- International Monetary Fund
- Published Date:
- May 1988
In 1982, the worsening world recession, the consequent loss of export earnings, high world interest rates, a vulnerable financial system, and a decline in international competitiveness caused by rigid wage and exchange rate policies triggered a deterioration of domestic and foreign confidence in economic management, a reduction of net capital inflows, a sharp decline in real GDP, and an increase in the open unemployment rate to 20 percent. Although the authorities abolished the indexation of wages and adopted a crawling peg exchange rate system after a major devaluation, the rapid expansion of central bank credit contributed to a 40 percent decline in official international reserves in 1982.
The two-year stand-by arrangement (1983-84) supported a medium-term adjustment program designed to restore confidence in the economy, lay the foundation for the growth of output and employment, reduce domestic inflation, and improve the external payments position. A major element of the program’s policy package was an increase in public savings to support the maintenance of, and a subsequent increase in, public investment within the framework of sustainable fiscal deficits. The program took Chile from a large contraction in economic activity in 1982 to a positive growth rate by 1984. Real GDP grew rapidly in 1984 (by 6 percent), employment increased significantly, and the.domestic inflation rate subsided. The external current account deficit, however, exceeded the targets set for 1984, in part because of excess demand pressures.
In discussing the implications of the adjustment program for the poor, the adverse implications of the high real wages in the formal urban sector prevailing in the preprogram years must be considered. Chile is a highly urban society with a large majority of the poor located in urban areas, largely as unemployed workers, workers in the informal sector, and their families. The wage indexation scheme had benefited mainly the relatively better-off urban workers employed in the formal sector at the expense of the jobless poor and the workers in the informal sector. The strong emphasis of the program on growth and employment in the formal sector through the moderation of wage increases, an increase in public investment, emergency employment schemes, and the restoration of confidence in economic management had positive implications for the core poverty groups. The restoration of confidence in economic management was critical in halting capital flight, encouraging domestic private investment, and creating jobs.
The program aimed at achieving fiscal adjustment initially through cuts in current expenditure. The Government sought to mitigate the adverse effects of the fiscal adjustment on the poor, initially by raising additional revenue to finance an increase in outlays for employment and health programs in 1983, and subsequently by increasing the fiscal deficit to allow for an increase in public investment in 1984. In retrospect, expenditure developments during the program period indicate that interest payments increased relative to GDP, while the wage bill declined. The reduction of the wage bill facilitated the maintenance of nonwage outlays in the areas of health, education, and other social services benefiting the poorest segment of the population. For example, while reducing real expenditure on health by cutting real wages of civil servants in health services and the programs benefiting upper-income groups, the Government expanded a feeding program benefiting the lowest-income groups, thus protecting human assets—the sole assets—of the core poverty group.
The Chilean experience illustrates an adjustment program with an emphasis on an increase in employment in the formal sector for the jobless urban poor and the poor engaged in the informal sector through an increase in investment, the growth of output, and an improvement of the functioning of the labor market. These objectives and policies clearly had positive implications for the alleviation of poverty.
The Chilean experience also indicates that the manner in which adjustment measures are implemented can have important adverse distributional implications. Delays in taking exchange rate action and in implementing tariff increases allowed the wealthy segments of the population a chance to hoard imported goods in anticipation of such policies.
During 1981-82, the Dominican Republic experienced a sharp deterioration in its external terms of trade, which reinforced the effects of a prolonged expansionary fiscal policy stance and resulted in a sharp decline in its external payments position. Although the volume of imports was compressed severely, the external current account deficit did not decline in 1982, external payments arrears continued to mount, and net international reserves of the central bank reached minus US$590 million. Real GDP virtually stagnated in 1982.
The three-year extended arrangement (1983-85) was intended to support an economic program designed to reduce the external payments imbalance while increasing domestic savings and investment. The program sought a significant improvement in the public sector’s deficit performance along with an increase in public investment and a real effective depreciation of the peso through an expansion of the parallel foreign exchange market. The arrangement, however, was interrupted, because the performance criteria for the last quarter of 1983 were not observed, and negotiations for the second-year program were not concluded.
Although the arrangement did not run its full course, the program’s objectives and policy measures had important implications for key elements of the poor, which consisted largely of unemployed urban workers and rural agricultural landless workers, particularly in the sugar-growing areas. The program included increases in both public and private investment—the former largely in the area of infrastructure and the latter in the areas of agriculture, export-oriented manufacturing, tourism, and low-cost housing construction. The investment in housing was specifically aimed at generating employment. These policies, by improving the chances for an increase in earnings for farm workers and smallholders in the export-oriented, dominant sugar sector, were intended to benefit major groups of the poor.
The program envisaged a number of revenue measures, including an import surcharge (with exemptions for petroleum and other essential goods), a capital gains tax, and a broad-based value-added tax (VAT). The nature of these measures was essentially progressive. The revenue measures implemented, however, deviated from the original proposals, were narrow-based, and were relatively regressive. The import surcharge was adopted as planned, but the VAT was implemented in a drastically limited form. A 50 percent increase in cigarette excises, not envisaged in the program, was introduced.
