Chapter

8 Colombia: Economic Adjustment and the Poor

Editor(s):
Ke-young Chu, and Sanjeev Gupta
Published Date:
April 1998
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Author(s)
Claire Liuksila

In the mid-1980s, faced with a rapidly deteriorating economic and financial picture, Colombia undertook a strong adjustment program. By putting the economy on a sounder footing, the government felt that the population in general stood much to gain from the program in the medium run. But it also recognized the likely short-run hardships for low-income groups.

How did the adjustment program affect the poor? This chapter attempts to answer this question by laying out the events that led to the adoption of the program. It then describes the major ingredients of the program and policies that the Government of Colombia adopted to protect the poor. The impact of the program on the poor is illustrated by a practical methodology that embodies the main ingredients of the program. Finally, the chapter ends with a concluding section and some caveats.

Economic Events

Colombia’s economy began to show signs of a serious deterioration in the early 1980s, when real economic growth averaged only 1.6 percent, sharply down from the 4.9 percent annual rate seen during 1975–80, and the public sector and balance of payments deficits widened markedly. This was due both to outside factors, principally the decline in international coffee prices, and to expansionary domestic policies.

The intensification of exchange and trade restrictions was a central element of the authorities’ initial strategy to stem the loss of net international reserves over 1982–84. By early 1984, 83 percent of all items in the tariff schedule were subject to prior licensing, 16.5 percent were on the prohibited import list, and only 0.5 percent of items could be imported without any administrative control. To reinforce this policy, the authorities accelerated the rate of depreciation of the peso against the dollar and adopted fiscal revenue measures in 1983 and 1984. These steps helped to reduce the fiscal and external current account deficits somewhat in 1984, but the deficits still remained unsustainably large. By the mid-1980s, the economy was marked by an overvalued exchange rate and a distorted price system.

The 1985–86 Adjustment Program

In response to the continuing economic and financial deterioration, the authorities adopted a comprehensive adjustment program that was supported by a monitoring arrangement with the Fund and adjustment loans provided by the World Bank that were designed to support structural reforms in trade policy, agriculture, and related areas. The program included a broad range of measures affecting virtually all areas of economic policy.

External Policy

The external policy measures included (1) a cumulative (1985–86) 30 percent depreciation of the real exchange rate; (2) a significant liberalization of import restrictions—by the end of 1986 nearly 70 percent of goods could be imported freely; (3) broadening of the tax base for import duties; (4) reduction of export incentives granted through tax credit certificates; and (5) imposition of an 8 percent surcharge on most imports.

Fiscal Policy

In addition to (5) above, revenue measures included (1) abolition of some sales tax exemptions; (2) prepayment of 20 percent of future income tax liability for companies and individuals with incomes in excess of 2 million pesos; (3) a range of measures designed to raise revenue from income and investment taxes; (4) elimination of the special income tax deduction for Carboco and the special discount for Empetrol, two state monopolies; (5) an increase of 50 percent in the stamp tax and its indexation to the consumer price index; (6) a cumulative increase of 35 percent in the gasoline tax, and (7) gradual elimination of transportation subsidies.

Policy measures on the expenditure side included (1) a reduction in current expenditure of 1 percent of GDP; (2) capping the weighted average salary increases of central government workers at 10.5 percent;1 and (3) cuts in noninterest current and capital expenditure and social spending.

Monetary Policy, Wage Policy, and Other Price Measures

A tight monetary policy was adopted that involved increases in preferential lending rates to reduce the subsidy element. In 1985, the minimum wage was increased by 20 percent, in line with projected inflation for the low-income consumer price index. Other price measures included raising electricity, water, and telephone rates by 35–40 percent in 1985 and by a further 2 percent in 1986.

