- Alejandro Izquierdo, Ward Brown, Brian Ames, and Shatayanan Devarajan
- Published Date:
- August 2001
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There has been an emerging consensus on how to make actions at the country level, and the support of development partners, more effective in bringing about sustainable poverty reduction. This consensus indicates a need for poverty reduction strategies that are country-driven, with broad participation of civil society, elected officials, key donors, and relevant international finance institutions; outcome-oriented; and developed from an understanding of the nature and determinants of poverty. Under the new framework, the country-led strategy would be presented in a Poverty Reduction Strategy Paper (PRSP), which is expected to become a key instrument for a country’s relations with the donor community.
Macroeconomic stability is a situation where key economic relationships are broadly in balance and sustainable.
The sourcebook is available at http://www.worldbank.org/poverty/strategies/sourctoc.htm.
These points are reflected in the design of programs supported by the IMF’s Poverty Reduction and Growth Facility (PRGF), which are derived from a country’s own poverty reduction strategy. The strategy itself should be based upon fully integrated macroeconomic, structural, and social policies. See Key Features of IMF Poverty Reduction and Growth Facility (PRGF) Supported Programs, August 16, 2000, available at http://www.imf.org/external/np/prgf/2000/eng/key.htm.
Examples include the relationship between infant mortality rates and per capita income, the ratio of female to male literacy and per capita income, and average consumption and the incidence of income poverty. In all three cases, national poverty indicators improved as per capita income rose. See the discussion in the World Bank’s World Development Report, 2000.
Devarajan, Swaroop, and Zou (1997) and Devarajan, Easterly, and Pack (forthcoming).
There is little empirical evidence, however, that public sector capital expenditure has a positive impact on growth, reflecting the tendency for such investment in the past to be wasteful or inefficient. This does not mean public investment is unimportant—only that efficiency considerations must be central in any public investment program. See Easterly and Rebelo (1993), Devarajan, Swaroop, and Zou (1997).
Empirical evidence confirms a strong negative relationship between inflation and economic growth at all but the lowest levels of inflation. See Fischer (1993), Bruno and Easterly (1998), Ghosh and Phillips (1998), and Sarel (1996).
For any given increment in per capita income, the impact on poverty will depend on how that increment is distributed across the population. While growth is almost always accompanied by a reduction in income poverty, and negative growth is accompanied by an increase in poverty, for any given growth rate the impact on poverty can vary substantially.
To the extent that people with high income save a larger proportion of their income than do those with low income, policies that redistribute income in favor of the lower-income population may impede savings and, to the extent that such savings are channeled into productive investment, long-term growth.
This refers to developing economies, where often income (and wealth) inequality is particularly acute. In general, there is likely to be a point beyond which greater equity is incompatible with adequate labor and enterprise incentives, which, in turn, would be detrimental to growth. See Alesina and Rodrik (1994); Bénabou (1996); Birdsall and Londoño (1997); Deninger and Squire (1998); Perotti (1992, 1993, and 1996); and Persson and Tabellini (1994).
By increasing the human capital of the poor, redistributive policies can increase the productivity of the workforce, thereby enhancing growth. Others have argued that there is also a political economy channel as well—in countries with greater income equality there is greater political support for public policies that are more conducive to growth. See Alesina and Rodrik (1994), and Persson and Tabellini (1994). For empirical support for this effect, see Deininger (1999); Thomas and Wang (1998); Klasen (1999); and Dollar and Gatti (1999). For dissenting views, see Forbes (2000) and Li, Xie, and Zou (1999).
It is also often argued that if growth results in the expansion of lowskilled employment, then the poor are more likely to be the beneficiaries of the growth. One recent cross-country study (Fallon and Hon, 1999) found that the more labor-intensive the growth pattern, the faster the decline in the incidence of poverty.
In certain cases, the return to a steady growth state may also require structural reform and measures to improve the functioning of markets.
Broadly speaking, this means leaving the underlying stance of macroeconomic policy unchanged (or, in some cases, the stance may be adjusted temporarily to mitigate the impact of the shock) and adjusting policy targets in a way that takes into account the impact of the shock. However, if such a policy stance cannot be financed in a noninflationary way, then some adjustment will also be necessary.
Indeed, a key feature of programs supported by the IMF’s Poverty Reduction and Growth Facility (PRGF) is to assess the distributional impact of key macroeconomic policies and to put in place countervailing measures needed to protect the poor. See Key Features of IMF Poverty Reduction and Growth Facility (PRGF) Supported Programs, August 16, 2000 at http://www.imf.org/external/np/prgf/2000/eng/key.htm.