In discussing the implications of the Dominican Republic program on the poor, the events following its interruption provide an important lesson. The Dominican Republic had a system of subsidies that operated through the application of an overvalued official exchange rate for their import. Nontargeted subsidies provided through the exchange rate over-valuation typically are highly inefficient at reaching the poorer segments of the population, though the perception of the poor may be that these subsidies are of direct material benefit. In an attempt at reform, the authorities announced a series of measures to increase domestic food prices. Even though exceptions for a number of items critical for low-income groups were included, as the authorities moved cautiously in the removal of subsidies, this announcement led to major social unrest.
Both adverse external developments and prolonged inappropriate domestic policies caused an extended deterioration in the Ghanaian economy. The effects of a worsening in the external terms of trade, a succession of severe droughts, and the influx of emigrant workers returning from Nigeria were compounded by a severely overvalued exchange rate and a misaligned domestic relative price structure. In 1982, real per capita income was lower than in 1970 by 30 percent, real export earnings by 52 percent, and import volumes by 30 percent. Depressed real wages had caused a large-scale emigration of skilled workers.
The three-year economic recovery program (1983–85), supported by a one-year (1983-84) stand-by arrangement and a subsequent 18-month (1984-85) stand-by arrangement, was aimed at establishing a foundation for economic growth and a viable external payments position. It sharply restructured relative official prices through a drastic devaluation and an increase in official producer prices, including those of cocoa, and was accompanied by a liberalization of imports, reconstruction of the economic and social infrastructure, and restoration of fiscal and monetary discipline. The program was successful in many respects. Recorded GDP grew in real terms at 7 percent during the final two years (1984-85) of the program and exceeded the targets; domestic inflation was reduced; and the overall fiscal position improved significantly.
The largest number of the poor in Ghana are landless agricultural workers and smallholders in rural areas. The producers of traded goods, particularly cocoa, although affected by the fluctuations in official prices, may have been able to shield themselves from the adverse effects of an overvalued currency by engaging in informal transactions with neighboring countries. Thus, in the absence of quantitative information it is difficult to determine whether cocoa producers should be classified among the poorest segments of the population. A substantial group of the poor also exists in the urban informal sector.
The program’s emphasis on growth clearly had positive implications for the rural poor. The exchange rate and pricing policies, by increasing the relative prices of traded goods, are likely to have benefited rural smallholders and farm workers, although they probably worsened the situation of the urban poor. Given the widespread operation of black markets prior to the program, however, it is not clear to what extent the new official prices deviated from the earlier un-official prices at which most transactions took place. These policies also contributed to an improvement in the country’s revenue base and, as public expenditure had fallen sharply in the preceding periods, the Government was able gradually to increase social expenditures in the areas of health and education as well as public sector salaries for those in the lower pay scale. The urban poor also benefited from the initial doubling and subsequent tripling of minimum wages during the program period. However, because of the simultaneous liberalization of many administered prices, the net result on real wages is inconclusive.
The program improved revenue mobilization not only through an increase in output but also through a shift of transactions from illicit to open markets. Thus, the liberalization of both domestic and foreign trade contributed to the Government’s revenue mobilization at the expense of illicit traders and the holders of import licenses. Measures were also taken to correct past inequities in the tax law between salaried workers and the self-employed through an increase in the minimum exemption level and a lowering of the marginal tax rates of the personal income tax. On the other hand, other more regressive measures were introduced—namely, an increase in cigarette and beer excises.
The program succeeded in arresting the prolonged economic decline. Although the program policies on the whole had more favorable implications for the earnings of the rural poor than of the urban poor, the latter also appear to have benefited from the program. It should be pointed out, however, that the growth of incomes and output indicated by official data may overestimate the actual increase in output, since some of the increase may reflect shifts of transactions from illicit to open markets. It is also difficult to assess the change in income distribution within the urban sector.
Following the coffee boom in the late 1970s, Kenya experienced a worsening of its domestic and external imbalances. Between 1978 and 1981, both the Central Government’s fiscal deficit and the inflation rate doubled—the latter to 20 percent. During this period, the large external current account deficit persisted. The authorities attempted to address the imbalances through a series of Fund-supported adjustment programs during 1979-82, but none of the programs was successfully concluded.
The 18-month stand-by program (1983-84) sought a substantial reduction in the external current account deficit (excluding grants), from 8 percent of GDP in 1982 to 5 percent in 1984, with a similar reduction envisaged for the fiscal deficit. These targeted adjustments were mostly achieved. The growth of real GDP, at about 2 percent a year during 1983-84, was very low, partly because of a severe drought in 1984, but was about the same as during the two preprogram years. Real wage rates declined, but the decline was less in the agricultural sector, where most of the poor work, than in the industrial sector.