Government Policies to Protect the Poor

By realigning the relative prices of foreign and domestic goods, reducing inflation, and improving economic growth, the government hoped to raise living standards in both the short and the long run. These policies were expected to benefit everyone, including the poor. At the same time, however, the government recognized that certain measures of the adjustment program could hurt lower-income groups in the short run. These included an increase in the cost of imports due to the large depreciation of the exchange rate and the imposition of an 8 percent import surcharge; large increases in gasoline prices and public sector tariffs; the elimination of transportation subsidies; the removal of certain exemptions from the sales tax; and a sharp reduction in real terms in the public sector wage bill.

Against this background, the government opted for new measures to protect lower-income groups and to intensify the existing antipoverty programs. These measures took the following forms.

Wage Policies

As stated earlier, the minimum wage was increased by 20 percent as were wages of public sector workers at the bottom of the wage scale. Adjustment of the minimum wage has been traditionally an important social policy tool in Colombia, a country in which wage indexation is widespread. While generally adjusted annually, the minimum wage is set at a very low level, just equivalent to the income required to keep an individual above the government’s definition of the “poverty line.”

Although there is no direct evidence concerning the relevance of the minimum wage for the poor, recent studies indicate that the adjustment of the minimum wage explains a significant portion of the increase in average wages in construction, the public sector, and the informal sector—activities in which the poor might be expected to be more heavily represented. Moreover, the adjustment of the minimum wage has apparently had a moderate, but increasing, influence on the growth of the average wage in rural areas where poverty tends to be high.

Selective Exemptions from Import Surcharge

A number of goods were exempted from the 8 percent surcharge, most notably food and fertilizers. There are no data on the importance of imports and imported production inputs in the food consumed by low-income groups. However, this measure, although not well targeted, was intended to mitigate the effect of the surcharge on low-income groups.

Antipoverty Programs

The government also continued to channel resources into one of its core poverty alleviation program—the DRI (Program for Integrated Rural Development)—which concentrates on providing basic services and financial resources to small farmers. After 1986, a number of other antipoverty programs were launched, including:

  • the Plan for National Rehabilitation (PNR)—a program that focuses on providing the basic necessities for the poorest 10–12 percent of the population and includes land distribution, improvements in infrastructure, and increased public services;

  • the Better Homes for Children (HBI)—an innovative and successful World Bank-supported program that combines supplemental feeding and day care for children in poor communities with the education and training of their mothers; and

  • the Plan for the Eradication of Absolute Poverty (BEPA)—a program aimed at poverty in urban areas; and a variety of other programs designed to improve the basic education, health, and housing of the poor.

Economic Impact of Adjustment Program

This chapter only attempts to examine possible first-round effects of the adjustment program on the poor. It does not question the basic policy thrust of the adjustment program. It does not attempt to measure what the program’s impact might be in the longer run, nor conjecture what the position of the poor might have been in the absence of adjustment. Moreover, with the data available, it is difficult to pinpoint the impact of the program on the poor in general or on different socioeconomic segments within the category of those classified as poor. Bearing in mind these limitations, a two-step analysis is used to assess the impact of the program on the relative position of the poor. First, an estimate of first-round price and income effects is made without the benefit of ex-post information, that is, as if the program were being initiated now. Second, the estimates are then contrasted with the actual results for 1985–86.

First-Round Impacts on the Poor

The adjustment program contained a number of measures that affected prices. The evidence suggests that the depreciation of the exchange rate, the imposition of the 8 percent import surcharge, the broadening of the tax base on the sale of imported goods and the reduction in the implicit level of import duties raised the total domestic cost of imports by 20.8 percent in 1985 and by 30.6 percent in 1986 (Table 8.1). By weighting the increased cost of imports by the share of imports in aggregate demand, and assuming a complete and relatively quick pass-through of the higher cost of imports to domestic prices, one can conclude that these measures may have added 3.3 percentage points to the consumer price index (CPI) of low-income households in the first round of price adjustment in 1985, and 4.5 percentage points in 1986 (Table 8.2). An alternative approach to gauging the impact of higher import prices on domestic prices would be to use the calculated elasticities derived from various econometric studies that have investigated the relationship between import prices and domestic prices. These studies generally found that a 10 percent increase in the cost of imports raised domestic prices between 1 percent and 2 percent.2 Using this methodology, the increase in the domestic cost of imports calculated in Table 8.1 would raise consumer prices between 2 and 4 percentage points in 1985, and by 3.1 to 6.2 percentage points in 1986, This is similar to the results obtained with the method employed in Table 8.2.

