Iran Food Subsidy Reform Impacts Living Standards

There is no shortage of grievances in Iran, so explaining the recent protests that have engulfed the country is not hard. 
The economy has stagnated for over a decade and Inflation has been very high. But the timing of the protests suggests a connection between the protests and President Ebrahim Raisi’s program to cut food subsidies. Some media reports speak of “bread protests”, but the price of the staple bread has not changed, reads a new report by economist Djavad Salehi Isfahani and published on his weblog. Below is the full text:
The events raise an important question regarding the protest: Are rising prices — for chicken, cooking oil, dairy and the like — cut into the food consumption of ordinary people? Will the program swell the ranks of the poor at a time when food budgets have been squeezed for years?
Last week, the Raisi government unveiled its first major economic policy initiative to reform food subsidies. Not a predictable move from a government that calls itself “revolutionary”, but it makes a lot of sense. 
Since 2018, some $10-15 billion of foreign currency have been sold to food importers annually at 42,000 rials per USD, which is far below the free market and the semi-official rates in the so-called Nima market (where licensed importers and exporters trade), about 5-6 times the subsidized rate. So, talk of removing the subsidy has been around for a while, and the recent global increase in food prices and anticipated shortages in coming months may have forced the government to act now.

Comparison With 2010 Energy Price Reform

Raisi’s program shares a key feature with the 2010 energy price reform of former president, Mahmoud Ahmadinejad, the forerunner revolutionary administration. 
Both programs combine price increases with cash transfers. Whereas the 2010 program focused on energy price reform, the aim of the current program is to remove the foreign currency subsidy for food imports. Raisi’s cash transfers are less generous than Ahmadinejad’s — which is a good thing — and is not universal. Individuals in the bottom 40% of the income distribution receive 4,000,000 rials each per month (less than one-fifth of the minimum wage) and about three-quarters of the 2010 transfers in real terms. Except for people in the top 10%, who receive nothing, the rest receive 3,000,000 rials each.
Despite similarities, the responses to the two programs in Iran’s city streets have been quite different. In 2010, people reacted to Ahmadinejad’s hefty energy price increases calmly, presumably because they figured they would come ahead in the exchange of energy subsidies for cash transfers, and most did, especially in the first two to three years.
Earlier this month, the Raisi administration started implementing its food subsidy reform program, depositing cash in people’s accounts while raising the prices of basic food items several fold. Protests broke out soon afterwards. 
An ill-fated gasoline price increase in 2019 ignited similar widespread urban protests, but then the government of president, Hassan Rouhani, in keeping with his dim view of cash transfers to the poor, did not couple the price increase with compensating cash transfers. (It did a few days later, but it was too late).
Given that Raisi’s subsidy reform offers generous compensation for higher food prices, why is it facing violent protests? Do protesters believe the compensation is inadequate; that the program will leave them poorer? Do they fear rising general inflation that will leave them poorer? Or, are they angry for any number of reasons?

Impact on Living Standards

In this post, I will take up the question regarding the impact of the program on living standards. Some simple arithmetic tells me that about half the people will not experience a decline.
The government has so far announced cash transfers for two months. Assuming that it will continue them for the rest of the year, simple calculations show that about half of all Iranians will come ahead. 
More precise estimates of the balance of higher food prices and cash transfers will have to wait for the 2022 round of Household Expenditure and Income Survey, which will be released a year from now, or more sophisticated modeling of demand for food. In the meantime, the 2020 round of the survey offers a rough guide as to who wins and who loses from Raisi’s program.
My rough estimates below are based on two further assumptions. First, assume that the distribution of income and expenditures this year remains the same as in 2020, and prices this year continue to increase at the same pace as last year (40%). That means that the average price level will be twice as high as in 2020. This allows me to multiply all expenditures by a factor of 2 to obtain expenditures for 2022. 
I then add the cash transfer to the appropriate household expenditures in the relevant deciles and deduct the increase in food expenditures to arrive at the net transfer. Second, I assume that overall food expenditures will increase by 50%, a bit more than the general inflation. 
A more realistic simulation would use income and price elasticities to predict food expenditures, but those are beyond my limited aim here.
These assumptions lead to the conclusion that about half the population may be net winners. The table below presents the distribution of transfers and per capita household expenditures in rials per day before and after the transfers. Net transfers suggest that individuals in the first four deciles of per capita expenditures gain, the middle decile breaks even, while those in the top 5 deciles lose. The average loss is very small, about 20,000 rials per person per day.

Gini Index 

These rough calculations also show that the distribution of incomes improves — the Gini index decreases by 5 points, from 37.7 to 32.7, which is not nothing, and the poverty rate decreases substantially, from 13.6% to 6.1%.
As costly as the reforms have been in terms of social disruption, they do not fully remove the distortions caused by multiple exchange rates. 
Most of the wheat flour sold to traditional bakeries (khabbazi flour) will continue to be heavily subsidized while those for other uses, such as for macaroni, baked sandwich rolls and sweets will be sold at cost. The price of these items has already jumped way up, but ordinary bread is still selling as before, about 5 cents per 300-gram loaf. To limit demand for bread, the government plans to introduce smart cards that will allow each individual to purchase a fixed amount of bread at the current low price.
Of all food subsidies, those for bread are the most defensible. They are evenly distributed between the poor and the rich, and reach the most vulnerable groups, like children, more effectively. 
However, given the tenfold gap between the prices of flour for bread and other uses, incentives for illegal arbitrage are very high. There are already reports of bread bakeries selling their flour on the black market and cutting their baking hours. This may cause long lines or a higher price for the staple breads, in which case consumers will bear a part of the cost of the dual price system.