Major policy instruments for the adjustment were a substantial real devaluation at the beginning of the period and a reduction in the share of government expenditure in GDP. The former policy had favorable implications for the earnings of the impoverished farm workers, smallholders, and their families in the coffee and tea areas, who constitute the core poverty groups in Kenya. The latter policy was aimed largely at a reduction of capital outlays on road construction, a sports complex, and on a national airlines company. Among current expenditure, real salaries were allowed to decline, limiting the cutback in essential services for the poor.
Ex post, expenditure developments indicate that the areas most severely affected were general administration and defense. Real expenditure on health services was reduced; the reduction, however, mostly affected health facilities in urban areas rather than those in rural areas, thus protecting the health services of the landless poor.
The slow growth during the program period, following a similarly slow growth during the two preceding years, aggravated the plight of the poor. In assessing the implications of this, however, not only the role of the severe drought in 1984 but also the unsustainability of past policies should be taken into account. It would be misleading to compare the conditions at the end of an adjustment program with those at the height of the unsustainable policy, as a result of which the adjustment had to be implemented. On balance, the policy measures appear to have had positive implications for the largest group of the poor—those in the rural sector. The presence of a fairly large rural subsistence sector may have limited the adverse effects of some policies. The use of capital outlays as an instrument to reduce the fiscal deficit also raises questions on the longer-term implications for economic growth (and poverty alleviation).
Between 1980 and 1982 the Philippine economy deteriorated rapidly. The external terms of trade worsened by more than 35 percent. A domestic financial crisis resulted in expansionary financial policies that sharply raised the government fiscal deficit and the credit expansion of the banking system. The high world interest rates reinforced the adverse impact of the continuing world recession on the external balance. Between 1980 and 1982 the fiscal deficit widened from 1.3 percent to 4.3 percent of GDP, the external current account deficit from 5.4 percent to 8.2 percent, and real GDP growth dropped from 4.4 percent to 2.7 percent. Both the 1983 program and the 1984-85 program, neither of which ran their full course, were formulated and executed during a period of continuing deterioration of the external environment.
The stabilization period may be broadly delineated between October 1983, when a severe foreign exchange shortage emerged, and the end of 1985, when, in anticipation of the presidential elections in February 1986, several program policies were reversed. During most of 1984 the Philippines did not have a formal arrangement with the Fund, but the authorities took a series of adjustment measures in the form of prior actions for the stand-by negotiations. In this case, therefore, it is particularly difficult to disentangle program policies from those taken at the initiative of the authorities.
The October 1983 foreign exchange crisis effectively closed the Philippine economy and induced a major recession. The immediate response was a series of devaluations, spread over a year, and the introduction of severe import and payments restrictions. But an expansionary monetary policy accommodated a rapid increase in inflation, which averaged 50 percent in 1984. Against this background, the authorities formulated the 1985-86 package with a view to restoring confidence, reversing the external sector restrictions, and improving the growth prospects of the economy. The serious erosion of the tax base, however, constrained the Government’s spending policies and in fact caused a serious curtailment in infrastructure projects. The authorities attempted to mitigate the severe erosion of real incomes by raising wages and salaries several times during 1984, but real wages nonetheless declined by 20 percent in 1984 and by 5 percent in 1985.
Monetary policy was initially accommodating and thus validated the inflationary pressures, which in turn caused a serious decline in real wages. The eventual tightening of credit expansion affected poverty groups in urban areas on the sources of income side by raising unemployment in commerce and service activities.
The decontrol of commodity prices reversed a distorted system of price incentives that had beset the Philippine economy for a number of years. At the same time, the impact on consumers was minimal, since many commodities already commanded market prices through premiums extracted by various intermediaries. On balance, the liberalization of pricing policies had a positive impact on the sources side for producers and a neutral impact on the uses side for urban dwellers. Despite an explicit policy commitment under the 1984-85 stand-by arrangement, the authorities failed to proceed with reforms of the sugar and coconut sectors, which exacerbated and prolonged poverty in the rural areas.
External sector policies may be divided into two subperiods: the year 1983, when the financial crisis came to a peak; and 1984-85, when the situation stabilized and later began to improve. During the earlier period, the external policies had adverse distributional effects on all segments of the population, but especially on urban workers. On the uses side, low-income groups were affected by the sharp increase in the price level and by the commodity shortages, both precipitated by the interaction between the devaluations and the import restrictions. On the sources side, the urban poor were particularly affected in the areas of manufacturing, mining, and trade.
Budgetary policies were generally ad hoc and were almost exclusively aimed at revenue targets to sustain a deficit objective. As a result, both the allocational and the distributional concerns of fiscal policy were largely neglected. Tax measures were largely ineffective and their impact on the poor minimal, primarily because they affected the middle- and upper-income groups.
