Sugar is produced in 121 countries in the world.¹ It remains one of the most distorted sectors of the world economy, and only in a handful of countries producers face world prices. The elimination of OECD’s protectionist policies in this sector could bring large benefits to many developing countries which have a natural comparative advantage in the production of sugar.

Brazil is likely to be one of the main beneficiaries.² It is the largest producer and exporter of sugar in the world, accounting for 28 percent of world sugar cane production and 25 percent of world sugar exports. But who is likely to be the largest winner within Brazil? Are poor households likely to benefit from these reforms, or are all the benefits going to be captured by rich households, or foreign multinationals investing in Brazil’s sugar sector?³ This is the question we addressed in a recent paper.⁴

The sugar sector accounts for a substantial share of employment among the poor in Brazil. A third of sugar workers in the North and Northeast are illiterate, and almost 60 percent have not completed primary school. Moreover, the sugar sector's overall contribution to GDP and employment is around 1 percent and reaches 3 to 4 percent in Pernambuco, one of the poorest states. General equilibrium effects may lead to a relatively high impact on wages and employment in other sectors as well, depending on inter-industry linkages and factor mobility across sectors and industries.

In order to assess the impact that changes in world sugar prices would have on labor income and poverty in Brazil we proceed in three steps. We first estimate the extent of price transmission from world markets to 11 Brazilian states. Some states are more isolated than others, preventing a full price transmission from world markets to sugar producers. Empirical results suggest that there is indeed some heterogeneity in long-run price transmission across states. The coefficieint of transmission can be as high as 1 in Goias, Minas Gerais and São Paolo, and as low as 0.75 in Pernambuco and Bahia. Thus, increases in world prices are not homogeneously transmitted to households in different states.

In the second step we simultaneously estimate the impact that changes in local sugar prices have on wages and employment for individuals with different characteristics (i.e., living in different regions, with different levels of education, age gender and sector affiliation, among others). The relative strength of the wage and employment channels in affecting household income for different workers depends on labor demand and supply conditions as well as labor market regulations.

Our results show that better-educated workers experience higher wage increases following a rise in sugar prices. This may be partly due to the fact that mechanization and the entry of foreign multinationals has made this sector more capital-and skilled-intensive.

The large pool of unemployed unskilled workers puts downward pressure on the wages of poor and unskilled workers. Therefore, their wages are relatively less sensitive to changes in labor demand. This is confirmed by the fact that even though more educated workers experience higher increases in wages, the largest increases in employment were observed for workers at the bottom of the income distribution. Thus, if the wage effects tend to benefit relatively more workers in the top income quintile, the employment effect benefited relatively more workers belonging to the bottom income quintile, who are moving out of unemployment.
 
We believe this result has important implications. Indeed, the empirical puzzle that often trade liberalization leads to more wage inequality in developing countries may only be part of the story. Our results suggest that it can simply be explained by the fact that in developing countries where unemployment is often high, the focus should not be on wage inequality, but rather on labor income inequality.

Finally, the third step uses the estimates of the first and second stage to simulate the impact of a 10 percent increase in world sugar prices on household labor income and poverty.⁵ The simulation’s result confirms the earlier econometric results regarding skilled and unskilled labor. In effect, as the correlation between the level of education of workers and their level of income is positive, the results indicate that rich households will benefit relatively more from increases in wages, whereas poor households will benefit relatively more from movements out of unemployment following an increase in sugar prices, as illustrated in Figure 1.

Figure 1: Difference in the percentage change in income of the bottom income quintile minus the top income quintile after a 10 percent increase in sugar prices

More importantly, the results suggest that a 10 percent increase in world sugar prices will lead to an increase in aggregate labor income of around 0.33 percent of GDP. The largest percentage increase in labor income is experienced by the bottom income quintile, who experience an increase of 0.38 percent. We then calculate the change in poverty induced by the increase in income at the bottom quintiles using a nominal $1 a day per capita poverty line (close to a $2 PPP poverty line) and also calculate the predicted number of poor people in each state before and after a 10 percent increase in the world price of sugar. Our estimates suggest that around 280 thousand individuals will move out of poverty.
 
Extrapolating results to different agricultural goods should be done with caution, but if the Doha round were to include significant liberalization of other agricultural sectors (e.g., dairy, meat, cereals, soy) in which Brazil also has a comparative advantage, this may lead to some large income gains in Brazil. More importantly, these large income gains are likely to be experienced by those that need them the most.
 
One could also extrapolate to different countries and contexts. In many Latin American countries today, price controls and export restrictions are imposed on sugar (and other basic commodities) to spare poor consumers from rapidly rising world prices. Clearly, these price controls distort production incentives, which are likely to exacerbate the negative effects of the upward trend in prices on the poor by reducing production of basic commodities. But more importantly, our results suggest that these policies ignore that often times the labor income of poor households (wages and employment) is negatively affected by low commodity prices. Thus, price controls and export restrictions may end up hurting those which they intend to help.

Clearly, the poverty effects of price changes depend on whether poor households are net producers or net consumers of agricultural products and on the magnitude of price swings. Over the past two years international sugar prices more than doubled, reaching record levels in January 2011. Although these elevated prices affect poor consumers relatively more due to the fact that they spend a larger share of their budget on food in comparison with richer households, sugar accounts for only a small portion of their basic consumption basket, and the employment effect of high sugar prices on the poor is likely to outweigh the negative effect on consumption.

¹ Around 60 to 70 percent of world production takes place in tropical countries from sugar cane and 30 to 40 percent in more temperate climates from sugar beet.
² Brazil won an important WTO dispute that requires the EU to reduce its sugar subsidies. Moreover, the EU has announced a reform that would cut its reference price by around 40 percent. If accompanied by a reduction in border barriers in the EU, this could lead to a significant increase in the world price of sugar. 
³ Indeed, since Brazil opened its sugar sector to foreign investment in the late 1980s around 30 European firms established their presence in Brazil, representing about 10 percent of the sector's total output (see Marcia Moraes, 2004. Analysis of the labor market of the Brazilian sugar alcohol sector. Mimeo. University of São Paolo).
⁴ Ekaterina Krivonos and Marcelo Olarreaga, 2009. Sugar prices, labor income, and poverty in Brazil. Economia 9(2), 69-102. 
⁵ A 10 percent increase in the world price of sugar is at the lower end of the range of estimates provided in the literature (see Mitchell, 2005). To obtain percentage changes in income for other estimates of changes in world price, see footnote 4.3.