Thus, from a detailed

examination of the incidence of the subsidy it is possible to estimate the

value of public income committed to the subsidy program. Using our

estimates of the relative welfare weights for marginal additions to

consumption (d) derived in Section 3.4, it is possible to estimate the

marginal benefit, the increase in consumer welfare relative to the average

level of urban per capita income, of an expenditure of LE 1.00 on

additional consumption subsidies. The cost of the subsidy -- that is the

reduction in uncommitted public sector income denominated in terms of

foreign exchange -- is given by the consumption conversion factor f .

Thus, the welfare valuation of a marginal unit of public income committed

to consumption subsidies is given by the ratio of the marginal welfare

benefit to the marginal resource cost:

Vj i-l wiji]fc (14)

where v. is the marginal valuation of public income committed to

- 125 -

specified marginal tax rate. Marginal tax rates range from 4 percent for an

annual income of LE 325 per year to 92 percent at an annual income of

LE 8500. Results of the regression are reported in Table 3-9. Rather than

supress the intercept, we have estimated a standard OLS regression which

permits us to test for the presence of an intercept significantly different

from zero.

Table 3-9: An Estimate of n from the Egyptian Tax Tables

Coefficient Standard Error

Constant -0.014 0.095

ln (yb/yi) -0.957 0.044 R2 = .978 Obs = 13

The results yield a statistically significant estimate of n .96, an

intercept not significantly different from zero, and show a remarkably good

fit. This is undoubtedly an overestimate of n, since we have made no

attempt to allow for exemptions and other exclusions of income which might

lower the marginal tax rates in upper income brackets. It does suggest,

however, that the upper bound for the elasticity of the marginal valuation

of income should be set at 1. We have, accordingly, taken 1 as our

principal estimate. For comparative purposes in some calculations we have

also employed values of n = 0.5 and n = 2.0.

3.6 The Value of Public Sector Income (v)

Our unit of account is public sector income, denominated in terms

of foreign exchange. Because we wish to express the value of changes in

private incomes relative to this unit of account, we require an estimate of

the value of public sector income (the numeraire) relative to marginal

addditions to private consumption at the average level of urban per capita

- 126 -

consumption (income). With this parameter (v) it is then possible to

transform the relative income weights derived in section 3.4 into a set of

absolute income weights: w = d/v.

Because at the margin public sector income may be used for a wide

range of activities -- investment, education, defense, consumer subsidies,

general administration etc. -- the appropriate value for v is the weighted

average of the relative values of public expenditure on these items to

average per capita consumption. As a practical matter it is difficult to

establish relative valuations for such activities as education, general

adminstration or defense. In principle, however, a rational government

will allocate expenditure to equalize the marginal social benefit of all

areas of expenditure. In these circumstances, an estimate of one component

of v is sufficient to provide information on the relative value of the

numeraire in any other activity. It is doubtful that Egypt has explicitly

followed such a course of public expenditure analysis, particularly with

regard to defense, education, and general administration. Lacking

sufficient information to provide independent estimates of the value of

expenditure in these areas, however, we shall focus on three areas of

public expenditure where there is sufficient information to estimate the

relative value of public sector income; consumption subsidies, public

sector employment policies, and public sector industrial investment. Since

the Government of Egypt undoubtedly enjoys greater budgetary discretion

over these three items than over defense and general administration, they

may comprise the main component of marginal public expenditure, and hence

provide an appropriate estimate of v.

- 127 -

subsidization of commodity j, w.. is the expenditure weight on commodity

nj of expenditure group i, E w - 1 and d. is the welfare weight for

i ij I

expenditure group i relative to that for average per capita consumption in

the urban sector.

The calculations of the marginal benefits for subsidies of grains,

oils, meat, beans, and sugar are set out in Table 3-10. In columns (1) and

(2) we present the distribution of urban households by income class.

Columns (3)-(5) present the relative income weights by class of household

for three values of the elasticity of the marginal valuation of income, and

columns (6)-(10) provide the consumption weights for each income class for

each of the five subsidized commodities. The marginal welfare benefit is

found by multiplying the expenditure weight by the relevant welfare weight

and summing over all expenditure categories. The results show a value of

the transfer relative to average per capita income ranging from .967 for

meat subsidies (n = .5) to 1.61 for beans (n = 2). At our preferred value

of n = 1 the value of the transfer lies in the interval 1.00 - 1.17

depending on the product category.

The relative rankings of the welfare value of the transfer are

similar under any assumption regarding the elasticity of the marginal

valuation of income. The greatest welfare benefits accrue to commodities

which have the highest expenditure weights for low income households, beans

and grains, and the lowest benefits accrue to high income consumption goods

such as meat and sugar. Indeed, in the case of meat subsidies the

Government could achieve approximately the same welfare benefit by

transferring income directly to individuals at random.

Table 3-10: The Social Value of Urban Consumption Subsidies

Income Class Percentage of Relative Expenditure Weight Proportion of Total Consumption of Subsidized ItemLE Per Annum Urban Households N = 0.5 N = 1.0 N = 2.0 Grains Beans Oils Meat Sugar

5-49 0.4 1.72 2.97 8.80 .001 .000 .000 .000 .00050-74 0.5 1.46 2.14 4.57 .001 .001 .001 .001 .00175-99 0.9 1.59 2.52 6.33 .003 .003 .002 .001 .002

100-149 4.0 1.50 2.26 5.09 .017 .Ot9 .011 .009 .014i30-199 5.3 1.45 2.10 4.41 .031 .025 .021 .017 .022200-249 6.6 1.43 2.04 4.16 .047 .043 .033 .025 .035250-299 8.9 1.31 1.71 2.93 .067 .066 .051 .041 .053300-349 8.1 1.24 1.54 2.36 .070 .070 .056 .048 .054350-399 7.8 1.23 1.52 2.30 .n72 .074 .057 .051 .060400-499 14.7 1.17 1.37 1.86 .100 .148 .137 .114 .125500-599 12.0 1.06 1.13 1.27 .138 .136 .131 .116 .126600-799 12.8 .97 .94 .88 .158 .148 .165 .165 .155800-999 6.9 .82 .68 .46 .085 .091 .108 .117 .114

1000-1399 6.9 .77 .60 .36 .098 .108 .127 .149 .1321400-1999 3.0 .63 .39 .15 .088 .044 .059 .089 .0592000+ 1.6 .54 .29 .08 .023 .025 .041 .058 .048

n = .05 1.037 1.056 1.010 .967 1.006n = 1.0 1.143 1. 173 1.079 .996 1.074n - 2.0 1.568 1.606 1.390 i.216 1.393

(166-20)

- 129 -

The cost of the transfer per unit of subsidy is given by the

consumption conversion factor (f ) for urban consumption, since this

represents the commitment of foreign exchange per unit of income

transferred. In Section 2.3, we estimated that the consumption conversion

ratio was 1.11 for urban consumption. In Table 3-11, we therefore

calculate the implied value of public income committed to consumption

subsidies by product category, v;, and estimates of v subs Our results

suggest that the subsidy program has been pushed to the point where overall

marginal benefits are approximately equal to marginal resource costs. If

we assume n = 1 the value of v is approximately 1.0, indicating thatsubs

public income committed to the subsidy program is no more valuable than a

marginal increase in the income of an individual at the average level of

urban per capita income. If n is allowed to rise to 2, v subs is

approximately 1.3; a result which indicates the importance of the assumed

degree of pro-egalitarian bias in establishing the value of public income.

Table 3-11: The Value of Public Sector Subsidies

Weight in Marginal Social Value Vj

SubsidyExpenditure n = 0.5 n = 0.1 n = 0.2

C-rains .565 .934 1.030 1.413

Beans .041 .951 1.057 1.447

Oils .208 .910 .972 1.252

Neat .081 .871 .897 1.095

Sugar .105 .906 .968 1.255

Weighted Average .922 1.002 1.338

Simple Average .914 .985 1.292

- 130 -

In evaluating these results, several possible limitations should be

kept in mind. First, the subsidy program may not represent an optimizing

decision by the Government with respect to the desired level of transfer. For

example, if the subsidies on some higher income consumption items are

maintained essentially for political reasons, it would not be surprising to

find that social costs exceeded social benefits of those programs. If these

subsidies are expected to remain at their existing levels, marginal changes

would be concentrated among commodities with higher relative welfare weights.

We have no evidence to indicate, however, that the composition of the subsidy

program is likely to change dramatically. Hence, our average values for

v represents the expected future value of the subsidy. Second, because

some items are sold by coupon or in ration shops, actual consumption of

subsidized commodities may differ from the assumed distribution based on

expenditure shares. At the opposite extreme, we may take the assumption that

consumption of subsidized commodities is the same for all households, which is

tantamount to assuming that the transfer accrues in proportion to the

frequency distribution of households in the total population. This assumption

raises slightly the estimated value of the subsidy, indicating the importance

of the relatively high income elasticities of demand for meat, oils and sugar

in determining the overall value of the subsidy program.

Finally, it is possible that high income consumers do not use certain

subsidized commodities. This appears to be particularly true for meat.

Subsidized meat which is imported frozen is regarded as an inferior good in

Egypt, and high income consumers tend to avoid purchasing it whenever

possible. It is uncertain at what point on the income distribution this

becomes a relevant consideration, however, and we have not attempted to adjust

- 131 -

our estimate of v. for meat accordingly. For other subsidized commodities,

there is no evidence to indicate systematic avoidance or exclusion of higher

income consumers from purchasing subsidized commodities, but any such tendency

would tend to raise the estimated values of vsubs'

(b) The Social Value of Public Sector Employment

Fgyptian policies with regard to the staffing of Government

administration and public sector enterprises offer another opportunity to

observe the Government's own perception of the value of public income relative

to private sector consumption. The problem of overstaffing of general

administration and public sector enterprises in Egypt has been widely

discussed. 1/ At various times public policy has guaranteed employment in the

Government or the public sector to numerous categories of workers including

university and technical school graduates, secondary school leavers, and

discharged conscripts. As a consequence, Egypt has experienced rapid rates of

growth in public sector employment, and the Covernment sector is characterized

by large redundancies of two very different groups of largely unskilled

employees, university graduates with high formal education but few appropriate

skills, and conscripts with little or no formal education.

The guaranteed employment program for university graduates may be

viewed as a failure of the educational pl'anning system, since it was

undoubtedly originally intended to increase the return to formal education and

thus to encourage human capital formation. The employment program for

conscripts, however, was an explicit income redistribution scheme. In 1978,

the guarantee of employment for all returned conscripts was abrogated and the

1/ See for example, Handoussa (1980c) or ILO (1981).

- 132 -

automatic inflow of new workers has stopped, but the problems of overstaffing

in public sector corporations are still acute. According to Werner

International (1976), the labor force in Egyptian textile mills was more than

four times the size of similar mills in Europe. At the largest integrated

spinning and weaving mill operated by the public sector employment in 1975 was

35,400. A North American mill with identical equipment, on the other hand,

would require only 4,600 workers to produce the same level of output. Similar

evidence for other public industrial sectors suggests that' despite the

cessation of the employment guarantee for conscripts, labor has been hired

well beyond the profit maximixing level.

The pure transfer component of the public sector employment guarantee

is the difference between the wage for a marginal unskilled worker and his

marginal value product. As an extreme assumption, we may take the marginal

value product of a typical conscript worker as zero. The whole of hie wage

payment of LE 25 per month (at 1975 prices) is therefore a transfer. The

welfare valution of the marginal IE transferred to a household with an annual

household income of I.E 300 in 1975 was: 1.25 (n = 0.5), 1.54 (n = 1.0) and

2.36 (n = 2.0).

The cost to the Government of the transfer is given by the

consumption conversion factor of 1.11. Thus the value of public income in

terms of consumption implied by this policy is:

Elasticity of Marginal Marginal Value ofValuation of Income (n) Public Sector Income (v)

0.5 1.131.0 1.392.0 2.13

- 133 -

These values are somewhat greater than our estimates of the relative

value of public income committed to the subsidy program, largely because the

estimates are based on transfers directed specifically at households with per

capita incomes below the urban average.

There is one important limitation of this method of evaluating public

income. Because the employment guarantee was specifically directed to

conscripts, it was undoubtedly intended in part to compensate them for income

earning opportunities lost while in the military; and for the hazards and

inconvenience of military life. Thus from the welfare gain associated with

the transfer we should deduct something for the welfare cost of the income

forgone while in military service and for the disutility of risk. Indeed, the

true value of the transfer is the annualized difference between the

military-cum-public sector income stream and the income stream in a

conscript's alternative employment less a risk premium. Lacking data for such

an exercise, we simply note that the values for v listed above probably

overstate the true welfare value of public employment policy.

The two components of public sector current expenditure which we have

analyzed yield estimates of the value of public income in the range .994 to

1.13 (n = 0.5), .985 to 1.39 (n = 1) and 1.29 to 2.13 (n = 2). If our

argument concerning the likely overestimate of the value of income committed

to the employment program is correct, the best estimate probably lies toward

the bottom end of the interval. Hence we take as our estimate of the value of

public sector income committed to consumption .95 for n = .5, 1.00 for n = 1.0

and 1.30 for n = 2.0.