The decline in tax yield triggered substantial expenditure cuts, especially in maintenance and operating expenditures and in capital projects. On the sources side, such adjustments limited the productive capacity of the rural poor and probably transferred resources from the smallholders to large-scale farm industries in monopoly sectors (sugar and coconuts), with adverse distributional implications. On the uses side, the reduction in social expenditures limited the benefits accruing to the poor from such important programs as health, education, and housing. However, although in absolute terms such cutbacks reduced the real consumption of the poor, their distributional implications are unclear because of a questionable progressivity pattern in the original incidence of benefits. In other words, if the original distribution of benefits was pro-rich, a curtailment of public programs would improve the relative position of middle- and lower-income groups, while in absolute terms the situation of the poor could still deteriorate.
In conclusion, the adjustment measures reflected in the 1983 and the 1984-85 stabilization programs, as well as those taken during that period outside the stand-by arrangements, had a clear adverse impact on the poor in the short run. During the latter part of the adjustment period, certain structural policies, especially the removal of import restrictions and price liberalization, set the stage for an increase in the productive capacity of the poor and the shift of their resources to more efficient uses over the medium term.
In 1977, Sri Lanka instituted economic reforms aimed at removing major bottlenecks to growth. Although the reforms were successful in setting the groundwork for long-term gains in terms of improved living standards, during 1977-82 an expansionary policy stance and adverse external developments resulted in large domestic and external imbalances. In 1982, the negative effects of the world recession and poor weather were aggravated by slow policy adjustment. The fiscal deficit continued to increase, and the exchange rate appreciated sharply in real effective terms. The external current account deficit continued to increase, resulting in negative net international reserves.70
The one-year stand-by program (1983-84) aimed at reducing the external current account deficit while maintaining sustained economic growth. Domestic inflation was to be halved. Economic developments during the program period were mixed. In spite of social disturbances arising from ethnic problems and a major drought, the growth of real GDP, at 5 percent in 1983, slightly exceeded the program target. Credit expansion to the private sector, including public corporations, however, exceeded the ceiling, jeopardizing efforts to reduce domestic inflation and causing a large increase in import demand. Although the program lasted for only five months before it was interrupted, many of the significant policy measures were implemented. However, the inability of the authorities to maintain the momentum of adjustment suggests that the results of the following analysis may be inconclusive.
Substantial increases in the domestic prices of paddy, key energy products, and food were introduced. The increases in some prices for food (milk, rice, and wheat flour), energy, transport fares, and fertilizers inevitably had adverse effects on the living standards of the poor. The price of kerosene, used extensively by the poor, increased by 69 percent, more than the increases for gasoline and diesel. However, when the price increases were implemented, the Government had a kerosene stamp program for low-income groups.71 Government expenditure under the kerosene stamp program increased at about the same rate as the increase in the kerosene price, thus mitigating the adverse effects of the price increase on the real consumption of the poor.
The Government also continued its efforts to reduce the role of food subsidies. Although expenditure under the food subsidy program declined relative to the consumer price index, it remained virtually unchanged relative to the price of rice, on which most of the subsidies were spent by the recipients. Thus, the adverse effect of the policy to reduce food subsidies on the nutrition of the poor was probably negligible.
The use of compensatory measures to mitigate the effects of the adjustment measures on the poor is an important lesson of this program. The kerosene stamp scheme may have been more effective in targeting poverty groups in genuine need than a policy of keeping kerosene prices low. The increase in paddy prices may have had a positive impact on the incomes of farm workers and of smallholders in paddy farming areas. The pricing measures—aimed at more efficient use of scarce goods—also contributed to fiscal consolidation.
The program also sought to cut capital outlays as a means of achieving fiscal adjustment. Although its possible adverse implications for longer-term economic growth are important, the authorities had long recognized the unsustainability of the high level of public investment.
During the program period, minimum wages declined in real terms, despite their increase in nominal terms. This reflected a domestic inflation rate that exceeded the program target. These developments in real minimum wages had adverse implications for unskilled workers, primarily in the urban formal sector.
Following a strong economic performance during the two decades through the late 1970s, adverse fiscal and external developments and an ambitious development plan resulted in a weakened external payments position and increased domestic inflation. The 1981—82 world recession further weakened Thailand’s fiscal and underlying external payments position, although the external current account deficit actually declined in 1982 as a result of a drop in imports that reflected the low real growth of the economy.
The program aimed at restoring growth while achieving fiscal adjustment and improving the underlying external payments position. The growth of real GDP was targeted at 6 percent in 1983, with the external current account deficit to increase somewhat from the low level of 1982. Thus, the program was prepared in response to underlying internal imbalances and, in this respect, was not similar to other sample programs, which were prepared in response to a severe deterioration of external imbalances. The outcome of the program was mixed. Favorable weather, an improvement in the external terms of trade, and program policies contributed to the attainment of the growth target, and the increase in output helped reduce domestic inflation. Real minimum wages increased. However, the expansion of domestic credit to the private sector exceeded the target. This, together with the real effective appreciation of the baht, contributed to a sharp increase in the volume of imports and a consequent exceeding of the external current account deficit target.