Table 8.1.Colombia: Calculation of Program-Induced Price Effects on Import Prices(In billions of pesos)
198419851986
Value of imports (c.i.f.)452.9587.9748.3
Taxes levied on imports, net of exemptions74.0122.3193.6
Customs duties45.353.785.0
Tax on sale of imports25.840.862.7
Surcharges12.927.845.9
Total domestic cost of imports526.9710.2941.9
(Percent change)34.832.6
Program-induced effect on import pricesn.a.109.7217.6
Exchange rate2n.a.84.2175.2
Discretionary tax element
Customs duties3n.a.−1.13.7
Tax on sale of importsn.a.3.10
Surcharge: 8 percentn.a.23.538.7
Surcharge: 2 percentn.a.00
(In percent)
Implicit increase in the domestic cost of imports caused by exchange rate and discretionary tax measures20.830.6
Sources: IMF staff estimates; and Contraloría de la República, Informe Económico (1985 and 1986).Note: n.a. denotes not applicable.

Includes both 8 percent and 2 percent surcharges.

Calculated with the nominal effective exchange rate.

Change in implicit tariff.

Sources: IMF staff estimates; and Contraloría de la República, Informe Económico (1985 and 1986).Note: n.a. denotes not applicable.

Includes both 8 percent and 2 percent surcharges.

Calculated with the nominal effective exchange rate.

Change in implicit tariff.

Table 8.2.Colombia: Estimation of Program-Induced Price Effects on Low-Income Households1(In percent, annual averages)
19851986
ChangePrice impactChangePrice impact
1.Import costs20.83.330.64.5
2.Gasoline price15.00.620.00.8
3.Elimination of VAT exemption for soft drinks10.00.1
4.Electricity40.01.026.80.7
5.Water40.00.826.80.5
6.Telephone40.00.126.80.1
7.Reduction of transport subsidies32.90.917.20.5
8.Total induced effects6.87.1
9.Other goods and services220.514.720.514.7
10.Total change in CPI (10 = 8 + 9)21.521.8
Source: IMF staff estimates.

To calculate the price impact, with the exception of import costs, the change in the price of the relevant article was multiplied by its weight in the low-income CPI. For imports, the price change was multiplied by the weight of imports in aggregate demand.

This represents an extrapolation from past trends. The trend value for other goods and services was derived by regressing the log of the index for these items on a time trend over the period 1965–84.

Source: IMF staff estimates.

To calculate the price impact, with the exception of import costs, the change in the price of the relevant article was multiplied by its weight in the low-income CPI. For imports, the price change was multiplied by the weight of imports in aggregate demand.

This represents an extrapolation from past trends. The trend value for other goods and services was derived by regressing the log of the index for these items on a time trend over the period 1965–84.

The 40 percent average increase in electricity, water, and telephone rates would have added a further 1.9 percentage points to the index in 1985, while the 26.8 percent increase in these public sector tariffs in the following year would have raised the CPI for low-income households by 1.3 percentage points. Assuming that the reduction in transport subsidies was passed through fully to higher bus fares, this measure would have raised consumer prices by 0.9 percent in 1985 and by 0.5 percent in 1986. The elimination of the VAT exemption for soft drinks could be expected to have had a very small impact on prices in 1985 and no impact in 1986. Assuming an underlying rate of inflation of about 20.5 percent for the other items in the CPI, it is estimated that the CPI for low-income households would have risen by about 21.5 percent in 1985 and by 21.8 percent in 1986.