- 134 -

(c) The Value of Public Sector Investment

Investment makes possible a stream of future consumption, the present

social value of which depends on the marginal productivity of public sector

industrial activities, the consumption rate of interest, and the social value

of the incremental consumption made possible by the investment activity. In

this section we bring together our previous estimates of these parameters to

provide an estimate of v. nv, the value of public sector resources committed

to investment relative to consumption at the average level of urban per capita

income.

In section 3.1, we considered the marginal social productivity of

public sector investments. Based on the best available data, the average rate

of return to public industrial activities at border prices was found to lie in

the range of 8 - 12 percent. This level of performance at border prices is

relatively good, and we anticipate that future investments in the public

sector are unlikely to yield significantly higher marginal productivities of

capital.

To determine the value of public sector investment in terms of

consumption,-we need to identify the uses to which the returns to investment

are put. In Egypt there are essentially three possible outcomes for the use

of the incremental profits of public sector enterprises. First the profits

may be saved and reinvested. This may occur either at the level of the

enterprise, via retained earnings or in the form of transfers to the

consolidated public sector account which are subsequently channeled back into

the investment budget. Second, a portion of the earnings of public sector

enterprises may leak into private sector consumption in the form of increased

wage payments. This outcome is most likely to occur if the Government of

Egypt continues to expand the guaranteed employment schemes for certain

- 135 -

categories of public sector workers. Finally, profits from the public

enterprises may be transfered to public sector current expenditure.

It is unlikely that a significant amount of profits from new

industrial investments will leak into the private sector in the form of

increased wage payments. Recent reforms in public enterprise management have

sought to free enterprises from the requirements to hire workers in excess of

their needs. Thus, barring a major return to the guaranteed employment

programs of the past, the only leakage via the wage bill would be as a

consequence of the bidding up of wages for certain skill categories of

workers. We shall consider this possibility in greater detail in our

discussion of the labor market in Chapter 4, but given the capital intensity

of most public sector industrial investments, apy leakage via increased wage

payments is likely to be small. Hence, we assume that the entire return to

public investments accrues to the public sector. The social value of that

return is;T

vinv t- E[s vjn + (l-s) vc] q/ (1+CRI)t (15)

where s is the marginal propensity to save out of public sector income, vc

is the marginal social value of public sector current expenditure relative to

average urban per capita consumption, and CRI is the consumption rate of

interest. Assuming vinv and vc to be constant over the time horizon

involved, we obtain:

Vi [(l-s) v q *(i,t)]/ [CRI - sq *(i,t)] (16)

w"ere * (i, t) =1 - (1CR)T,w-iere ~~(1+CRI)-

It is apparent that the value of vi depends crucially on two

parameters which we have not previously discussed, the marginal propensity to

save out of public sector income, s, and the assumed lifetime of public

investment, T. Public sector savings behavior in Egypt is particularly

- 136 -

difficult to predict. Between 1974 and 1979 there was great variation in the

level of public savings. A simple estimate of the marginal propensity to save

out of total pubic sector income yeilds the following parameter values:

SAVINGS = - 296.5 + .261 INCOME R2 = .661(280.1) (.093) (Standard Errors)

indicating a marginal propensity to save of approximately 26 percent. The

marginal propensity to save implicit in the base run projections of the DRM

model works out to be .225 over the period 1980-1990. There is one reason to

believe, however, that these estimates of the marginal propensity to save out

of total public sector income may understate somewhat the propensity to save

out of industrial investments. Handousse (1980b) has indicated that there is

a growing tendency among public sector enterprises to retain earnings for

self-finance of investments in the form of general reserves, rather than to

declare the whole of net returns as profits and transfer the stipulated 90

percent to the treasury. In these circumstances, enterprise accounts

understate the operating surplus of the public sector and the level of savings

out of economic profits of public sector industrial investments. Without a

detailed examination of the accounting practices of the enterprises concerned

it is impossible to determine the extent to which we should revise our

estimate of the marginal propensity to save upward. For this reason, we

experiment with three values of the marginal propensity to save: 0, .25, and

.50. We also experiment with two values of T. First we assume that the

public industrial sector saves and grows at a constant rate with a constant

marginal product of capital q; this is equivalent to assuming that T = oo.

Such an assumption is not tenable in the long run and has important

implications for the Accounting Rate of Interest as we noted in Section 3.3

but it does permit us to establish an upper bound for the value of v .

- 137 -

As an alternative we have taken T = 15, which is a reasonable estimate of the

period over which the parameters in (16) may be expected to remain stable.

The results of our estimates of the value of public income committed

to investment appear in Table 3-12. The extreme sensitivity of this parameter

to assumptions regarding savings rates, the lifetime of the investment, and

the marginal productivity of capital is readily apparent from the table. For

our best guess as to the savings rate of s = .25 and of n = 1.00 our estimates

of vi range between .75(q = .08; T = 15) and 3.60 (q = .12; T = K ). A

simple average of the results yields a value of v. = 1.80. This is not anin v

unreasonable value and is consistent with a fairly wide range of values for

the marginal propensity to save, the marginal productivity of capital, and the

lifetime of the investment.

Table 3-12: The Value of Public Investment

Marginal Product of s 0 s .25 s .50Capital at Border Prices T = 15 T = T = 15 T = X T = 15 T =

q = .08 n = 0.5 .912 2.530 .900 5.700 .877n = 1.0 .800 1.450 .750 1.710 .666 2.670n = 2.0 .594 0.990 .681 .918 .549 .800

q = .10 n = 0.5 1.140 3.170 1.220 14.250 1.430 *

n = 1.0 1.000 1.820 1.000 2.500 1.000 10.00n = 2.0 .966 1.240 .889 1.220 .768 1.18

q = .12 n = 0.5 1.370 3.800 1.620 * 6.740 *

n = 1.0 1.200 2.180 1.290 3.600 1.500 *

n = 2.0 1.160 1.490 1.120 1.560 1.050 1.730

Note: The values in the table are based on the following values for other

variables.

vc = .950 CRI = 3.0 when n = 0.5vc = 1.000 CRI = 5.5 when n = 1.0vc = 1.300 CRI = 10.5 when n = 2.0

- 138 -

(d) The Value of Public Income - v

The results of our various estimates are set out in Table 3-15. For

both n = 0.5 and n = 1.0 the rankings of the value of income committed to

alternative uses is the same, consumption subsidies followed by public

employment, and finally industrial investment with the greatest social value.

For n = 2.0, the social value of industrial investment is very low, reflecting

the high consumption rate of interest relative to the marginal social

productivity of capital. The reader should also bear in mind our cautionary

remarks regarding the estimate of the social value of the employment guarantee

which could conceivably reverse the rankings of the two components of

consumption expenditure.

Table 3-13; Best Estimates of the Value of Public Incomein Alternative Uses

Elasticity of the Marginal Valuation of Incomem = 0.5 m = 1.0 m = 2.0

Consumption subsidies .92 .99 1.31

Public Employment Policy 1.13 1.39 2.13

Industrial Investment 4.74 1.80 1.05

The greater consistency of the estimates for n = 1 and for n = 0.5

provides weak support for our assertion that the elasticity of the marginal

valuation of income in Egypt probably does not exceed unity. We are now in a

position to arrive at an overall estimate of the value of v. Taking our best

estimates of the value of public consumption and investment and weighting by

the proportions of public expenditure at the margin, we arrive at a weighted

- 139 -

average value of public income relative to average urban per capita

consumption. Our best guess of the investment weight, and the one consistent

with our estimates of the value of public investment, is .25. Hence the

overall estimate of v is:

Estimate of n Estimate of v

0.5 1.,90

1.0 1.20

2.0 1.24

Thus, whether n = 1 or n = 2 the resulting value of public income is not very

different, because the value of capital expenditure falls as n rises, while

the value of current expenditure moves in the opposite direction.

Nevertheless, we have sound reasons to prefer a value of n approximately equal

to unity, which suggests that the preferred value of v is 1.2.

3.7 Consumption Distribution Weights and the Critical Consumption Level

In this section we combine our estimates of the relative weights

assigned to marginal changes in consumption (d) and the value of public income

(v) to produce a set of absolute consumption distribution weights ( LA= d/v)

which give the value of marginal changes in the consumption of household

relative to the value of uncommitted public income. We also use our estimated

consumption weights to estimate the critical consumption level, that level of

per capita consumption at which the Government is indifferent between

transferring a marginal unit of income to individuals at that level and

retaining the income for other Public sector uses, and we examine independent

evidence on the critical consumption level as a check on the consistency of

our system of welfare weights.

- 140 -

(a) Consumption Distribution Weights

Consumption distribution weights by household expenditure category

for both rural and urban consumption are presented in Tables 3-14 and 3-15.

The tables reveal the increased concern for equity manifested by greater

values of n. Indeed, with n set equal to .5 there is no level of household

income at which the Governm,ent deems a transfer of income to private

individuals as equal in value to uncommitted public income. Two kinds of

weighted averages are calculated. In the first in which numbers of households

are the weights, we obtain the expected welfare value of a marginal transfer

of income to a household drawn at random.

Table 3-14: Consumption Distribution Weights forUrban Households

Income % Urban Welfare Weight Relative to Uncommitted Public IncomeClass Households n = 0.5 n = 1.0 n = 2.0

5-49 0.4 0.905 2.475 7.09750-74 0.5 0.768 1.783 3.68575-99 0.9 0.837 2.100 5.105

100-149 4.0 0.789 1.883 4.105150-199 5.3 0.763 1.750 3.556200-249 6.6 0.747 1.700 3.355

250-299 8.9 0.689 1.425 2.363300-349 8.1 0.653 1.283 1.903350-399 7.8 0.647 1.267 1.855400-499 14.7 0.616 1.142 1.500500-599 12.0 0.558 0.942 1.024600-799 12.8 0.511 0.783 0.710800-999 6.9 0.432 0.567 0.371

1000-1399 6.9 0.405 0.500 0.2901400-1999 3.0 0.332 0.325 0.1212000+ 1.6 0.284 0.242 0.065

Average Weighted by Household .596 1.116 1.661Average Weighted by Expenditure .508 .803 .987Critical Consumption Level 22.0 73.5 83.4

(LE per capita)

- 141 -

Table 3-15: Consumption Distribution Weights for

Rural Households

Income % Rural Welfare Weight Relative to Uncommitted Public Income

Class Households n 0.5 n = 1.0 n = 2.0

5-49 2.000 0.895 2.408 6.726

50-74 2.700 0.963 2.808 9.137

75-99 3.500 1.011 3.083 11.048

100-149 7.800 0.932 2.617 7.952

150-199 11.200 0.879 2.333 6.315

200-249 11.800 0.842 2.100 5.129

250-299 12.600 0.805 1.958 4.435

300-349 10.200 0.779 1.817 3.847

350-399 8.900 0.732 1.617 3.048

400-499 11.300 0.695 1.458 2.476

500-599 4.400 0.653 1.283 1.911

600-799 6.500 0.605 1.100 1.411

800-999 3.000 0.553 0.917 0.976

1000-1399 2.400 0.447 0.600 0.419

1400-1999 1.300 0.447 0.592 0.411

2000+ 0.500 0.268 0.217 0.056

Average Weighed by Households .777 1.865 4.423

Average Weighted by Expenditure .667 1.420 2.793

Critical Consumption Level 21.0 84.3 94.4

(LE per capita)

The second uses expenditure shares as weights and therefore provides the

expected welfare value of a transfer of income which accrues to households in

proportion to their expenditure.

(d) The Critical Consumption Level

We can also use the results to calculate the critical consumption

level - the level of per capita income at which marginal increases in private

consumption are considered socially as valuable as uncommitted public income.

At the critical consumption level C*, the welfare value of the transfer of

LE 1.00 expressed in terms of the numeraire must equal the social cost of

- 142 -

providing the transfer in terms of the numeraire, which is given by the

consumption conversion ratio: thus (C*) = d(C*)/v = f and

C* = C (v f )lIn Estimates of the rural and urban critical consumptionc

level are listed in Tables 3-14 and 3-15. Not surprisingly, given the

closeness of the estimated values of v, the critical consumption levels for n

1 and n = 2 are also rather close together. Both are less than the urban

per capita average of LE 97.9. Thus, a transfer of income to households with

per capita levels of income equal to or greater than the urban average is

considered socially less valuable than public income.

In the rural economy, the role of the lower foreign exchange cost of

rural consumption is apparent. The rural consumption conversion ratio of 1.07

coupled with the fact that in Egypt rural real incomes are below those in

urban areas for the same nominal income raise the critical consumption level

for the rural economy to LE 84.3 for n = 1.

The usefulness of the critical consumption level as a check on the

assumed value of n is apparent from the estimate of C* derived when n = 0.5.