Fiscal adjustment, aimed at reducing the deficit, was to be achieved largely through three sets of measures. The first set, targeted at relatively wealthy income groups, included a reduction in collection lags for the corporate income tax and the personal income tax on professionals, the conversion of excise rates on imported liquor from a specific to an ad valorem basis, and an increase in the excise rates on selected petroleum products (excluding fuel oil). The second set, targeted at broad groups of imported consumer goods, included an increase in overall tariff rates. The third set, intended to promote external adjustment, included a reduction in the export duty on rice. The latter measure favored the smallholders and farm employees who are the majority of the poor in Thailand.
The Thai program illustrates an early response to potential problems. It illustrates a revenue-oriented fiscal policy package that was fairly progressive. It also illustrates economic developments on which exogenous events had a dominant impact, with important implications for the poor. Favorable weather caused a 12 percent increase in paddy production, thus contributing to an increase in the earnings of paddy farmers while favorably affecting the urban poor by reducing rice prices. The increase in the excise rates on petroleum products was also implemented when the petroleum prices were falling; thus, in spite of the increase in excises, the consumer prices of petroleum products actually fell during the program period.
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Examples of related studies in 1986 and 1987 include those supported by the Overseas Development Institute, a book published under the sponsorship of the UNICEF (Cornia, Jolly, and Stewart (1987)), a series of papers presented at the Second Takemi Symposium on International Health at Harvard University, those presented at a conference on adjustment policies and poverty sponsored by the Cornell Nutritional Surveillance Program, and several World Bank and Fund studies.
Such arguments assume either that less rapid adjustment should be supported by more external financing or that improved program design can reduce the loss of output and the cost of adjustment. In either case, it is argued, the poor could be better protected during the initial period of adjustment. Arguments are made by Cornia, Jolly, and Stewart (1987) and Taylor (1987).
See Taylor (1987).
The UNICE F study contains a strong argument for such an activist role for adjustment programs—see Cornia, Jolly, and Stewart (1987), pp. 131–46.
Such measures include money and credit policies and pricing, labor market, and exchange rate policies. Other external sector policies, including trade restrictions or liberalization and the role of tariffs, are also examined.
In some countries, confining the period of analysis to 1983-84 may omit a period in which Fund-supported programs had a significant distributional impact. For example, the stand-by and extended Fund arrangements with Sri Lanka in 1977—78 and 1979—81 may, in retrospect, have been more appropriate for such an analysis. The 1977-78 adjustment program, in particular, struck at the very core of direct government assistance through consumer subsidies, price controls, and the provision of free health and education services. Thereafter, direct provision of goods was targeted toward the poorer half of the population, based on an income cutoff point.
In characterizing the poor, a country-specific definition of the poverty line has been used in this study, based on estimates provided by the World Bank. Typically, the focus is on the lowest 30 percent of income distribution. Nevertheless, the drawing of the poverty line is in some respects arbitrary and will obviously differ between countries.
In the absence of exact quantitative information, it is difficult to distinguish between the poor engaged in the production of tradable goods and those involved largely or exclusively with crops destined for domestic consumption.
While considerable efforts were made in the early 1970s to understand the factors underlying poverty in developing countries, the process by which the poor are affected during the course of an economic adjustment program has only recently received attention. See Glewwe and de Tray (1987), Thorbecke and Berrian (1987a), and Bourguignon (1987).
The approach of linking the dominant policy instruments with a typology of the poor was not formalized in the case studies, owing to a lack of the required data. A more detailed framework for further investigations along these lines is provided below, pages 11–13.
See “The Analytical Implications of a Significant Informal Sector,” page 11, below.
Changes in absolute poverty may arise in a number of ways—from a change in the number of the poor or from an increase in the aggregate poverty gap (e.g., the amount of income needed to bring all households in poverty to the poverty income threshold). A reduction in the size of the latter without a reduction in the number of households in poverty may be observed. Also, the effect of measures will differ depending on which groups of the poor are focused on—those in the rural or urban sectors, those in the lowest 10 or 30 percent of households, or children or adults of poor households. Finally, the definition of absolute poverty will probably differ across countries.
Some important conceptual issues have already been addressed in an earlier Fund Occasional Paper (International Monetary Fund (1986)) and are therefore not discussed here. These issues include discussion of the appropriate role of counterfactual analysis. Also worthy of attention are a number of papers recently written for a conference at Cornell University, “Analytical Methods for Estimating Short-Term Nutritional and Poverty Effects of Macroeconomic Adjustment Policies in Developing Countries” (see Achdut and Bigman (1987), Addison and Demery (1987), Behrman and King (1987), Catsambas (1988), Glewwe and de Tray (1987), and Thorbecke and Berrian (1987a and 1987b)).
As shown, for example, by participants’ comments at the Cornell University conference noted in footnote 14.
However, even a direct, simplistic link between nutrient intake and health status has been challenged. See Behrman and King (1987).
This study, therefore, does not explicitly consider the differential impact of adjustment programs on the number of the poor as opposed to the poverty gap. It also ignores issues related to nutritional intake, health status, and intrafamily consumption characteristics, which would have to be addressed under an all-encompassing definition of poverty.