Social safety nets are designed to mitigate possible adverse effects of reform measures on the poor. These instruments include temporary arrangements, as well as existing social protection measures reformed and adapted for this purpose, such as limited food subsidies, social security arrangements for dealing with various life cycle and other contingencies, and targeted public works. See Chu and Gupta (1998).
Even if the strategy can be fully financed with concessional resources, policymakers will need to assess the degree to which poverty-reducing spending may place pressure on the price of nontraded goods and thereby threaten stability.
The Sourcebook can be found at http://www.worldbank.org/poverty/strategies/sourctoc.htm.
Ensuring there is appropriate flexibility in fiscal targets and supporting authorities’ efforts to secure commitments of higher donor flows when warranted are key features of the IMF’s PRGF-supported programs. See Key Features of IMF Poverty Reduction and Growth Facility (PRGF) Supported Programs, August 16, 2000, at http://www.imf.org/external/np/prgf/2000/eng/key.htm.
“Priority areas” are defined as those activities identified as crucial for poverty reduction.
For a discussion of tax policy and developing countries, see Tanzi and Zee (2000).
The real interest rate represents the real cost of borrowing—that is, the cost in terms of goods—and is approximately equal to the nominal interest rate minus the expected rate of inflation.
The real exchange rate represents the relative price of a basket of goods in two countries. It is commonly measured by multiplying the nominal exchange rate by the ratio of consumer price indices in the two countries. If the real exchange rate appreciates, the basket of goods becomes more expensive in the home country. This can happen if either the home currency appreciates, or if the home country’s prices rise relative to those of the foreign country.
For example, as indicated earlier, recent studies have shown that in some countries, the income of the poor is more associated with tradable goods and consumption with nontradable goods than the income and consumption patterns of other income groups. In these countries, this implies that a depreciation or devaluation of the domestic currency would make the country’s exports more attractive and stimulate demand for tradable goods. Since the poor’s incomes are tied to the production and export of tradables, this would, in turn, increase their income while the cost of their consumption of nontradables would remain unchanged.
Other nominal variables can also serve as anchors. What is essential is that the variable targeted be nominal, and not real, since real variables cannot provide an anchor for nominal prices. For example, countries that have targeted the real exchange rate have generally had worse inflation performance than other countries. See Phillips (1999).
The two most commonly used nominal anchors are a fixed exchange rate and a money aggregate (such as reserve money or broad money). Under a fixed exchange rate regime, whenever the market rate threatens to depart from the predetermined rate, the monetary authorities buy or sell foreign exchange for the domestic currency to ensure that the exchange rate remains fixed. Similarly, under a monetary anchor the monetary authorities specify a predetermined path for a monetary aggregate, and tighten or loosen the monetary stance when the aggregate threatens to depart from that path.
Under a fixed exchange rate, the monetary authorities give up control of the money supply. Under a monetary anchor, the authorities cannot pursue an exchange rate target.
If there are no explicit policy targets, the monetary authorities have full discretion. This differs from the concept of independence of the monetary authorities.
Reform programs should be designed with the poor and vulnerable in mind. The mix and sequencing of reform measures should be designed to minimize the hardships brought about by the program. The appropriate mix and sequencing cannot, however, ensure that the adverse effects will be removed entirely and, hence, social safety nets are needed to mitigate possible short-run adverse effects on the poor. In some cases, it may be appropriate to delay reforms until adequate safety net measures can be put in place. See Chu and Gupta (1998).
Contrary to what some may believe, the poor do save, to smooth consumption over time, as well as to guard against adverse shocks. For a recent analysis, See Deaton and Paxson (2000).
Also, capital controls that drive a wedge between domestic and world real interest rates make it possible to extract an inflation tax, which especially hurts the poor.
For many countries, domestic asset holdings of the poor are mainly composed of currency, so it would seem that this channel is not relevant. But this may just reflect that low controlled interest rates provide a disincentive to save in bank deposits. Removing financial distortions could shift the allocation of domestic assets in favor of deposits and, to the extent that market interest rates account for expected inflation, insulate the poor’s savings from inflation.
Collateralization may be initially the only way for small firms to gain access to credit markets, but its amplification effects should not be understated. Instead, policies that reduce informational problems (i.e., the reason for collateralization) should be implemented.