The implied level of household income at a per capita level of LE 22 would

place the household among the lowest one percent of urban households and would

not provide an adequate level of income for minimum subsistence. Such a

critical income level is inconsistent with the behavior of the Egyptian

Government in subsidizing the consumption of households at much higher levels

of per capita income, and we conclude therefore that n = 0.5 is inconsistent

with revealed behavior concerning the distribution of income. With n = 1, on

the other hand, the welfare value of a transfer of income to a household taken

at random from the urban sector is equal in value to the resource cost of

providing the transfer; that is the critical consumption level is almost

- 143 -

precisely equal to the expected per capita income of an urban household chosen

at random. For n = 2 the critical consumption level is greater than the

expected per capita income of a randomly chosen household. This may be

inconsistent with the apparent efforts of the Government of Egypt to target

consumption subsidies toward commodities with high shares in low income

expenditure.

The only independent estimate of the critical consumption level which

we have is provided by the structure of the direct tax system. El Edel (1980)

has estimated the incidence of direct taxes by expenditure class for 1974/75.

Direct taxes via the tax on wages and salaries begin in the expenditure

interval LE 400-499. Urban households in this income category have a per

capita income of LE 71.7 which is very close to our estimate of the urban

critical consumption level for n = 1 of I.E 73.5. With n = 2, the urban

critical consumption level of 83.4 exceeds the per capita income of households

subject to minimum direct taxation. Since a consistent government should not

be prepared to levy direct taxes on the incomes of households at or below the

critical consumption level, and considerations of incentives may cause it to

set the base of the tax net above the critical consumption level, the

relationship implied by n = 2 is not consistent rational public sector tax

policy. This evidence from the structure of the direct tax system provides

some additional support for the use of an elasticity of the marginal valuation

of income of unity.

- 144 -

Appendix 3-1: Rural-Urban Price Differentials in Egypt 1979/80

In section 3.4 we discussed the need to express all incomes in terms

of LE of constant purchasing power. In this appendix, we estimate the extent

to which rural and urban prices diverged in Egypt in 1979/80 and arrive at the

somewhat surprising conclusion that, unlike most developing economies, rural

prices exceeded urban prices by approximately ten percent.

There is substantial uncertainty surrounding these estimates. Apart

from the normal index number problems associated with comparisons of different

consumption baskets and the usual difficulty in comparing heterogeneous goods,

a crucial assumption regarding the extent to which subsidized food products

are available in the rural areas has great impact on the magnitude of the

urban/rural price index. After some consideration, we have assumed that

subsidized commodities are not in general available in rural areas. This

implies that rural consumer prices for such commodities as wheat, maize, dry

beans, and lentils are set by the farmgate price which in most instances is

substantially above the subsidzed urban consumer price. In many instances the

rural urban price ratio exceeds 2:1 for major food items.

A second expenditure category where there is likely to be a major

rural/urban price differential and where our information is very incomplete is

in housing. Rental values in Cairo have been rising very rapidly. It is

therefore not unreasonable to expect a substantial differential to exist in

rents between urban and rural areas, but it is quite difficult to pin down the

precise magnitude of the difference. Our discussions have indicated that for

marginal housing units of equivalent quality the annual rental in urban areas

is approximately five to ten times that in the countryside. Since it is quite

- 145 -

likely that the differential will widen in the medium term, we have chosen a

rural/urban price ratio of .10.

Table A3-1 presents the components of the price index. Expenditure

weights are taken from the 1974/75 household survey. Because incomes have

been rising quite rapidly since the survey was completed, it is likely that

the expenditure patterns reported there overstate the share of agricultural

commodities in consumer expenditure and understate the shares of housing and

consumer durables. This is likely to impart some upward bias in our estimates

of the average price ratio.

Column 4 of Table A3-1 gives the price ratios finally adopted for

each expenditure category. Rural farmgate prices were converted to retail

equivalents by adding margins for transport and distribution. For households

in which there is substantial autoconsumption or those in which incomes are

received as payments in kind the price differential is accordingly

overstated. Where no direct price comparison could be made, we assumed that

rural and urban prices were the same. For some imported (or importable)

manufactured goods rural prices are likely to be higher than those in urban

areas. This would tend to reinforce our picture of higher average rural

relative prices and may offset to some extent the upward biases noted above.

Using urban weights the rural urban price differential is estimated

to be about 3 percent. It exceeds 21 percent on the basis of rural

expenditure shares, which are more heavily weighted toward subsidized

agricultural commodities. The geometric mean of the two is 1.12, which we

have rounded down to 1.10 to reflect the possible upward bias in our

estimates. Indeed, we would not go far wrong if we assumed that rural and

urban prices were approximately the same.

- 146 -

Table A3-l: Rural and Urban Relative Prices 1980

Expenditure Item Expenditure Weight Rural/UrbanUrban Rural Price Ratio

(1) (2) (3) (4)

Grain & carbohydrate .098 .187 2.46Dry beans .015 .023 1.18Vegetables .044 .044 .50Fruits .036 .029 .50Meat .101 .110 .87Fish .022 .018 1.10Milk & eggs .050 .043 1.00Oils & fats .041 .058 2.04Sugar & sweets .029 .038 1.43Miscellaneous food .036 .022 1.00Tea & coffee .016 .024 1.00Other beverages .022 .010 1.00

Textiles & clothing .132 .124 1.00Housing fuel light .129 .098 .10Furniture .036 .034 1.00Health & hygiene .018 .010 1.00Transport & Communication .038 .030 1.00Education .020 .010 1.00Culture & Entertainment .013 .004 1.00Other .103 .083 1.00

Urban Weights 1.033Rural Weights 1.215Geometric Mean 1.120

- 147 -

Chapter 4: Shadow Wage Rates for Skilled and Unskilled Labor

In this chapter we consider the shadow wage rate for skilled and

unskilled labor in Egypt. The principles underlying the estimation of the

shadow wage are by now well established (see Scott et al (1976) or Squire and

van der Tak (1975) for example), and we shall not rehearse the arguments

underlying the approach in great detail. Rather, we focus on those aspects of

the Egyptian labor market which are relevant in determining the opportunity

cost of labor supplied to various sectors of the economy. In the first

section of the chapter we briefly review the structure and functioning of the

Egyptian labor market. The second section presents a general formula for the

shadow wage and discusses the relationship between social and efficiency price

formulations of the shadow wage rate. We then consider estimates of the

shadow wage rate for skilled and unskilled labor in sections three and four

respectively.

4.1 Labor Force, Wage and Employment Trends in Egypt

There are two recent studies of the Egyptian labor market which

provide a rather detailed picture of labor force, wage and employment trends

in the 1970's (Sabot, Taylor and Boutros-Ghali (1981 and ILO (1980)). Rather

than summarize their findings we shall focus on those aspects of wage and

employment trends which have particular relevance for our estimates of

accounting prices for labor.

Tables 4-1 and 4-2 present the available information on the

distribution of employment by sector. Over the past 30 years the sectoral

structure of employment in Egypt has changed significantly. Agriculture's

share in total employment declined from 58.4 percent in 1947 to 43.8 percent

- 148 -

in 1976. Prior to 1970, although agriculture's share in total employment

declined, the absolute size of the agricultural labor force continued to grow

slowly. There is now, however, evidence to suggest that the agricultural

labor force has begun to decline in absolute size. Indeed labor force surveys

show a rapid decline in male agricultural employment between 1972 and 1979.

It is not known, however, to what extent this represents a permanent reduction

in the agricultural labor force, since little is known about the permanence of

the migration or its effect on the participation of women and children in the

agricultural labor market. The ILO has suggested that there is apparent

tightening of the rural labor market and some evidence of an emerging scarcity

of agricultural labor. In the non-agricultural sectors of the economy

government and construction stand out as leading sectors in terms of

employment growth, with manufacturing in third place.

The leading role of government as an employer in Egypt has important

implications for the structure and functioning of labor markets in the formal

sector of the economy. The most important employment generating government

policies have been the expansion of and overstaffing in the public sector,

both in public administration and the public sector enterprises. From 1966 to

1973 government employment - excluding the armed forces - grew at 6.7 percent

per annum. From 1973 to 1978 the rate of increase was 7.0 percent. In the

public industrial enterprises managers were compelled to hire labor in excess

of their requirements and prohibited from making labor, once engaged,

redundant. In addition, the public enterprises were at various times

compelled to hire all university graduates and returned conscripts from the

- 149 -

Table 4-1: EGYPT - Labor Force by Industry, 1960-76

Number of Persons Annual Shares of Shares of increasethousands Rates of total, x 1960-76

Industry Growth, _

1960 1976 Compound 1960 1976 Number,X Thousands x

1. Agriculture,fishery, etc. 4,406.3 4,881.0 0.6 65.3 43.8 474.7 14.4

2. Mining,quarries 21.2 33.8 3.0 0.3 0.3 12.6 0.4

3. Manufacturing 647.2 1,369.5 4.7 8.3 12.3 722.3 21.9

4. Electricity,gas, etc. 16.9 61.8 8.3 0.2 0.6 44.9 1.4

5. Construction 158.9 425.1 6.3 2.0 3.8 266.2 8.1

6. Trade, etc. 690.8 861.3 1.4 8.8 7.7 170.5 5.2

7. Transportation,c ommunicat ion,etc. 260.2 482.3 3.9 3.3 4.3 222.1 6.7

8. Financing, etc. 72.5 88.4 1.2 0.9 0.8 15.9 0.5

9. Services 1,333.3 1,868.3 2.1 17.0 16.8 535.0 16.2

10. Not adequatelydescribed 5/ 224.7 1,060.2 10.1 2.9 9.5 835.5 25.3

Total 7/ 7,832.0 11,131.6 2.2 100.0 100.0 3,299.6 100.0

of which (288.9)1/ 1,779.0 (12.9)3/ (3.7)1/ 16.0 (1,490.1)3/ (45.2)Government (932.9)2/ (6.3)4/ (846.1)4/ (25.6)

1/ 1961; comparability with the 1976 figures is uncertain.

2/ 1965/66; comparable.

3/ 1961-76.

4/ 1965/66-75.

5/ Including unemployed.

6/ Not including military conscripts and public enterprise employment both of whichare reported in industries 1 to 10.

7/ Including military conscripts.

Sources: Population censuses, adjusted for comparability; see A. Nassef, 1980. ForGovernment, 1965/66-78 see Central Agency for Organization and Administration,"Development of Employment in Government Administration, 1965/66-1978",Information Centre, Data Series No.11, September 1979, p.15.

liible 4-2: Ib,or Force in Egypt by lnda,itry, 171-79

Number of Persons Annual Shares of Shares of increase Shares of Increasethousands Rates of total, 2 1960-76 in Employment

Industry Growth, Outside Agriculture

1971 1979 Compound 1971 1979 Number,% Thousands x x

1. Agriculture,fishery, etc. 4,469.5 4,002.0 -1.4 54.2 41.8 -467.5 -35.6 -

2. Mining,quarries 7.2 22.8 15.5 0.1 0.3 15.6 1.9 0.9

3. Manufacturing 1,030.2 1,531.9 5.0 12.5 16.0 501.7 38.2 28.2

4. Electricity,gas 25.8 65.7 12.4 0.3 0.7 39.9 3.0 2.2

5. Construction 193.2 448.5 11.1 2.3 4.7 255.3 19.4 14.3

6. Trade, etc. 797.4 918.4 1.8 9.7 9.6 121.0 9.2 6.8

7. Transportation,communications 323.1 488.4 5.3 3.9 5.1 165.3 12.6 9.3 i

8. Finance, etc. 83.2 116.8 4.3 1.0 1.2 33.6 2.6 1.9

9. Services, etc. 1,268.7 1,820.4 4.6 15.4 19.0 551.7 42.0 31.0

10. Unspecified 54.2 150.4 13.6 0.7 1.6 95.2 7.3 5.4

Total employed l/ 8,252.5 9,565.3 1.8 100.0 100.0 1,312.8 100.0 -

of which inGovernment 1/ 2/ 1,270._ 2,065.3 3/ 7.2 15.4 21.9 3/ 794.8 3/ 60.5 3/ 47.1 3/

Total laborforce 1/ 8,405.6 10,023.5 2.2 100.0 100.0 1,617.9 100.0 -

of which unemployed 153.1 400.2 12.7 1.8 4.6 307.1 19.0 -

1/ Not including military conscripts.

4 19 8 oinc1udinggublic enterprises.

Source: Labor Force Surveys, CAPMAS. For the Government, see CAOA, op.cit.

- 151 -

armed forces. The result of these employment policies has been to leave the

public sector overstaffed with unskilled workers of two very different types,

largely illiterate former conscripts and highly educated graduates with few

specific industrial skills. Recent innovations have released public

enterprises from the requirement to guarantee employment to conscripts and

have increased the scope for managerial discretion in hiring and firing of

labor, but there remains a substantial hangover of redundancies from the time

of the employment drive. In some enterprises, the size of the labor force is

sufficiently large to introduce the possibility that the marginal product of

labor is in fact negative, since workers require supervision and

administration without contributing to output. The extent of overstaffing in

the public sector and government is difficult to pinpoint, but the ILO has

estimated that between 1960 and 1976 perhaps as many as 750,000 jobs were

created in excess of employment requirements.

The market for skilled labor in contrast has been characterized by

growing shortages of workers particularly in construction trades and some

skilled industrial occupations. In recent years, Eygpt has experienced a

tremendous increase in the scale of external migration of its labor force.