A classification along these lines was presented in Kanbur (1987).
Glewwe and de Tray (1987).
Khan and Knight (1985), p. 24.
It is difficult to judge the magnitude, for reasons touched on in Section III, pages 10–11. In some extreme cases, parallel market prices might follow the rate of official price decontrol.
The labor market policies that apply specifically to the public sector are discussed in Section V.
For a discussion on the supply-side effects of prolonged unemployment, see Blanchard and Summers (1986).
Some employment programs degenerated into de facto income transfers and may have discouraged the movement of labor into tradable activities or activities supporting the supply of tradables.
If such support is lacking, a vicious circle of inflation and devaluation will result. Poverty groups are often least able to protect themselves against this vicious circle. For an overview of the role of exchange rate policy in Fund-supported adjustment programs, see Johnson and others (1985).
For a discussion of the factors determining the distributional effects of depreciation in a stylized neoclassical model of international trade with a tradable and a nontradable sector, see Johnson and Salop (1980). They show that in the very short run, with no intersectoral mobility, real incomes of the factors of production employed in the tradable sector increase. If labor is mobile across sectors but capital is not, the effect on real wages depends on the share of tradables in the consumption basket of workers. In the long run, with perfectly mobile labor and capital, the factors most intensively used in the tradable goods sector benefit.
In countries with severe external imbalances, the poor usually do not have access to all tradable goods at official prices. Consequently, poverty groups are forced to purchase some of these goods in parallel markets at prices that exceed official prices. Although a depreciation of the exchange rate may result in a large increase in official prices of tradable goods, its impact on actual prices paid by the poor may be relatively small or even negative.
Such policies are also consistent with the objective of structural adjustment. By enhancing the supply response, they mitigate the possible contractionary effects associated with depreciation and permit external adjustment to occur at higher levels of absorption. One should not underestimate, however, the production and marketing rigidities that dominate the rural sector of most developing countries. Such constraints may seriously limit the producers’ ability to expand output or may channel the benefits from export price increases into a long chain of middlemen. Under these circumstances, the proposition that the rural poor typically benefit from devaluation remains questionable, unless the exchange rate adjustment is accompanied by measures to reduce supply rigidities and bottlenecks in production and marketing.
In order to deal with a foreign exchange crisis in 1983, however, the authorities in the Philippines not only devalued the exchange rate but also imposed import restrictions and capital controls. Subsequently, they removed many of these restrictions and floated the exchange rate at the end of 1984.
The program with Ghana increased the export tax on gold. This tax ensured that the windfall profits in the mining sector associated with the depreciation would accrue to the public sector rather than to the few mining companies.
This may also have happened in the Philippines.
In Chile, minerals constitute an important share of exports. Consequently, the agricultural sector shared the benefits from the depreciation with the mining sector.
In the extreme case of perfectly mobile labor and perfectly competitive markets, real wages fall if the share of tradable goods in the consumption basket of workers is large (see Johnson and Salop (1980)). Land reform helps to increase the immediate positive effects of depreciation on the rural poor. Sachs (1987) argues that land reform reduces the political resistance to timely depreciations.
External borrowing may be appropriate if the external imbalance is expected to be temporary.
Another alternative to exchange rate depreciation is an increase in concessionary finance or grants from the rest of the world. This involves a redistribution of income across nations.
In Chile, the delay reflected the authorities’ perception at that time that the external disequilibrium might have been temporary and that policy measures other than devaluation might have been more efficient in the circumstances.
This process can be viewed as capital flight in the face of an unsustainable external position. Instead of foreign assets, domestic residents acquire foreign goods to protect themselves against the effects of measures aimed at restoring external balance.
Similarly, the restrictive trade policies implemented in the Philippines in 1983 hit most poor groups particularly hard because they led to shortages of tradable commodities.
These policies reduced the real depreciation required to establish external and internal balance, which suggests that exchange rate policy needs to be assessed in the context of an overall policy package.
The 1984–85 program with the Philippines removed the import restrictions that had been imposed earlier.
The program with Chile allowed the fiscal stance to ease moderately during the second year of the program. The maintenance of fiscal discipline, however, continued to be a principal element of the program. In particular, the program envisaged an improvement in the savings performance of the public sector.
For some evidence on the incidence of government expenditure in Colombia, see Selowsky (1979). Tanzi (1974) argues that lower-income classes in Latin America are predominantly rural individuals who benefit very little from government programs because these programs are focused on the urban areas.
An alternative to targeting, which may have serious disincentive effects, is subsidization through rationing schemes or food-for-work programs.
For a review of domestic pricing policies affecting petroleum under Fund-supported programs during 1980–82, see Kibuka (1987).
However, higher energy costs feed into prices of goods consumed by the poor. To illustrate, the cost of public transportation may increase because of higher fuel costs
Alternatively, if the tax burden of financing expenditure is borne largely by the poor, assisting the poor may in fact call for a cut in expenditure in order to achieve a lower fiscal deficit, reduce taxation, or lower inflation.
