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Strengthening PRGF Programs Through PSIA

Author(s):
Antonio Spilimbergo
Published Date:
August 2006
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David Coady

The introduction of the Poverty Reduction and Growth Facility (PRGF) in 1999 reflected a desire to make pro-poor growth considerations central to the design of IMF-supported programs in low-income countries. Since the introduction of the PRGF, empirical research on the impact of these programs on poverty and growth has accelerated. In addition, the Poverty and Social Impact Analysis (PSIA) Group was created in the IMF’s Fiscal Affairs Department in July 2004 to facilitate the absorption of policy insights from PSIAs into the design of PRGFs on a more systematic basis. This article provides a brief summary of recent IMF research on this topic.

As is obvious from its name, the Poverty Reduction and Growth Facility pursues two goals. The underlying premise is that growth without poverty reduction—one might say growth without equity—is simply not acceptable. The importance of growth as a means to reduce poverty is widely recognized. What is less well understood is what policies can best promote not only growth, but equitable growth. The IMF has been working to better understand the complex interrelationships between growth and poverty reduction.

Much of recent research has focused on the relationship among growth, inequality, and poverty using a crosscountry regression approach. A key result of this research has been that growth-enhancing macroeconomic and fiscal policies have not had a direct negative effect on income inequality. To the contrary, growth itself can reduce poverty. Moser and Ichida (2001) verified the beneficial impact of growth on poverty reduction in countries in sub-Saharan Africa and on non-income measures of poverty, such as life expectancy, infant mortality, and gross primary school enrollment. Subsequent research by Ghura, Leite, and Tsangarides (2002) using data for 137 developed, transition, and developing countries expanded the set of policy variables that had been considered in the literature and identified what were labeled “super pro-poor” policies. Policies that lowered inflation, reduced public expenditures, promoted financial development, and improved educational outcomes were all found to directly reduce poverty; in addition, they indirectly reduced poverty by increasing growth. Other variables typically found to encourage growth (e.g., trade openness, investment levels, and fiscal stability) did not appear to have any direct adverse effect on poverty, reinforcing the absence of a trade-off between growth and poverty reduction. For further extensions of this crosscountry regression approach using different samples and specifications, see Epaulard (2003) and Iradian (2005).

Over and above the effect of growth on poverty, policies that shape the distribution of income have a separate and important impact. Kraay (2004) used household surveys for 80 developing countries to examine the relative importance of changes in mean income and changes in the distribution of incomes in explaining changes in absolute poverty. Although change in mean income accounted for 66–90 percent of the change in poverty over the long run, it accounted for only 50 percent over the short run. Growth in mean incomes also explained less of the poverty reduction when poverty was measured by indices that were more sensitive to changes in extreme poverty, suggesting that growth may be substantially less effective than more direct redistributive policy instruments in reducing extreme poverty.

Cross-country analysis has also examined the relationship between poverty and foreign currency inflows (i.e., external indebtedness and foreign aid). The conventional wisdom has been that external indebtedness has an adverse effect on growth, especially at very high levels of debt. Moreover, debt can also have a more direct effect on poverty if it crowds out social expenditures. Loco and others (2003) find that the impact of external indebtedness on poverty comes mainly through its indirect effect, via lower growth, rather than its direct effect. Masud and Yontcheva (2005) examine the differential impact of two types of foreign aid (bilateral aid and aid provided by nongovernmental organizations (NGOs)) on infant mortality and illiteracy in low-income countries. NGO aid was found to decrease infant mortality through increased total health spending (i.e., the sum of such spending by the government and NGOs), whereas bilateral aid did not have an effect, since it largely crowded out domestically financed government spending.

Cross-country analyses have also looked at how the composition and efficiency (e.g., the proportion allocated to health and education expenditures or, within these expenditures, to primary health care or lower levels of education) as well as the level of government spending affect poverty. For instance, Gupta, Verhoeven, and Tiongson (2004) found that per capita health expenditures had a consistently statistically significant impact in reducing infant and child mortalities for poor households. The likely explanation is that poor households cannot afford high levels of private health care, so that if they have access to more public health services, there is likely to be less crowding out of private health care.