The number of Egyptians working abroad in 1965 was estimated to be

approximately 100,000, while in .1976 the figure had reached 1.4 million.

Out-migration has reduced the rate of growth of the labor force from

approximately 3 percent per year to 2 percent, with consequent tightening in

at least some segments of the labor market.

Thus, the picture of employment trends which enmerges is one of

increasing scarcity of labor in the agricultural sector, largely as a result

of pull factors from external migration, government employment and military

- 152 -

conscription. Surplus labor appears to be concentrated in the public sector,

certain types of small-scale agriculture and perhaps in the urban informal

sector. Among skilled workers there is increasing tightening of the labor

market in response to external migration. The construction industry is one

area of acute labor shortage, particularly in skilled trades.

Recent wage trends appear to reflect the tightening of the labor

market. Wage formation in Egypt runs from the government and public

enterprises with their rigid pay scales and grades which exhibit little if any

response to market forces to the market for hired agricultural labor with its

apparently highly flexible wage ranges which adjust to clear markets in a

reasonably efficient fashion. In between are the private industrial

enterprises which are subject to minimum wage legislation and unionization and

the small scale and casual sectors, about which very little is known.

The available information on money wages by sector is summarized in

Table 4-3. The data are subject to substantial error but they are indicative

of broad trends. Between 1966 and 1972 both agricultural wages and government

wages were largely static and therefore declining in real terms. After 1972

agricultural wages experienced rapid increases while the government wage

levels increased at more moderate nominal rates. The tightening of the labor

market in construction is not readily apparent from Table 4-3, but an

alternative wage series reported in Table 4-4 reveals the extent of wage

increases in the construction sector.

Wage differentials in Egypt are large as is the case in most

developing economies. Table 4-5 shows wage rates on a daily basis for

selected major sectors in 1966 and 1976. There has been some narrowing of the

differential between agriculture and public employment in both manufacturing

Table 4-3: Money Wages in Agriculture, Establishmentsand Public Admiinistration, 1966-76(Indexes, 1966 = 100)

Agriculture Establishments 10 Employees, Average Weekly GovernmentAv. Daily Wages Administration

Total Manufacturing Construction Annual SalaryMen Women & Per EmployeeChildren Private Public Private Public Private Public

(1)- (2) (3) (4) (5) (6) (7) (8) (9)1966 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.01967 100.0 100.0 103.5 100.0 103.2 98.8 91.5 1,06.2 97.01968 96.0 95.8 110.3 101.7 109.6 103.5 107.4 117.5 94.21969 99.1 102.5 110.0 113.3 109.3 119.2 107.6 118.3 98.61970 99.9 105.0 113.5 111.2 113.6 118.2 108.4 115.5 101.91971 99.9 101.7 122.4 112.9 128.2 116.6 102.3 116.8 100.61972 103.4 105.8 145.3 118.0 118.6 124.8 105.7 117.5 103.51973 111.6 114.7 137.7 125.8 139.6 134.5 (89.0) 130.4 110.21974 138.9 136.7 107.81975 182.2 171.7 176.2 144.9 187.9 149.2 125.2 162.9 115.01976 239.2 230.2 212.1 164.0 225.0 174.7 156.0 188.4 129.41977 298.2 296.1 147.81978 345.4 343.3 159.61979 411.7 171.8

1966 25 PT 12 PT 340 PT 466 PT 280 PT 432 PT 527 PT 388 PT LE 333.771975 46.5 PT 21 PT 599 PT 675 PT 526 PT 631 PT 660 PT 632 PT LE 383.76

Sources: Cols. 1, 2 - Ministry of AgricultureCols. 7i 8 - CAPMASCols. 9, 10 - General Organization for Public Management for the total

government wage bill and the number of employees in the Government.Simple average per employee. Includes cost-of-living allowances.

Table 4-4: Average Wages in Construction and Agriculture

Construction

Establishments Occupations Index of Agriculture,Year 10 Employees labor Men

Excavation Concrete Concrete Mason Plumber costsCarrier Carpenter

1970 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.01971 100.7 - - - - - - 100.21972 .101.6 - - - - - - 110.61973 111.7 200.0 160.0 138.9 166.7 187.5 153.0 137.61974 138.6 - - - - - - 165.81975 139.5 333.3 350.0 222.2 233.3 500.0 301.0 190.11976 162.5 - - - - - - 226.21977 - 500.0 550.0 361.0 380.0 625.0 473.0 263.91978 - - - - - 290.21979 - - - - - - -- 334.5

Daily Wage, 1970 0.75 0.30 0.50 0.90 1.50 0.80 - 0.261975 LE 1.05 1.00 1.75 2.00 3.50 4.00 - 0.465

Sources: Col. 1: CAPMAS, Private and Public 1975, public only weekly wages. Daily wages obtained byassuming six working days.

Col. 2-5: K. Fodah, Productive Efficiency in the Contracting Sector, quoted by ... . Daily wages.Based on a survey of contractors.

Col. 7: N. Chouri, R. Eckaus, A. Mohei-Eldin, "Migration and Employment in tbe ConstructionSection ... ", Ch. 8, MIT, 1978, p.1 09.

Col. 8: Ministry of Agriculture.

- 155-

and government, and a major widening of the differential between agriculture

and construction, reflecting the influence of emigration on the wage

structure. The average differential between agricultural employment and

manufacturing remains large, approximately 100 percent. We lack reliable

comparisons for unskilled labor, however, a problem which greatly complicates

our estimate of the shadow wage.

Table 4-5: Sectoral Wages, 1966 and 1975

Average Daily Wages1966 1975

PT Index PT Index

Agriculture, men 25 100 46.5 100Construction, excavators, men 25 100 100.0 215Manufacturing industry

Public 70.5 282 105.1 226Private 46.5 186 85.9 185

Government 103.3 413 127.9 275

Source: ILO(1980). It is assumed that employees in the manufacturingindustry work 6 days per week and government employees 300days per year.

4.2 A General Formula for the Shadow Wage

Consider a project which employs an additional worker. In principle,

the worker could be drawn from anywhere in the economy, and the social cost of

employing him in sector i is given by:

SWR. = z p.(M. + C. - B.) (1)1 J J J J J

where

p. = the probability that the worker will be drawn from sector j

into sector i;

- 156 -

M. = the value at accounting prices of the output foregone by

withdrawing a worker from his previous occupation i into

occupation j;

C = the social cost in terms of the numeraire of providing the

additional,resources required to meet any extra consumption,

and savings of the worker and his household arising from the

excess of wages in sector (i) over wages in his previous

employment in sector (j), from any changes in the incomes of

other household members, and/or from any increase in the

disposible incomes of workers in sector (j) as a result of

bidding up of wages in sector (j);

Bj = the social benefit evaluated at accounting prices of the

increase in disposible incomes of workers transferring from

sector j to sector i, from a change in the income of other

members of the worker's household, and from any transfer of

income to workers remaining in sector j as a result of the

bidding up of wages.

The values which are assigned to each of the elements of the shadow

wage and the way in which the probabilities pj are estimated depend upon the

character of the shadow prices to be estimated and upon the assumed nature of

the labor market.

It has become usual in Bank practice to distinguish between shadow

prices calculated on the so-called "efficiency" basis.and social accounting

prices. The distinction between them is that efficiency prices measure the

traditional opportunity cost of using a commodity or primary input while

social accounting,prices incorporate distributional considerations, either

- 157 -

among contemporaries or over generations. Substantial time and ingenuity has

been devoted to the debate over the relative merits of the two systems,

largely with the result that the issues have become less rather than more

clearly defined. It should be apparent that the whole approach of this paper

has been to argue that project appraisals - particularly in an economy like

Egypt with a history of policy interventions affecting income distribution -

should be based on a system of social prices which reflect the relative

priorities assigned to various policy objectives. Bank practice, however has

traditionally emphasized the use of efficiency prices. For most commodities

the differences between social and efficiency prices is negligible, but with

respect to the shadow wage the distinction is very important. Thus, we shall

examine the components of the shadow wage expressed in equation (1) which make

up efficiency and social prices.

Traditional efficiency prices have been based on estimates of the

value of the marginal product of labor in its alternative employment expressed

in terms of the unit of account. Thus the traditional efficiency wage is:

SWR. = p.M = .p.( f.m.) (2)i i ii iJ J J J

where f. is the accounting ratio assigned to the output of sector j and m.

is an estimate of the marginal value product of labor in sector j at market

prices. Note that this formulation introduces a very powerful assumption:

--p.( C. -B.) = 0 (3)

that is that the net resource costs of providing additional employment are

confined to the fall in national income evaluated at border prices resulting

from a change in the existing allocation of labor. This is appropriate if

C. = B. for all j, which implies that the social cost of the resources

required to finance the increased consumption of each class of households is

- 158 -

precisely offset by the social benefit of the increased income. This is not .a

weak distributional assumption; rather it is a very strong one. It implies

that at the margin public sector income is no more or less valuable than the

income of any potential private recipient. Such an assumption is inconsistent

with the whole tenor of our evaluations of tax and subsidy policy in Egypt and

with the policy debate surrounding the need to increase public sector savings

and investment, as well as with the received wisdom of the theory of planning

and optimal growth.

Even if we were to assume that wages were the same in all sectors of

the economy and that the creation of a new public sector job did not result in

any change in household incomes, if the new job resulted in the migration of a

worker from rural to urban areas (or vice versa) the combination of different

expenditure patterns and differential taxes and subsidies mean that the

resource cost per unit of rural and urban expenditure differ substantially.

It seems inappropriate to consider the marginal product of labor as a

legitimate efficiency cost but to ignore the resource costs associated with a

change in the pattern-of household expenditure. In Egypt, for example, the

resource cost associated with creation of an urban job is substantially

greater than that associated with the creation of a rural job. Shadow pricing

should reflect this phenomenon and guide investment accordingly.

To this end we also consider what have come to be called "extended

efficiency prices". The extended efficiency shadow wage is written as:

SWR. = £p. (M + C. -i J J :i J U

= Ep. (f.m. + f .Y.-f .Y. - b(Y. - Y.) (4)j jj cii C] j j

where fcj and fci are the conversion factors applicable to consumption in

sectors j and i respectively, Yi and Y. are the household incomes in

- 159 -

present (sector i) and former-(sector j) employment and b is the single income

weight applicable to the income of all households. This parameter is equal to

the inverse of the parameter v, the value of uncommitted public income

relative to urban average per capita consumption. (Note that as v becomes

large, b declines and the benefit associated with the increase in consumption

tends to zero.)

It should be clear from (4) that even if Y. = Y. the extended1 J

efficiency shadow wage will only equal the efficiency shadow wage if

fci=fcj. In all other cases, the extended efficiency shadow wage will

reflect changes in the composition and accounting cost of consumption

expenditure even for equal household incomes.

Finally, we consider the social accounting wage. This version of the

shadow wage rate incorporates a full set of differential income weights by

class of household. Hence

SWR. = p.(FM. + C. - B.)1 J]I J J J

= pj( f m.+f .Y.-f .Y.-b..(Y.-Y.)) (5)i j ci. I C] j ij 1 j

where bij is the welfare weight applicable to the change in income

(Y. - Y.).

4.3 The Shadow Wage for Skilled Labor

In setting out the general formulae for the shadow wage in section

4.2, we noted that the parameter values applicable to each of the components

of the shadow wage depend upon the structure of the market for the relevant

type of labor and on the assumptions made concerning the way in which that

market adjusts to marginal increases in the demand for labor. In this section

we consider a very simple model of the market for skilled labor in Egypt which

- 160 -

nonetheless captures the essential elements of adjustment to the high levels

of external migration of skilled labor discussed in section 4.1.

Our evidence on the structure of the market for urban skilled and

semi-skilled labor leads to the conclusion that within the Egyptian economy

wages for these categories of workers are reasonably competitively determined,

and since there are no domestic restrictions on emigration it may be argued

that the labor market for skilled and semi-skilled workers is in equilibrium.

Thus, the marginal migrant should be indifferent between emigrating and

remaining in Egypt. There is, however, a substantial differential in the wage

rates paid to homogeneous categories of labor in Egypt and in the Gulf states.

We, therefore, require a model of the labor market which is

consistent with our assumption of competitive equilibrium and with the

persistence of an Egyptian-foreign wage differential for identical categories

of labor. Such a model of the labor market is depicted in Figure 4-1. We

assume that the supply of skilled labor is fixed at the level 00'. The

foreign demand curve for Egyptian skilled labor is given by DfDf and the

domestic demand curve by D D . The effective supply curve of Egyptian

skilled labor to foreign employment is given by S S which lies above the

marginal value product curve D D . Thus we have assumed that the supply

price of Egyptian labor to foreign demanders exceeds its marginal value

product (assumed equal to the wage) in Egypt, due for example, to such factors

as imperfections in information flows, the psychic disutilities of foreign

migration, the real resource costs of moving from one sector to another, and

the fact that migrant jobs are not tenured and involve eventual return

- 161 -

migration. 1/ Foreign demanders hire Egyptian labor equal to O'L at a wage

W . Domestic skilled labor OL receives a competitively determined wage W

and there is a foreign domestic wage differential WfWe.