Capital expenditure seems particularly vulnerable to cuts in public expenditure (Cornia, Jolly, and Stewart (1987) and Hicks and Kubisch (1984)).
This explains why strategies that are costly in terms of external indebtedness are often unsuccessful in generating employment for the disadvantaged.
See Cornia, Jolly, and Stewart (1987), pp. 73–89; and Hicks and Kubisch (1984).
Whereas on average real per capita social expenditure fell by more than a third during this period, the largest declines occurred in housing (about 75 percent) and health (about 40 percent).
A recent study financed by the Inter-American Development Bank argues that expenditures on primary education generally have the greatest redistributive impact of all social expenditures: expenditures on secondary education are slightly progressive, while expenditures on higher education are regressive. See Inter-American Development Bank (1986).
In an attempt to improve the efficiency and targeting of public expenditures, for example, the authorities increased rates and tariffs on goods and services sold by public enterprises. Consequently, the contribution of public enterprises to public savings rose during the program period.
The poor would be hurt indirectly if they were employed in the production of the luxury goods. In the sample countries, however, it would be fair to say that luxury consumption is primarily import oriented.
In practice, however, because of special allowances, preferential rates, and loopholes, the overall incidence of theincome tax is usually less progressive than its rate structure indicates.
Even though, in the long run, the burden could be shared by labor.
On the other hand, since tobacco products are injurious to health, the poor may not be better off in a total welfare sense when they are cheap.
It could also be argued, however, that the proper comparison is not with a disorderly adjustment, but with a more balanced adjustment process that would have placed less emphasis on demand management.
Poverty groups generally are least able to respond quickly and to protect themselves when an unsustainable production structure collapses.
These examples are not representative of the short-run effects of adjustment policies on the poor. In many cases, partly depending on the structure of poverty, the same type of adjustment policies significantly benefited important poverty groups in the short run.
The adverse effects tend to be less in countries with important parallel markets in tradable goods, where a devaluation of the exchange rate may have little impact on the actual prices for tradable goods paid by the urban poor.
When compared with the counterfactual case, the adverse longrun effects need to be balanced against the likely positive long-run effects on poverty groups associated with a reduced need for financing. Also, the cuts in capital expenditure might have been even greater without a Fund-supported program.
The moderate macroeconomic policy management in most of the programs was due not only to the supply-side measures incorporated but also to rather favorable external circumstances and to the recovery from the 1981–82 worldwide recession. Indeed, excessive demand restraint may seriously damage supply, including that of the poor, by deteriorating the stocks of human and physical capital. Supply-side programs may require more financing because the effects of structural policies may take more time to materialize policies focused on demand restraint. For a discussion of this issue, see Tanzi (1987).
For a longer-term analysis of the impact of adjustment policies on the distribution of income in Sri Lanka, see a number of studies, including Bhalla and Glewwe (1986), pp. 35–64, and Sahn (1987), pp. 809–30. The Bhalla and Glewwe study concludes that Sri Lanka’s policies to promote growth-oriented adjustment accelerated growth and raised a number of living standard indicators without worsening expenditure inequality. The Sahn study notes that during 1977–84 policies promoted investment in physical capital (social infrastructure) at the cost of human capital (nutrition and health expenditure) and that the fiscal deficit increased, aggravating domestic inflation and reducing real wages; however, the study does not attempt to analyze whether the continuation of the pre-1977 policies to alleviate poverty directly through government expenditures would have resulted in more favorable results for the poor.
It should also be noted that the large increase in kerosene prices was a delayed response to the increase in world oil prices in 1979–80; kerosene prices in Sri Lanka had been kept low for a prolonged period, while the prices of other petroleum products were raised quickly.
Occasional Papers of the International Monetary Fund
2. Economic Stabilization and Growth in Portugal, by Hans O. Schmitt. 1981.
5. Trade Policy Developments in Industrial Countries, by S.J. Anjaria, Z. Iqbal, L.L. Perez, and W.S. Tseng. 1981.
6. The Multilateral System of Payments: Keynes, Convertibility, and the International Monetary Fund’s Articles of Agreement, by Joseph Gold. 1981.
8. Taxation in Sub-Saharan Africa. Part I: Tax Policy and Administration in Sub-Saharan Africa, by Carlos A. Aguirre, Peter S. Griffith, and M. Zühtü Yücelik. Part II: A Statistical Evaluation of Taxation in Sub-Saharan Africa, by Vito Tanzi. 1981.
10. International Comparisons of Government Expenditure, by Alan A. Tait and Peter S. Heller. 1982.
11. Payments Arrangements and the Expansion of Trade in Eastern and Southern Africa, by Shailendra J. Anjaria, Sena Eken, and John F. Laker. 1982.
12. Effects of Slowdown in Industrial Countries on Growth in Non-Oil Developing Countries, by Morris Goldstein and Mohsin S. Khan. 1982.