There are a number of obvious pitfalls in this type of analysis. First, as stated earlier, the analysis attempts to measure first-round price effects only. Second, it assumes that the expenditure pattern implicit in the low-income consumer price index is valid for all poor households. The evidence appears to indicate that the poor spend a much larger proportion of their income on food than is suggested by the low-income CPI. Third, with the available data, it is not possible to differentiate by broad categories of goods the impact of higher import costs on prices and to match this with the expenditure patterns of those classified as poor. Fourth, as food represents nearly half of the low-income CPI, and probably considerably more of the expenditure of the very poor, exemption of food items from the 8 percent import surcharge could have helped to soften its impact on low-income groups. However, because of data limitations it is not possible to disentangle the negative impact on the poor of the import surcharge from the positive impact owing to exemption of some items (including food) from the surcharge. Finally, the analysis is based on the assumption of constant markup, which may not be valid since the pace of economic activity was expected to slow down following the implementation of the adjustment program.

In designing the adjustment package, an attempt was made to maintain the purchasing power of the lower-income groups by providing for a 20 percent average increase in the minimum wage in 1985. In addition, the ceiling of 10.5 percent on the average increase in public sector wages was weighted to give a higher-than-average increase to lower-paid employees. For those at the lowest end of the wage scale, the increase amounted to 20 percent.

As part of the effort to improve the public sector balance, current expenditure was to be cut by 1 percent of GDP in 1985, but no further cuts were planned for 1986. This led to a reduction in social expenditure of 0.9 percent of GDP in 1985 and 0.4 percent in 1986. Most of the reduction took place in education expenditures, transport subsidies, and housing expenditure. Public transfers (direct income support) rose by only 7.4 percent in nominal terms in 1985, implying a decline of 12.6 percent in real terms with a projected inflation rate of 20 percent. There are no sufficient disaggregated data to discern whether this real decline in transfers was an across-the-board cut or was limited to certain programs. However, to the extent that the poor’s income from transfers did fall, and considering that such transfers represent about 16.5 percent of the income of the poorest 10 percent of the population and 14 percent of the income of the next poorest group, this decline in real terms would have represented in 1985, all things being equal, a reduction in real income for these two groups of 2.0 percent and 1.8 percent, respectively. These trends were reversed in 1986; public transfers increased broadly in line with inflation while the minimum wage was raised in line with actual inflation observed during 1985.

Although the depreciation of the exchange rate was expected to affect negatively the buying power of the poor in the first instance through its effect on prices, it could be presumed to have had a positive impact on the earnings of the poor in the traded goods sectors, particularly for agricultural small holders but also for wage earners through its second-round effects on employment and perhaps also on wages. Unfortunately, there is no hard evidence to support this intuitive conclusion.

In summary, the first-round effects of the 1985 stabilization program, on balance, could have resulted in a relatively small reduction in the real incomes of the poor because the negative first-round price effects would have been largely offset by the 20 percent increase in the minimum wage and by the positive impact of the depreciation of the exchange rate on the tradable sector.

Macroeconomic Impacts: Objectives Versus Outcomes

Economic developments during 1985–86 turned out to be better than targeted, partly as a result of favorable external factors. Real GDP grew by 3.1 percent in 1985, compared with a projection of 2.0 percent under the program. The low-income CPI rose by 22.7 percent on average compared with 21.5 percent based on first-round price effects. Most of the acceleration of inflation in 1985 seems to have been due to a sharp increase in food prices. However, the rate of growth of housing costs, which includes expenditures for electricity, water, and telephone services, also accelerated from 12.9 percent in 1984 to 14.9 percent in 1985, about in line with the 1.9 percentage point increase calculated as a first-round impact. The rate of increase in the cost of clothing and other items included in the low-income CPI actually decelerated in 1985 compared to the previous year (Table 8.3). These figures make it difficult to pinpoint the impact of higher import costs on domestic prices. The acceleration in food prices was apparently only weakly linked to the depreciation of the exchange rate and had more to do with supply shortages.