5E~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~S

We.

0 L L' ,

Figure 4-1: Equilibrium in the Labor Market for Migrants

The shadow wage for skilled labor depends on the process of

adjustment of this labor market to an increase in the demand for skilled labor

in Egypt. Assume the demand for skilled labor shifts outward by LL'. The

reservation wage for Egyptian skilled labor supplied to foreign demanders

1/ Indeed, a more complete model would treat the migration decision as anintemporal optimization problem in which the marginal migrant must equatethe present discounted values of the stream of benefits and costs ofmigration job search and return to the opportunity cost of remainingemployed in Egypt. The qualitative results of such a model, under

reasonable assumptions, lead to a supply price in excess of the static

wage.

- 162 -

increases accordingly and the effective supply curve of migrants shifts to

S S . This will raise the wage rates both in the domestic economy ande e

abroad. The increased demand for labor in the domestic economy will be met by

a reduction in the volume of migrants who are obtained by the bidding up of

domestic wages as well as by the deprivation of other producers in the

domestic economy. The proportions in which workers are drawn from foreign

and domestic employment into the new project will depend on the elasticities

of foreign and domestic demand, on the initial allocation of labor between

foreign and domestic employment and on the elasticity of supply of migrant

workers. The shadow wage will consist of the cost to the economy of foregoing

L"L migrants plus the cost of withdrawing L"L' workers from other domestic

employment plus the resource cost (net of any income benefit) of the increase

in domestic consumption made possible by the bidding up of the domestic wage

w we w

Let Vf and yd be the elasticities of foreign and domestic demand

(defined so as to be positive) respectively and s be the elasticity of

supply of migrants to foreign employers. Then the proportion of workers drawn

from foreign employment is:

Pf -(6)

f Sf rff + (l-sf)c (6)

where sf is the proportion of the Egyptian skilled labor force working

abroad. The proportion drawn from domestic employment is:

(1-Pf) = (7)Sf fl + ( 1 s)C

and the increase in the wage rate is:

We dE (1-pf)We dEsflf + (1-sf)T E (1-sf)% E (8)

where W is the domestic market wage and dE/E is the percentage change in

demand for skilled labor.

- 163 -

It is now possible to consider the social cost of foregoing an

incremental migrant. When a skilled laborer is withdrawn from overseas

employment there is a reduction in Egyptian national income denominated in

terms of foreign exchange equal to the value of his annual remittances (rem).

Hence M = rem.m

There is also an increase in the committment of resources to

consumption and private savings equal to the difference between his domestic

wage and the amount of total remittances. The resource cost of meeting this

change in the household income of the migrant and his family is therefore:

Cm = W (6 kf +(l-6 sk)fc) - (rem)(6 remf s+(- rem )c (9)

where 6sk and 6 e are the marginal propensities to save out of income of

households at the level of income associated with skilled workers and out of

remittance income respectively and f and fc are the conversion factors

for savings and consumption as defined in Section 2.3.

Finally, we consider the benefit from the change in household

income. Given our assumptions of equilibrium in the labor market, there is no

net benefit from the change from foreign to domestic employment by the

marginal migrant. The change in wages is precisely offset by the changes in

conditions of employment, disutility of migration, differences in real incomes

etc. Hence we set B = 0.m

We next consider the cost of drawing skilled labor from the existing

allocation in domestic employment. If we assume that the labor is drawn from

a variety of industries, both traded and nontraded, it is probably most

appropriate to identify the value of output foregone with the market wage

multiplied by the standard conversion factor (f ). Therefore;

M =W (f ). (10)sk e sc

- 164 -

The bidding up of the domestic wage also results in a transfer of

income from the consumers of output produced by skilled workers or from their

employers to the workers employed in the domestic economy. The value at

market prices of the transfer is:

(l-sf ) WEddW dE (11)

dd

where E d is the level of domestic employment of skilled labor. The

consumption cost of this transfer per worker (dE = 1) is:

Csk = EddWe (f ct-fc) = ((S)fWe/Id)fct -fc) (12)

where f is the conversion ratio for consumption applicable to those whoct

bear the transfer. In general, we shall assume fct = fc and hence that

sk

Finally, we consider the consumption benefit of the transfer:

Bsk = L(( sf) We)/11U](bt-b k) (13)

where the parameters bt and b k are the welfare weights assigned to the

incomes of those bearing and receiving the transfer respectively.

We put together our best estimates of the various parameters of the

shadow wage for skilled labor in Table 4-6. First we consider the opportunity

cost of foregoing one additional migrant. Average remittances for migrant

workers in 1975 - 1978 (expressed in constant 1975 prices) are LE 917. The

resource cost of additional consumption is based on two important

assumptions. First, we take as the market wage of a typical migrant in Egypt

(W ) an annual value of LE 1092 (at 1975 market prices) which is the average

of the daily rates for skilled construction workers (masons, carpenters, and

plumbers) at constant 1975 prices over the period 1975-1977. We also make the

important assumption that marginal savings out of remittance income are

significantly higher than those out of domestic employment income.

Table 4-6: Shadow Wages for Skilled Labor Drawnfrom Various Sectors of Origin

Sector of Origin Social Value of Resource Cost of Social Benefit of Total Netof Skilled Labor Decline in Output Change in Consumption Change in Consumption Social Cost

Mj Cj Bj SWR

REM 9/7 sk = .25 SWR = 1206

Migrant Worker f = .60 SWR = 1.104

fc = 1.10

Mm = 917 km = .50 Cm = 289 Bm = 0

Sf = 150 SWR = 1332

Other Domestic We 1092 d = 1.000

Employment fsc= .965 bt .80 SWR = 1.220

MSk = 1054 Csk = 0 bsk = .50 Bsk= 278

- 166 -

The assumed marginal savings rate out of remittance income of 0.5 is

consistent with the assumptions of the DRM model and with recent evidence

regarding the commodity composition of own exchange imports which are more

than 50 percent producer's goods. Our assumed value of the marginal

propensity to save out of domestic employment income of 0.25 may be too high,

since as we noted in Chapter 2, we lack any empirircal basis for estimating

household savings. If the expenditure elasticity of savings is approximately

1.5 (the value employed by Taylor in World Bank (1980b), a marginal propensity

to save of .25 would be consistent with a household income in the range LE

1000 - 1399, and we therefore adopt that value. By assumption we have set

B = 0.m

The net resource cost of foregoing one migrant is therefore LE 917 +

289 = 1206, which is our estimate of the shadow wage of a marginal worker

drawn out of migration (at 1975 constant prices). The ratio of the shadow

wage to the market wage is 1.10. This accounting ratio is applicable to

contemporary market price data on skilled labor costs.

We now turn to an estimate of the resource cost of withdrawing a

skilled worker from domestic employment. To find the social value of the

decline in output we multiply our estimate of the market wage (LE 1092) by the

standard conversion factor of .965. By assumption there is no resource cost

of the change in the employment, since pre- and post change household incomes,

behavioral parameters, and accounting ratios are identical.

To estimate the extent of the income benefit (or cost) which results

from any bidding up of wages in the domestic economy we assume that skilled

workers fall in the household income category LE 1000 - 1399. The

distribution weight appropriate to recipients of the transfer is, therefore,

- 167 -

.50. Next, we need an estimate of the distribution weight for those losing

income. If wage increases are passed through to consumers, the impact will be

to transfer income from households in proportion to their share in total

consumption expenditure. The income weight appropriate to the expenditure

weighted average of urban households is .803. This is probably an

overestimate of the welfare loss of a marginal increase in skilled wages. It

may be argued that high income consumers account for a disproportionate share

of the expenditure on skill intensive commodities. Secondly, not all of the

wage increase may be passed on. That portion of the wage increase which comes

from private profits will have a welfare cost which depends on the levels of

savings and consumption by private entrepreneurs and on the social returns to

private investments. The portion of profits consumed will receive a

relatively low weight, if capitalists are among the high income groups. But

the portion committed to savings may carry a relatively high weight, if the

social returns to private sector investment are high. Finally, if the wage

increases affect the public sector as well, they may lead to a reduction in

uncommitted social income, provided that the price increase is not fully

passed on.

All of the possibilities described above are likely to occur to some

extent. Since we have little concrete information regarding which outcomes

are most likely, we have experimented with two values for bt of .80 and

.50. In the latter case, there is no benefit from the transfer; in the former

case, since the welfare loss of those paying the transfer exceeds the gain to

skilled workers and their households, the effect of the transfer is to

increase the social cost of skilled labor.

- 168 -

Since the extent to which wages are bid up is a function of the

proportion of workers drawn into employment from the domestic economy and the

elasticity of domestic demand, the final estimate of the shadow wage is

sensitive to the assumed value of these two parameters. The shadow wage rate

for skilled labor as a proportion of the market wage may be written as;

SWRk bt

We = 1.10 Pf + (1-pf) if + ] (14)

where btf is the net welfare weight assigned to the transfer, (b t-b k).

The range of plausible values for pf, the proportion of workers

drawn from foreign employment, is explored in Table 4-7. The crucial

relationship involved here is that between the elasticity of foreign demand

and the elasticity of domestic supply of migrants to foreign demanders. It

seems reasonable to assume that there is a high elasticity of foreign demand

for Egyptian migrants, but it may not be perfectly elastic. In order for the

proportion of workers drawn from-foreign employment to exceed .80 the

elasticity of foreign demand must exceed the elasticity of supply of migrants

by a ratio of 22:1. This is not an implausible value and is consistent with

Table 4-7: Estimates of the Proportions of Workers Drawnfrom Migrant Employment Pf

Elasticity of Domestic Elasticity of Foreign Demand

Supply to Foreign DemandrLs 5.0 10.0 20.0 50.0 .

0.5 .64 .78 .88 .95 1.0

1.0 .47 .64 .78 .90 1.0

1.5 .37 .54 .70 .86 1.0

2.0 .31 .47 .64 .82 1.0

Sf= .150

- 169 -

elasticities of foreign demand for Egyptian migrants in the range of

10-50. 1/ Thus we choose values of pf equal to .8 and .9.

Estimates of the shadow wage (as a percentage of the market wage) for

alternative values of the percentage of workers drawn from migrants and the

elasticity of domestic demand appear in Table 4-8. To interpret the table

note that if foreign demand for migrants is perfectly elastic pf = 1.0 and

SWR/W = 1.10 if it is zero our best estimate of SWR/W is' 1.22. The

range of values depending on the elasticity of domestic demand and the

proportion of foreign workers drawn into domestic employment is relatively

compact, lying in the interval 1.07 - 1.19. We select as our best estimate of

the ratio of the shadow wage to the market wage a value of 1.08 at efficiency

prices and extended efficiency prices and of 1.12 at social accounting prices.

Table 4-8: Sensitivity of the Accounting Ratio for Skilled Laborto Estimated Social Values of Income Transfer andProportion of Foreign Workers

Pf = .80 Pf = .90

btfr .5 t=1. 0 r<k= 1. 5 yk_= .5 1_ 1.0 -rL- I. 5

0.30 1.193 1.133 1.113 1.146 1.117 1.107

0.00 1.073 1.073 1.073 1.087 1.087 1.087

1/ Recall that the elasticity of demand for Egyptian migrants is givenby (Wkw+(l-a)Ew)/a, where > is the elasticity of demand formigrants from all points of origin, Sw is the elasticity of

supply from alternative suppliers of migrant labor, and a is theproportion of total migrants supplied by Egypt. If a isapproximately .10 and ifvw andew both equal 2, the elasticityfacing Eygpt is 38.

- 170 -

4.4 Shadow Wages for Unskilled Labor

In this section we present estimates of the shadow wage rate for

urban and rural unskilled male labor. The focus of our effort is to determine

the social cost of employing an additional unskilled worker in a public sector

project.

For the purpose of this analysis the Egyptian economy may be divided

into four sectors. The formal sector is assumed to consist of private and

public enterprises which are subject to the minimum wage. The sector roughly

encompases urban and rural enterprises employing 10 or more workers which are

engaged in "modern economic" activities. Total employment in the sector in

1976, the last year for which complete data are available, was 1.03 million.

The distribution of employees between rural and urban enterprises and among

categories of industry is estimated in Table 4-2. The casual or informal

sector consists of traditional non-agricultural activities such as crafts,

petty trading and personal services. Very little is known about employment

and incomes in such activities in Egypt.

The agricultural sector in Egypt consists almost entirely of small

and medium holders engaged in export or food crop production, and casual or

permanent agricultural workers. Employment in export production occupies

approximately one-third of the agricultural labor force and food crop

production occupies the remaining two-thirds. Hired labor is estimated

variously at between 13 and 15 percent of the agricultural labor force.

Unemployment in rural and urban areas forms the forth sector considered. Here

again data are very scarce, but the best estimate available places the rate of

unemployment in 1979 at 4.5 percent of the labor force. (ILO (1980)).