13. Currency Convertibility in the Economic Community of West African States, by John B. McLenaghan, Saleh M. Nsouli, and Klaus-Walter Riechel. 1982.
14. International Capital Markets: Developments and Prospects, 1982, by a Staff Team Headed by Richard C. Williams, with G.G. Johnson. 1982.
15. Hungary: An Economic Survey, by a Staff Team Headed by Patrick de Fontenay. 1982.
16. Developments in International Trade Policy, by S.J. Anjaria, Z. Iqbal, N. Kirmani, and L.L. Perez.1982.
17. Aspects of the International Banking Safety Net, by G.G. Johnson, with Richard K. Abrams. 1983.
18. Oil Exporters’ Economic Development in an Interdependent World, by Jahangir Amuzegar. 1983.
19. The European Monetary System: The Experience, 1979-82, by Horst Ungerer, with Owen Evans and Peter Nyberg. 1983.
20. Alternatives to the Central Bank in the Developing World, by Charles Collyns. 1983.
22. Interest Rate Policies in Developing Countries: A Study by the Research Department of the International Monetary Fund. 1983.
24. Government Employment and Pay: Some International Comparisons, by Peter S. Heller and Alan A. Tait. 1983. Revised 1984.
26. The Fund, Commercial Banks, and Member Countries, by Paul Mentre. 1984.
28. Exchange Rate Volatility and World Trade: A Study by the Research Department of the International Monetary Fund. 1984.
29. Issues in the Assessment of the Exchange Rates of Industrial Countries: A Study by the Research Department of the International Monetary Fund. 1984.
30. The Exchange Rate System—Lessons of the Past and Options for the Future: A Study by the Research Department of the International Monetary Fund. 1984.
33. Foreign Private Investment in Developing Countries: A Study by the Research Department of the International Monetary Fund. 1985.
34. Adjustment Programs in Africa: The Recent Experience, by Justin B. Zulu and Saleh M. Nsouli. 1985.
35. The West African Monetary Union: An Analytical Review, by Rattan J. Bhatia. 1985.
36. Formulation of Exchange Rate Policies in Adjustment Programs, by a Staff Team Headed by G.G. Johnson. 1985.
38. Trade Policy Issues and Developments, by Shailendra J. Anjaria, Naheed Kirmani, and Arne B. Petersen. 1985.
39. A Case of Successful Adjustment: Korea’s Experience During 1980-84, by Bijan B. Aghevli and Jorge Marquez-Ruarte. 1985.
41. Fund-Supported Adjustment Programs and Economic Growth, by Mohsin S. Khan and Malcolm D.
42. Global Effects of Fund-Supported Adjustment Programs, by Morris Goldstein. 1986.
44. A Review of the Fiscal Impulse Measure, by Peter S. Heller, Richard D. Haas, and Ahsan H. Mansur. 1986.
45. Switzerland’s Role as an International Financial Center, by Benedicte Vibe Christensen. 1986.
46. Fund-Supported Programs, Fiscal Policy, and Income Distribution: A Study by the Fiscal Affairs Department of the International Monetary Fund. 1986.
47. Aging and Social Expenditure in the Major Industrial Countries, 1980-2025, by Peter S. Heller, Richard Hemming, Peter W. Kohnert, and a Staff Team from the Fiscal Affairs Department. 1986.
48. The European Monetary System: Recent Developments, by Horst Ungerer, Owen Evans, Thomas Mayer, and Philip Young. 1986.
49. Islamic Banking, by Zubair Iqbal and Abbas Mirakhor. 1987.
50. Strengthening the International Monetary System: Exchange Rates, Surveillance, and Objective Indicators, by Andrew Crockett and Morris Goldstein. 1987.
51. The Role of the SDR in the International Monetary System, by the Research and Treasurer’s Departments of the International Monetary Fund. 1987.
52. Structural Reform, Stabilization, and Growth in Turkey, by George Kopits. 1987.
53. Floating Exchange Rates in Developing Countries: Experience with Auction and Interbank Markets, by Peter J. Quirk, Benedicte Vibe Christensen, Kyung-Mo Huh, and Toshihiko Sasaki. 1987.
54. Protection and Liberalization: A Review of Analytical Issues, by W. Max Corden. 1987.
55. Theoretical Aspects of the Design of Fund-Supported Adjustment Programs: A Study by the Research Department of the International Monetary Fund. 1987.
56. Privatization and Public Enterprises, by Richard Hemming and Ali M. Mansoor. 1988.
57. The Search for Efficiency in the Adjustment Process: Spain in the 1980s, by Augusto Lopez-Claros. 1988.
58. The Implications of Fund-Supported Adjustment Programs for Poverty: Experiences in Selected Countries, by Peter S. Heller, A. Lans Bovenberg, Thanos Catsambas, Ke-Young Chu, and Parthasarathi Shome. 1988.
Note: Excludes those titles that are now out of print or that are now included in the series “World Economic and Financial Surveys.”
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