Table 8.3.Colombia: Developments in the Components of the Consumer Price Index(Average annual percent change)
General IndexMiddle-Income IndexLow-Income Index
All items
198416.118.318.3
198524.021.822.7
198618.921.620.7
Food
198419.618.619.6
198527.728.227.9
198623.724.523.3
Housing
198412.911.712.9
198515.515.214.9
198614.815.714.0
Clothing
198417.917.618.1
198516.315.516.7
198619.117.719.6
Other
198424.624.724.6
198519.319.319.3
198622.922.622.8
Source: Colombian Statistical Office (DANE), Boletín de Estadística (Bogotá, various issues).
Source: Colombian Statistical Office (DANE), Boletín de Estadística (Bogotá, various issues).

Looking at other indicators, the unemployment rate in the formal sector stabilized, but there was a major deterioration in real wages in all sectors ranging from a decline of 8.2 percent on average for public sector workers to 2.9 percent for wages in manufacturing. Wages in agriculture fell by around 4 percent on average in real terms in 1985. In contrast, minumum wages in agriculture and in services fell only slightly, by 1.4 percent. To the extent that trends in the minimum wage are representative of developments in the earnings of the poor, the incomes of the poor would have been relatively better protected than other groups during the adjustment period.

While it may be tempting to speculate what the position of the poor might have been had the adjustment effort not taken place, or about the long-run effects of the adjustment program on the relative position of the poor, there is insufficient information for such an analysis and, in any case, it is beyond the scope of this chapter. One could imagine that, in the absence of adjustment, ceteris paribus, the expansionary financial policies pursued in the early 1980s would have led to even higher rates of inflation, while the severe distortion of relative prices caused by inappropriate external policies would have further weakened economic growth. This combination, through its negative effects on real incomes and employment, would have had an adverse impact on all income groups, and on the poor in particular.

Any attempt to trace the impact of the adjustment measures in the long run is complicated by the sharp recovery of coffee prices in 1986. All things being equal, it would seem safe to assume that the adjustment, particularly the realignment of the exchange rate, placed the economy in a better position to benefit from the subsequent coffee boom and maintain balanced growth in the longer run.

Conclusion

The simple estimate of the first-round price effects suggests that the initial negative impact of the adjustment program was probably largely cushioned by the government’s action on the minimum wage, by the exemption of food from the 8 percent import surcharge, and by the fact that the items that increased in price as a result of the measures taken under the program accounted for only just over one-fourth of the goods and services included in the low-income CPI. In fact, the actual increase in the low-income CPI in 1985 was very similar to that predicted. In addition, the perceived negative distributional effects of the program were narrowly concentrated during 1985. By 1986, under the influence of the coffee boom, real wages had recovered strongly, as had growth and employment, and by 1988 there was a further improvement in the distribution of income.

Because of data limitations and the methodology employed, this chapter can give only a fairly rough indication of the impact of the 1985–86 program on the incomes of the poor. For future studies, it would be desirable to have direct data on the expenditure patterns of poor households, rather than having to rely on proxies, such as the weights of the low-income CPI.

More important, because of data limitations, this chapter has been unable to quantify the presumably negative impact of the depreciation of the exchange rate on the incomes of the poor in the traded goods sector, which can be substantial given the size of the depreciation. Finally, in a middle-income developing country such as Colombia, the poor are in fact quite heterogeneous. Not only are there important differences in the characteristics of the poor with respect to urban versus rural poverty, but there is also considerable differentiation within these two groups. It is therefore difficult to generalize about the impact of program-induced price measures on the poor as a group.

Note: This is an abridged version of IMF Working Paper 91/81 (Washington: International Monetary Fund, 1991).

Higher increases of up to 20 percent were allowed for lower-paid employees.

A survey of these studies appears in Santiago Herrera, “Relaciones de Causalidad Entre la Tasa de Cambio, los Precios y los Salarios: Alguna Evidencia Sobre el Caso Colombiano 1950–83,” Ensayos Sobre Politica Económica, No. 7 (June 1985).

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