- 171 -

At this point it is useful to introduce and discuss several

assumptions which simplify the application of the general formula for the

shadow wage. These assumptions specify the mechanisms of adjustment of the

labor market to an increase in the demand for unskilled labor, and therefore

define the values of the parameters for the estimates of the social cost of

labor drawn from each source. First we shall in general assume that new

workers in the formal sector orginate in one of three other sectors,

agriculture, the casual sector, or the pool of unemployed. Labor could be

drawn from other employment in the rural or urban formal sector, but in these

cases it seems reasonable to assume that any vacancies will be filled by

workers drawn out of one of the three sectors mentioned. Provided that the

transfer of occupation within the modern sector has no effect on formal sector

wage rates, the social cost of obtaining a worker from elsewhere in the formal

sector may be estimated by finding the cost of his replacement. Thus, he may

be regarded as having been indirectly drawn from one of the three primary

sources of modern sector labor. There is one important exception to this

assumption. As we noted in section 4.1, there is substantial overstaffing of

many public sector industrial enterprises. If the creation of a new formal

sector job allows other enterprises to release redundant labor, the social

cost of that labor will be less than the wage. Thus, we also consider the

case in which a proportion of workers drawn into new formal sector employment

originate in the pool of redundant workers in the public sector.

Second, we shall assume that drawing a worker from the casual sector

into formal sector employment will result in his immediate replacement by

another workers from the agricultural sector or from unemployment. In this

case, withdrawing a worker from the casual sector is analytically equivalent

to directly drawing his replacement from agriculture or unemployment into the

- 172 -

formal sector. Given the ease of entry from agriculture into casual sector

activities and the high rate of rural to urban migration, this assumption may

not be far from accurate. If it is not wholly accurate, it involves making

two offsetting errors. To the extent that withdrawing a worker from the

casual sector results in a net decline in casual sector output -- as for

example, when he is not completely replaced either .by the transfer of another

worker from agriculture or unemployment or by increased effort on the part of

remaining workers in the sector -- the price of casual sector goods should

rise. This will result in a rise in earnings from casual sector employment, a

transfer of income from consumers to producers of casual sector output, and in

a decline in the amount of casual sector output demanded. Disregarding the

net decline in casual sector output and neglecting the resource cost imposed

by any excess of casual sector wages over wages in the sectors from which new

casual sector workers are drawn involve neglecting a cost. Failure to fully

credit the benefit from the increase in disposable incomes of workers drawn

into the sector and from the transfer of income from consumers to casual

sector workers involves neglecting a benefit. 1/

Third, in estimating the social cost of a worker drawn into formal

sector employment, the effect (if any) of his departure on wages in the sector

from which he is drawn is assumed to be sufficiently small to be ignored.

The assumption allows us to take as the shadow wage rate in the sector from

which the worker is drawn, Mi, the social value of his marginal product.

1/ When the limited data are applied to an analysis similar to that in theappendix, we find that disregarding a potential fall in net output fromthe casual sector will result in an understatement of the "true" shadow

wage of workers drawn from the informal sector of less than 5 percent.

- 173 -

In the appendix to the chapter a general formula for the shadow wage is

derived for cases in which the market wage is bid up. 1/

(a) The Social Cost of Output Foregone

The preceding assumptions allow us to set the first element of the

shadow wage rate for formal sector workers, M., equal to the value at

accounting prices of the marginal product of labor in agriculture or

unemployment. The value of the marginal product of an unemployed worker is

taken as equal to zero. Estimating the accounting value of the loss in

agricultural output requires two parameter values, an estimate of the marginal

value product at market prices of agricultural labor and an accounting ratio

applicable to agricultural output.

There is an active market for hired labor in the Egyptian rural

economy with a considerable proportion of rural households being dependent

upon earnings from wage labor and rural off farm employment for their

livelihood. Table 4-9 summarizes the sources of income of rural households.

Column (4) of the table shows the proportion of the total number of households

in the sample which have an income originating from each of the nine sources

listed in column (1). It emerges that 48 percent of households in the sample

had income originating from family farms while 35 percent derived at least a

portion of their total income from agricultural wage employment. Particularly

striking is the importance of off farm employment as a source of income with

19 and 30 percent of households reporting sources of income from village and

non-village off farm employment respectively.

I/ We find in the Appendix that our estimate of the shadow wage may overstate

the "true" shadow wage by 5-7 percent if wages are bid up.

- 174 -

Table 4-9: Distribution of Rural Household"Income Claims" by Source

No. of % of % of all HouseholdIncome Distribution Having an IncomeClaims Claims Claim from Each Source

1. Wage other farms 305 17.9 35.22. Wages off farm in

village 163 9.6 18.83. Wages outside village 261 15.3 30.14. Family farm with

labor input 418 24.5 48.25. Family farm without

labor input 185 10.8 21.36. Rent of land 54 3.2 6.27. Rent of equipment

and livestock 21 1.2 2.48. Non-agricultural

productive assets 98 5.7 11.39. Remittances 201 11.8 23.2

TOTAL 1,706 100.0 Non-additive

Source: ILO (1980)

Note: These data were generated from a survey carried out by the ILO in 1977.The Survey covered a sample of 1,000 households liviing in 18 villages.For details see Samir Radwan and Eddy Lee,-The Anatomy of Rural Poverty:Egypt, 1977, 1980.

A recent ILO (1980) report argues-that the rural labor market is

becoming increasingly important and competitive as traditional institutional

arrangements, sexual differentiation of tasks and cultivation practices are

abandoned in response to changing economic incentives and technologies. Thus

it would seem reasonable to use the typical wage rate for hired agricultural

labor as an estimate of labor's marginal value product. Seasonal fluctuations

in labor demand, however, result in substantial variations in daily wage rates

and periods of employment throughout the year, and we must make some allowance

- 175 -

for the high incidence of non-farm employment as a source of income since

withdrawing a typical agricultural worker from the rural economy will also

result in a decline in off farm output.

Mohie-Eldin (1980) has estimated that, taking days of employment and

wages throughout the crop cycle, the average annual income from one farm wage

employment by male workers was LE 125 in 1976. To this he adds 20 percent for

off farm employment and arrives at an estimate of the annual income of male

agricultural wage laborers of LE 150. We convert this to 1975 prices using

the rural consumer price index and arrive at an estimate of the value of

output foregone by withdrawing an agricultural worker from employment of

LE 129 at constant 1975 prices.

The cost of withdrawing labor from rural employment in terms of the

unit of account is computed on the assumption that wage labor is withdrawn

from alternative activities in proportion to its employment. The relevant

calculation is set out in Table 4-10. Since the farmgate price lies below the

international market price for several important commodities, the weighted

ratio of output foregone at accounting prices to output foregone at market

prices is approximately 1.18.

The social value of the marginal product of an agricultural wage

laborer is given by:

M = LF 129 (1.18) = 152.22a

at accounting prices which we round down to LE 152.

Given the assumptions outlined above, the only other sector from

which a worker is withdrawn without replacement and, therefore, where there is

possibly some decline in output is in the public industrial sector. Redundant

workers may have a positive marginal value product despite the fact that it is

- 176 -

exceeded by the wage. At this point we shall make the extreme assumption that

the marginal product of a redundant worker in public industrial enterprises is

zero. (Indeed some commentators have argued that the marginal value product

of such workers is negative). We may, however, modify this assumption in

subsequent work when we have an empirircal basis for estimating the marginal

productivity of labor in public enterprise.

Table 4-10: A Conversion Ratio for Agricultural Production

Activity Labor Input C-opping Weights Accounting(Man Days Per Feddan) Pattern Ratio

Wheat 32.0 .129 .066 1.591Beans 30.0 .027 .013 .992Vegetables 66.5 .094 .100 .919Cotton 106.0 .111 .188 1.000Maize 57.0 .175 .160 1.313Rice 56.0 .096 .086 2.043Sugar Cane 86.0 .023 .032 .969Onions 85.0 .002 .003 4.259Misc. Ag. 37.0 .343 .203 1.007Off FarmEmployment - - .150 .965

1.177

(b) The Resource Cost of Workers Transferring Occupations

When a worker moves from other employment (or unemployment) into a

formal sector job, his household income will rise by the excess of formal

sector wages over wages in his previous employment adjusted for any change in

the earnings of other household members. For example, when an agricultural

worker migrates to an urban formal sector job, his disposable income increases

by the excess of formal sector wages over his earnings in agriculture. If he

migrates with his family, however, household income may not increase by the

- 177 -

whole of the difference, should earnings of other members decline as a result

of their move to the city. The second element of the shadow wage is the cost

in terms of the unit of account of providing the resources to meet the

increase in expenditure and savings brought about by an increase in household

income as workers are drawn into formal sector employment. It may be defined

using the following notation:

YFi = household income in final employment in i;

i = u for urban employment, i = r for rural

employment.

YAi = household income in alternative employment in

area i.

s marginal propensity to save assumed constant

for all households.

fs = accounting ratio for savings of workers'

households.

fci accounting ratio for marginal increases in

consumption of low income households in sector

1.

fci = accounting ratio for average consumption of

low income households in sector i.

P. = the share of household income remitted toiJ

relatives in sector j from sector i.

P. = the value of contributions by relatives iniJ

sector i to the support of unemployed workers

in sector j.

- 178 -

It is possible to present two general formulae for the resource cost

of workers changing occupations depending on whether the worker and his

household migrate from one area to another to take up final employment.

Consider first the simple case of a worker changing occupations without

migrating. A general formula for the resource of his transfer is;

CFiAi = (YFi -yAi )(sf + (l -s)f i) (2)

If the worker and his family migrate from one area to another to take up

employment, the household may face altered relative prices for consumption

goods. In such circumstances, patterns of expenditure will differ between

locations and the accounting ratio applicable to pre- and post-migration

expenditure on consumption will differ. The resource cost for migrants

changing occupations is given by:

FiAj PijYFi(sfs + (1 - s)f .)

+ ((1 - Pij)YFi YAj) s

+ (1 - s)((l - pi j)YFi ci - yAj cj

If we make the additional simplifying assumption that urban relatives support

the urban unemployed and rural relatives support the rural unemployed, these

general formulae also apply to cases of workers drawn from or entering into

the pool of unemployed. 1/

l/ Consider for example a worker drawn into employment from the unemployedwho does not migrate. While he was unemployed relatives contributedsupport Pi The resource cost of the change in income of the workerand his relatives is given by;

(YFi - Pii)(sfs + (1 - S)fci) + Pii(fss + (1 - S)fci)

thus receipts from relatives and expenditure by the unemployed cancel outand the resource cost is given by the accounting value of the consumptionand savings out of the wage in employment.

- 179 -

Estimates of the resource cost of workers changing occupations are

contained in Table 4-11. The entries in Column (1) refer to a male head of

household engaged in the occupations listed. For each type of activity other

household income is presented in Column (2). This is then divided between

income accruing to rural and urban households and between consumption and

savings. Market values are converted to numeraire values using the conversion

ratios for consumption and savings. The resource cost of a worker changing

occupations is given by the difference between the resource costs of the two

occupations required. 1/

The assumed value of the marginal propensity to save is singularly

uncertain. For convenience we assume that the marginal propensity to save of

all households is 10 percent. The national household budget survey does not

make any effort to examine savings behavior of households. The 10 percent

value for the marginal propensity to save is similar to that found for example

in India and Kenya but it cannot be justified on any empirical basis in Egypt.

All incomes and transfers of income in Table 4-11 are expressed in

constant 1975 prices. We have previously discussed the origin of our estimate

of the annual income of a fully employed wage laborer in agriculture. The

earnings of the rest of the family are based on the same 1977 ILO survey for

household of the size and composition appropriate to agricultural wage

employment. In evaluating the household incomes of the rural and urban

1/ Strictly this may only be done because we have been forced to use marginaland average accounting ratios for consumption which are the same. On this

point, see M. FG. Scott, J. D. McArthur, and D. M. G. Newbery, (1976).

Table 4-11: The Resource Cost of Unskilled Workers Changing Occupations

Head of Other Transfers Rural Urban Social CostHousehold Members From Relatives Savings Consumption Saving Consumption Saving Consumption

1. Agriculture 129 56 - 19 166 - - 12 178

2. Rural Unemployed 0 56 10 0 66 - - 0 71

3. Urban Unemployed 0 50 16 - - 0 66 0 73

4. Rural Formal Sector 268 56 - 32 292 - - 21 312

5. Urban Public Formal Sector 330 50 - - 38 342 25 380

6. Urban Private formal Sector 328 50 - - - 38 340 25 377

fs8 .65 fcrl 0 7 fs-.65 fcu-1 .1 1

Table 4-12: Welfare Gains to an Agricultural Worker Chaning Occupations

Changes in Disposable IncomeWorker and Compensation Net Gain of Social Value of Income Gain

Total Relatives Household Factor Household -

Rural Unemployed -129 -10 -119 -119 0 -8 -19

Urban Unemployed -129 -16 -113 -113 0 -13 -18

Rural Formal Sector 141 - 141 - 141 118 233

Urban Formal Sector (Public) 195 - 195 _ 195 162 239

Urban Formal Sector (Private) 193 _ 193 - 193 161 238

- 181 -

unemployed we have assumed that there is no change in the earnings of other

family members. The level of transfers from family members outside the

household was estimated by taking the household income per capita necessary to

sustain minimum subsistence (ILO (1980)) and multiplying by the number of

members in the household at that level of income. The difference between this

subsistence household income and the earnings of other family members was

assumed to consist of transfers from relatives. Finally, we consider the

basis for our estimates of the earnings of fully employed unskilled laborers

in the formal sector. Earnings of rural formal sector workers were taken from

the annual earnings of off farm non-village employment from the 1977 ILO

survey, converted to 1975 prices by the rural CPI. The annual wage for urban

public sector employees is taken from Handoussa (1980c) which gives average

earnings of production workers in the textile sector (most of whom are largely

unskilled) for 1970-1978. The average wage was adjusted downwards by 25

percent to allow for the effects of seniority and skill composition, and the

entry in Table 4-11 is the average at constant 1975 prices of this adjusted

wage for the period 1976-1978. The private sector wage was found by taking

the average of wages for unskilled construction workers and for production

employees of private sector manufacturing establishments employing 10 or more

workers. The annual wage estimated in this way is very close to the adjusted

wage in the public sector and provides a measure of corroboration of the two

independently derived estimates.