Case studies for Nigeria and Tanzania show the value of detailed analysis of particular country experiences in improving our knowledge of specific policies that are likely to make growth more pro-poor. Thomas and Canagarajah (2002) used household data for Nigeria for 1985–92 to examine the relative contribution of growth and redistribution to poverty reduction and to identify the likely determinants. They find that the incidence of poverty decreased by 9 percentage points over this period, from 43 percent to 34 percent. Growth led to a 14 percentage point decrease in poverty, but a rise in inequality resulted in a 5 percentage point increase. The increase in inequality was attributed to the bias of government policies toward the urban sector and capital-intensive industries. This experience contrasts with that of Tanzania examined in Treichel (2005). It implemented wide-ranging structural reforms in the early 1990s, including trade liberalization and the withdrawal of extensive state control in agriculture. The country achieved significant macroeconomic stabilization, with inflation falling from nearly 30 percent in the early 1990s to just over 9 percent during 1996–2003. Per capita income, which had been falling, increased at an annual rate of 4.2 percent between 1996 and 2000. Concomitantly, the incidence of poverty decreased from 43 percent in 1994 to 36 percent in 2000. A recent review of growth and poverty trends in sub-Saharan Africa by Pattillo, Gupta, and Carey (2005) confirmed the variation in response of inequality to pro-poor growth policies exemplified by these case studies.

Large increases in foreign aid have also raised the specter of Dutch disease, whereby currency appreciation leads to increased demand for nontraded goods, possible inflationary expectations, and a decline in production in the higherproductivity traded goods sector. Nkusu (2004) examines the experience of Uganda, which experienced large financial inflows (including grants and concessional loans) in the late 1990s. The results suggest that such inflows are less problematic in an environment where structural reforms result in a more efficient resource allocation and increase factor productivity. In Uganda, current account deterioration reflected a surge in investment and higher public expenditures on education, health, and public infrastructure rather than a decrease in savings to finance higher consumption.

A common feature of fiscal reforms in PRGF programs is the replacement of sales taxes with the value-added tax (VAT). A number of recent case studies (see Coady, 2006, for a review) have found that replacing sales taxes with a comprehensive VAT typically makes indirect taxes less progressive, so that lower-income households are likely to be net losers from revenue-neutral reforms. This reflects the fact that although a VAT is typically progressive, it has been found to be less progressive than the sales taxes it replaces. Studies also show, however, that the progressiveness of the VAT can be improved by zero rating certain categories, such as basic foods.

Case studies have also investigated the distributional effects of recent increases in the world price of petroleum products. A commonly expressed concern of governments is the likely adverse effect of higher fuel prices on poor households. Coady and others (2006) have estimated the likely magnitude and distribution of the real income burden of eliminating subsidies in six developing countries and found, not surprisingly, that most of the subsidy implicit in low domestic fuel prices accrues to higher-income groups. Although the elimination of subsidies can still lead to a sizable adverse impact on poor households, better-targeted direct transfers provide a more cost-effective approach to social protection and budgetary savings can be used to finance higher-priority povertyreducing public expenditures.

Finally, case studies are also addressing the challenges arising from proposals to massively scale up aid to meet the Millennium Development Goals (MDGs). For instance, Mattina (2006) describes an MDG scenario for Ethiopia that addresses both microeconomic and macroeconomic constraints and argues that a carefully sequenced MDG strategy is essential so that the scaled-up aid and public spending will remain in line with Ethiopia’s absorptive capacity.

Although the research already discussed in this article has provided important insights into the relationship between policies commonly promoted by PRGF programs and poverty reduction, much remains to be done. It has become clear that the poverty impacts of the broader policy measures are sensitive to the detailed reforms that are adopted. A better understanding of the relationship among these more detailed reforms and poverty is thus crucial to help design programs that are more pro-poor. Country case studies and greater use of microlevel data are very helpful in this regard. Cross-country analysis can also play an important role in providing a broader context for policy analysis, identifying key issues that need to be resolved, and helping to design a more comprehensive and rigorous case-study approach.

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