Earnings of the remaining members of the household were estimated by

taking the difference between the average household income of families headed

by production workers and the estimated earnings of the head of the

household. The predicted level of earnings of other household members derived

- 182 -

in this way is quite close to that of a rural household. If correct, this

indicates that there is little sacrifice of earnings by other family members

resulting from the migration of an unskilled worker from rural to urban areas

in Egypt. 1/

(c) Benefits from Increases in Income of

Workers Changing Occupations

When a worker moves from employment in one sector to another, the

social gain (or loss) resulting from his change of occupations is found by

evaluating the income gains and losses of all households affected by the

change of occupation. For example, if an agricultural worker moving into

formal sector employment remits nothing to relatives, all gains in income

accrue to the worker and his household.

The various elements involved in estimating the benefits to the

worker and his relatives from the change in occupations are summarized in

Table 4-12. The entry for the "compensation factor" is the pecuniary value of

compensation for a change in the conditions of work as a result of changing

occupations. For example, in line 4 the worker is assumed to migrate with his

family to the urban sector. He remits nothing to family in the rural sector

but he and his household must pay urban prices. In Table A3-1 the rural urban

1/ This may not be an unreasonable conclusion for Egypt where there isevidence of "circular migration" of households into and out of urban areasduring the year. Because of the relatively compact spatial organizationof the country, it is possible for households to engage simultaneously inboth urban employment an agricultural employment (ILO (1980)).

- 183 -

price differential for Egypt was estimated to be 10 percent in favor of urban

areas. Thus, the worker gains real income at rural prices of LE 33 due to the

lower urban prices. But there is the possibility that the movement of the

household from rural to urban employment may entail costs of migration. Given

our uncertainty concerning the magnitude (and even the direction) of the rural

urban price differential, we have chosen to consider that the gains in real

income are offset by other costs of migration and, therefore, that there is no

pecuniary value of the change in conditions of work in moving from

agricultural to urban formal sector employment.

In lines 1 and 2 the worker is assumed to leave agricultural

employment and enter the rural or urban unemployed. In such cases, relatives

are assumed to provide subsistence income of I.E 10 per year in rural areas and

LE 16 per year in urban areas. Urban relatives are assumed to support the

urban unemployed and rural relatives to support the rural unemployed. Thus,

the worker and his family sacrifice disposable income equal to LE 119 in rural

areas or LE 113 in urban areas as a consequence of the head of the household

becoming voluntarily unemployed. The compensation factor as a result of the

change in conditions of work is set equal to the loss in disposable income,

implying that the net loss incurred by the worker as a result of his movement

into unemployment is zero. The assumption of zero sacrifice may be justified

along the following lines. If the worker is free to remain in agriculture,

yet he chooses to be unemployed, he may not feel that he is incurring any loss

in welfare. His loss in income must then be exactly compensated by an

increase in leisure and mobility which permits him to seek alternative

employment, and the net loss resulting from the change in occupations is

zero. Alternatively, it is possible to allow for the willingness of a worker

- 184 -

to trade current income for the increased probability of finding a formal

sector job and hence a rise in expected future income. It seems plausible to

argue that entering rural unemployment will not materially increase the

probability of finding a formal sector job, and thus the worker should not be

prepared to make a large pecuniary sacrifice. For workers transferring to the

urban unemployed, the chance of finding a formal sector job may improve.

Thus, they may be prepared to incur some monetary loss in order to achieve an

expected increase in income. Any adjustment, however, would be essentially

arbitrary, and we shall not pursue the point further.

The social benefit in terms of the numeraire of the change in

disposible income is given under two sets of assumptions. In column (7), we

present the benefit appropriate to the calculation of the extended efficiency

wage which from Section 4.2 is b = 1/v times the change in income. In column

(8), we consider the distributional gain associated with the set of welfare

weights derived in Chapter 3 on the assumption that n = 1. We evaluate the

welfare function in Section 3 at each income and compute the value of the

intramarginal change.

It is possible to use the table to determine the net benefit of

unemployed workers moving into alternative employment. For example, consider

a member of the rural unemployed who moves into a rural formal sector job.

The net social benefit from the transfer of occupations is assumed to be given

by the difference between the net gains shown in lines 1 and 3 and Table

4-12. This is strictly correct for marginal workers since the form of the

utility function is such that if the benefits of moving from YO to YI and

from YO to Y2 are known the benefit of moving from YI to Y2 can be

deduced.

r 185 -

Estimating the Proportion of Workers Drawn from Different Sectors

In order to draw the estimates of social cost for each of the cases

discussed into a single estimate of the shadow wage, some measure of the

probability of drawing a worker from each of the cases examined must be

constructed. To summarize the relevant simplifying assumptions; workers are

assumed to be drawn from the agricultural sector, or from the rural or urban

unemployed. Drawing a worker from the casual sector or out of other formal

sector employment is assumed to have no effect on employment or wages in

either sector, and workers drawn from these sectors may be regarded as having

been indirectly drawn from agriculture or the unemployed. Estimates of the

proportion of formal sector workers drawn from agriculture and unemployment

are presented in Table 4-13.

As a first approximation, it was assumed that workers are recruited

into the formal sector in direct proportion to their numbers in the pool of

eligible labor -- represented by the total of agricultural employment, and

rural plus urban unemployment. Such an assumption is consistent with a

situation in which the creation of a new formal sector job results in complete

transmission of information regarding the job opening to all sectors. Workers

in all sectors are assumed to have equal opportunities to obtain the job.

In Column (2) of the table we allow for the possibility that the

creation of a new formal sector job may result in the release of some

redundant labor from existing public sector enterprises. There is no

objective method to establish the probability that a worker will be drawn from

existing redundancies in the public sector. We have, therefore, made the

assumption that redundant workers are released in proportion to their number

in urban employment. As a best estimate of the number of redundant workers in

the public sector we take 20 percent of the public sector labor force.

- 186 -

Table 4-13: Proportions of Workers Drawn intoFormal Sector Employment

To Urban Formal SectorFrom 1 2 3 4

Agriculture .909 .773 1.102 1.000Rural Unemployment .015 .013 .017 0.000

Urban Unemployment .076 .065 -.119 0.000Public Sector Redundancies 0.000 .150 0.000 0.000

To Rural Formal SectorFrom

Agriculture .909 .773 .984 1.000Rural Unemployment .015 .013 .016 0.000Urban Unemployment .076 .065 0.000 0.000Public Sector Redundancies 0.000 .150 0.000 0.000

The final estimates in Table 4-13 are based on applications of the

Harris-Todaro model of rural-urban migration. Estimate 3 makes use of the

simplest version of the model. 1/ Job seekers among the urban unemployed

equate the expected urban wage to the wage in agriculture, W = pW , whereau

p is the probability of obtaining a formal sector job. In the model

p = Lf/(Lf + L ), where Lf is the labor force in formal sector urban

employment and L is the number of urban unemployed. If an additional urban

1/ J. R. Harris and M. P. Tadaro, "Migration Unemployment and Development: ATwo Sector Analysis," American Economic Review, March 1970. For a model

based on the "small country assumption" of given world commodity pricessee W. M. Corden and R. Findlay, "Urban Unemployment, IntersectoralCapital Mobility and Development Policy," Economica, 1974.

- 187 -

sector job is created and wages remain constant in both agriculture and the

formal sector, p must remain constant and dL IdLf = L ILf. The

estimates of urban employment and unemployment in Table 4-13, permit a rough

estimate of dL IdLf of .119. Thus in estimate 3 urban unemployment is

given a negative weight of -.119.

Although the simple Harris-Todaro model makes it appear that an

increase in urban unemployment is inevitable, Scott has argued convincingly

that in the context of a dynamic model of rural-urban migration there are no a

priori grounds to assume that unemployment will either increase or decrease as

a result of increased formal sector employment. l/ Indeed, the limited

empirical work available does not lend strong support to the Harris-Todaro

hypothesis in its extreme form. Attempts to correlate the unemployment rate

in a number of LDC's to formal sector vacancies have been largely

unsuccessful. This suggests that in Egypt it is conceivable that

dL /dL = 0. In column (4), the proportion of unemployed workers is setu f

equal to zero. Thus all workers entering formal sector employment are assumed

to originate in agriculture. Corden and Findlay have noted that the

assumptions underlying estimates 3 and 4 form limiting cases of the more

general Harris Todaro type model W = apW where a is a parameter

reflecting the average level of risk aversion of migrants. Thus, if the

Harris-Todaro model is applicable to Egypt the limits of the impact on urban

unemployment should be given by estimates 3 and 4.

1/ Scott, McArthur and Newbery, (1976).

- 188 -

Our assumptions regarding the sources of rural formal sector

employment are similar. In columns (1) and (2), we employ the same

assumptions and proportions as in the case of urban employment. In column

(3), we allow for the possibility that rural jobs are filled only from the

rural economy and in column (4), we assume that they are filled wholly from

agriculture.

(d) Shadow Wages for Workers Drawn into the Formal Sector

Tables 4-14 and 4-15 summarize our estimates of the social cost of

labor drawn into formal sector employment from the four sources in Table

4-13. Four weighted averages are computed on the basis of the weights

provided in Section 4.4(c) above. Thus the tables provide a sensitivity

analysis of the shadow wage with regard to the form of market adjustment

assumed to take place in the labor market.

Our estimates of the shadow wage are presented for each of the three

accounting price methods discussed in Section 4.2. At efficiency prices, the

urban shadow wage for unskilled labor lies in the range of LE 117-168. Social

accounting prices yield a similar magnitude for the shadow wage of LE 104-141,

indicating that given our system of welfare weights the benefits associated

with the increase in household consumption made possible by the change in

employment slightly more than offset the costs. At extended efficiency prices

the shadow wage is substantially higher, in the range from LE 204 to 276. The

consumption costs of the increase in household income weigh more in the

extended efficiency price system because of the premium on public sector

income relative to consumption by individuals at all levels of income.

Our estimates of the rural shadow wage are qualitatively similar to

those for urban unskilled labor, although the estimates of social cost at both

Table 4-14: Shadow Wage Rates for Urban Unskilled Labor

Sources of Labor Components of Social Cost Social Cost of Worker

Mj Cj B- Efficiency Extended Efficiency SocialOEP SAP Prices Prices Prices

Agriculture 152 214 118 239 152 248 127

Rural Unemployment 0 334 170 258 0 164 76

Urban Unemployment 0 332 175 257 0 157 75

Public Sector Employment 0 0 0 0 0 0 0

(Redundancies)

Average Social Cost Weighted by Column I weights 138 240 122

Proportions of Workers from Table 4 (.420) (.729) . (.372)

Column 2 weights 11.7 204 -104(.357) (.620) (.316)

Column 3 weights 168 276 141

(.509) (.839) (.429)

Column 4 weights 152 248 127(.462) (.754) (.386)

Table 4-15: Shadow Wage Rates for Rural Unskilled Labor

Sources of Labor Components of Social Cost Social Cost of WorkerMj Cj Bj Efficiency Extended Efficiency Social

EP SAP Prices Prices Prices

Agriculture 152 143 118 233 152 177 62

Rural Unemployment 0 262 126 252 0 136 10

Urban Unemployment 0 260 131 251 0 129 9 1

Public Sector Redundancies 0 0 0 0 0 0 0 °

Average Social Cost.Weighted by Column 1 weights 138 173 57Proportions of Workers from Table 4 (.515) (.646) (.213)

Column 2 weights 117 147 49(.437) (.549) (.183)

Column 3 weights 150 176 61(.560) (.657) (.228)

Column 4 weights 152 177 62(.567) (.661) (.231)

- 191 -

extended efficiency and social accounting prices are substantially lower

reflecting the lower assumed level of rural formal sector wages and (in the

case of social accounting prices) the higher welfare weight attached to the

change in income. Indeed our estimates of the shadow wage at social

accounting prices are quite low because of the welfare benefits of raising

rural household incomes.

All of our estimates of the shadow wage fail to allow for the

possible effect of bidding up of wages in the agricultural labor market and

are therefore subject to a measure of upward bias. Our best estimate of the

shadow wage and the ratio of the shadow wage to the market wage is presented

in Table 4-16.

Table 4-16; Estimated Shadow Wages and Accounting Ratios

for Rural and Urban Unskilled Labor

Efficiency Extended Efficiency Social Accounting

Prices Prices Prices

Urban Unskilled Labor 150 250 130

(.456) (.760) (.395)

Rural Unskilled Labor 150 175 60

(.560) (.653) (.224)

These shadow wage rates apply to formal sector projects in the public sector

and the "organized" private sector (firms with more than 10 employees) only.

Our results indicate that in these sectors of the urban economy the shadow

wage for unskilled labor is about 40 percent of the market wage at both

efficiency and social accounting prices and about 75 percent of the market

wage at extended efficiency prices.

- 192 -

Appendix 4-1: Formulae for the Shadow Wage When Wages are Bid Upand Test for Biases in the Estimates of Shadow Wages

The accounting prices for rural and urban unskilled labor estimated

in Section 4.4 are based on the assumption that an increase in vacancies in

the formal sector will not result in any bidding up of wages in the sectors

from which new formal sector employees are drawn. In this appendix we develop

a more general formula for the social cost of labor when wages are bid up and

attempt to estimate the probable direction and magnitude of the biases

introduced by ignoring the bidding up of wages in our estimates of shadow

wages.

Initially, we consider a two sector economy. Labor in the urban

formal sector is paid an institutionally fixed minimum wage Wf. Labor in

the alternative sector of the economy, which is assumed to be agriculture is

paid a competitively determined wage, Wa) which is less than the formal

sector wage. There is no urban unemployment, and "Harris-Todaro" effects are

non-existant. 1/ A new formal sector project is established which withdraws

labor from the agricultural sector equal to the amount QlQl in Figure A.

Wages are bid up in the agricultural labor market to W which in the diagrama

results in a net fall in the services of agricultural labor market of

QlQl- Thus, as we have presented the rural labor market there is some

elasticity of the supply of effort in agriculture which results from the

l/ Actually these assumptions are slightly more restrictive than necessaryfor the simple model. We could have assumed that the Harris-Todaro modelworks as in case 4 in Section 4.4, and that the pool of urban unemployedremains constant in which case the estimate of the social cost of a workerdrawn into the formal sector is analytically equivalent to the onepresented above.

- 193 -

Uw.

t; , q, (ig

Figure 4-1

'Impact of an Increase in Wages on the Labor Market

- 194 -

remaining workers increasing their hours of work or from drawing new

participants -- wives and children, for example -- into the rural labor force.

The general formula for the social cost of labor drawn into the

formal sector from agriculture was given in Section 4:2

SWR = M + C - B (a)af a a a

In this case, however, the elements of the shadow wage themselves consist of

two components, the direct costs and benefits arising from the movement of

workers dQ = QlQl plus the indirect costs and benefits of changes in

output and effort in the rural labor market as a result of the rise in wages.

We introduce the following notation to supplement that of Section 4.4:

dQd = The decline in demand for agricultural workers

remaining in the rural sector as a result of the

rise in wages, e.g., QlQl in Figure A.

dQ = The increase in the supply of effort from workers

remaining in the agricultural sector, e.g.,

dW The rise in the market wage of agricultural labor

resulting from the bidding up of wages in the

sector, e.g., W W.a a

We shall further assume that only the incomes of heads of households

are affected by a change in occupation or wages. Thus, we derive expressions

for each element of the shadow wage. If agricultural workers are paid the

value of their marginal product at market prices, the market value of the

decline in output is given by the decline in demand for agricultural labor

multiplied by the wage in the pre-project equilibrium.

W dQd = Ql- dW na (b)

where the elasticity of demand for labor in the agricultural sector is defined

- 195 -

as customary as:

W dQd (c)

a Ql dW

The social valuation of the loss in output is, therefore:

Ma = fa a Q dW * n (d)

where f is the accounting ratio applicable to the marginal product of labora

in agriculture.

The increase in effort on the part of workers remaining in the

agricultural sector increases their disposable incomes by:

Wa* dQ = Ql- dWa g (e)

where the elasticity of the supply of effort by workers in agriculture is

defined as:

W dQ (f)Oa Q - dW

1 a

The value of the social cost imposed by providing the resources to meet the

increased consumption and savings by workers remaining in the agricultural

sector is: 1/

fyr- Q1 dWa ga (g)

The increase in disposable incomes of workers transferring from agricultural

employment to formal sector employment is:

dQp(Wf - Wa) (h)

and the social cost of providing the resources to meet this increase in

1/ fyr is the conversion factor applicable to marginal increases in ruralincomes (cfcr + sf5). Because the conversion ratios for rural andurban consumption are nearly identical we use this also to apply toincomes of agriculturalists moving to urban formal sector employment.

- 196 -

consumption and savings is:

fy * dQp(Wf -wa) (i)

Finally, we consider the benefits arising from the increases in

income. We assume that the increase in income of workers in the agricultural

sector exactly compensates them for the disutility of increased effort, and

thus there is no net benefit accruing from the rise in disposable income as a

result of increased effort. The rise in wages, however, also introduces a

transfer of income from employers of agricultural labor and, perhaps,

ultimately from consumers of their products to workers in the agricultural

sector. The value at market prices of this transfer of income is:

Ql. dW (j)

The social valuation placed on the transfer of income is given by;

Ql dW- (baw - bae) (k)

where baw and bae are the welfare weights given to marginal changes in the

income of agricultural workers and employers (or consumers of agricultural

output) respectively. These weights are determined in the manner described in

Section 3.7.

The social valuation placed on the gain in income to workers drawn

from agriculture into formal sector employment is determined in the manner set

out in Section 4.4 for non-marginal changes in income. It may be represented

here as:

dQ (W - W)b (l)p f a af

where baf is the weight determined on the basis of the formula for

non-marginal changes in income for typical agricultural workers transferring

from the agricultural to the formal sector.

- 197 -

The complete expression for the social cost of transferring workers

dQ from agriculture into formal sector employment is given by:

Q dW nafa + dQ (W f-W a)fyr + Q *dW *g. fyr

- dQ (W -W ) b -QdW (b -b ) (i)p f a af a ae aw

rearranging terms and noting that QdW = dQ W/(n + g ) we derive:

dQp(wf-WaXf yrf fb baf)

dQ W (n f + gf (b - b)) (n)+ -p a a a ayT *aw ae

(n + ga a

setting dQp = 1, the shadow wage rate for workers drawn from agriculture

when wages are bid up is:

SWR = (W -W )(f -b )af f a yr af

Wa(naof + g a*f -(b -b )) (a)+a a a a yr aw ae (

(nr + g )a a

Ignoring the effect of rises in agricultural wages in Chapter 4

allowed us to employ a much simpler version of the shadow wage rate. Because

we were able to assume that the market value of the fall in output was equal

to dQ W,a and because there were no indirect effects on the rural labor

market, the simplified form of the shadow wage was given by:

NWR = W= f + (W -W )(f -b ) (p)af a a f a yr af

Under what circumstances will the two measures approximately coincide and what

are the biases introduced into the estimates of the shadow wage by use of the

simplified form in Chapter 4? If wages are in fact bid up, we define the bias

as:

afR SWR Waf _ Wanafa _gafya f (b -b )) (q)

afa +g)

- 198 -

The formula in Chapter 4, SWR fl will equal the true shadow wage in the

presence of a rise in agricultural wages, if the elasticity of the supply of

effort in the agricultural sector is zero, and the net benefit from the

transfer of income from employers to employees (b -b ) is also zero. It

does not seem unreasonable to assume that for marginal changes in agricultural

employment and wages the supply curve of labor services is highly inelastic.

Increases in effort are limited by available working hours and by preferences

for other activities. It is commonly argued that subsistance farmers exhibit

a marked preference for leisure, and while it is beyond the scope of the

present paper to review the literature on labor supply response in traditional

agriculture low or zero elasticities of supply are not inconsistent with the

models presented. 1/

It is interesting to note that the case of a backward bending supply

curve of labor can also be handled within the general framework for the shadow

wage presented. In this case, which has been widely discussed in the

literature on the supply of effort in peasant agriculture, the elasticity of

supply of labor is negative. Reference to the general formula SWR f

indicates that in such a case the indirect effect resulting frm the bidding up

of wages will involve a fall in output greater than the value W dQ at

market prices. Set against this will be a decline in the resources needed to

1/ See for example, the contributions by C. Nakajima and J. W. Mellor in

C. R. Wharton, Jr., Subsistence Agriculture and Economic Development

(London, Frank Cass, 1970). In the simplest case of all labor in wage

employment and a utility function in labor income and leisure, the shape

of the supply curve for agricultural labor depends on the nature of

preferences of workers. If both income and leisure are normal goods a

completely price inelastic supply curve of labor can be obtained without

extreme assumptions regarding the shape of individual preference maps.

- 199 -

support the consumption and savings of the rural labor force. The net result

will in general be that given a backward bending supply curve of labor the

shadow wage rate will exceed that for forward falling supply curves.

Note also that as the elasticity of supply approaches infinity the

estimated bias approaches W f -W f , regardless of the elasticity ofa a a yr

labor demand. This is because the increase in effort by remaining workers

offsets the decline in output caused by removing one worker from the

agricultural sector, but at a cost in terms of the additional resources needed

to provide for the extra consumption of those remaining. If the accounting

ratios for agricultural output and for consumption by agriculturalists are

approximately equal, as they are in Egypt, the simplified formula for the

shadow wage which we have used in Chapter 4 is quite a good estimate of the

social opportunity cost of labor.

In order for b to equal ba the incomes per capita in the

household of employers and employees must be approximately equal. 1/ To the

extent that the transfer of income is from farmers in their capacity as

employers to farmers and their families in their capacity as workers the

social benefit is nil. Not all of the agricultural labor force is

self-employed, however, and if on average workers are less well off than their

employers this portion of the transfer of income will represent a net social

1/ The manner in which welfare weights are derived from information on incomeper capita is presented in Section 3.7. It should also be noted that ifthe rise in wages were passed wholly on to the consumers of agriculturalproducts the transfer of income would be from consumer to workers. Becauseprices for many Egyptian agricultural commodities are administrativelyset, this was not felt to be a major consideration. To the extent thatthe rise is passed on in higher prices the transfer of income willincrease the benefit somewhat more than the case presented in the text.

- 200 -

benefit. Data on wage employment in agriculture are severely limited. In

Chapter 4 we arrived at an estimate of the average share of the rural labor

force in wage employment in agriculture of 15 percent. If we further assume

that all agricultural laborers belong to the LE 150-199 income class in Table

3-15 and that employers belong to all households taken at random, the benefit

resulting from the transfer of income will be equal to

Wa (2.3 3-1.87)(.150)/ ri, for an elasticity of the marginal valuation of

income of one. Thus, for elasticities of demand for agricultural labor equal

to one or greater than one, the benefit arising from the transfer of income

will be less than 7 percent of the agricultural wage.

Table A4-1 presents a sensitivity analysis of the estimated bias in

the shadow wage caused by our failure to consider the possibility of bidding

up of agricultural wages. Parameter values underlying the table reflect

estimates in Chapter 4 of the agricultural wage, the conversion ratios for

agricultural output and consumption, and the marginal benefits assigned to the

income transfer. The values in the table are the percentage by which the

estimate of the social accounting cost of labor drawn from agriculture in

Chapter 4 of LE 127 at accounting prices exceeds the true social opportunity

cost when wages are bid up. To interpret the table consider two extreme

cases. If the elasticity of labor supply is zero, the estimated resource cost

in Chapter 4 results in an overstatement of the social cost of labor obtained

from the agricultural sector of about 7 percent due to the welfare benefit of

the transfer (recall that the increased cost of consumption by workers is

precisely offset by the reduced consumption of employers). In the other

extreme, if the elasticity of the supply of effort is infinite the estimated

resource cost also overstates the opportunity cost, but only by about 10

- 201 -

percent. This is because, althought there is no decline in output, additional

resources are required to provide for the increased consumption of the

remaining workers in agriculture.

If we take as our best guess that the estimated resource cost of the

marginal worker drawn from agriculture overstates true opportunity cost by 65

percent, this implies that our estimates of shadow wages at social accounting

prices overstate the true opportunity cost of labor by between 5-7 percent

depending on the weighting scheme used. This is well within the confidence

interval around our point estimate of the shadow wage.

Table A4-1: Estimated Biases in the Shadow WageWhen Rural Wages are Bid Up

Elasticity of Labor Supply Elasticity of Labor Demand in Agriculture (na)(ga) na =0 na =1 na = 2 na = 5

ga = * 7.0 3.4 1.4

ga = 1 17.1 8.6 6.7 2.8

ga = 2 13.7 9.1 6.8 4.0

ga = 5 11.5 9.3 6.3 5.3

ga = 10.1 10.1 10.1 10.1

Notesz Wa = 129

baw = 2.33bae = 1.87

fa = 1.18

fya = 1.08

- 202 -

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