Chapter

VI. Lessons of the Review

Author(s):
International Monetary Fund
Published Date:
May 1988
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The results of the study suggest that adjustment programs in general have important distributional implications. During the process of adjustment it is inevitable that some social groups gain while others lose, particularly when adjustment is aimed at a shift in sectoral resource allocation. Although many of the major policy instruments improved the position of the dominant poverty groups in the sample countries, other poverty groups were made worse off in the short run. The study has shown that in a number of cases the use of compensatory measures offers some scope for protecting these vulnerable groups during the process of adjustment, although the scope may be limited depending on the tightness of budget constraints.

The analysis in this paper also suggests that although adjustment policies may have certain undesirable distributional effects, stabilization may nevertheless, on the whole, play a constructive role in safeguarding the long-term interests of the poor from the adverse effects of domestic or external shocks. Given an external financing constraint, the alternative to an orderly stabilization program is often either disorderly adjustment through rapid inflation or continuation of unsustainable economic imbalances suppressed through direct government controls, resulting in black markets in goods and currencies.63 In either of these situations, the poor would suffer badly. The following arguments support this assertion:

  • The better-off are generally in a better position than those in poverty to protect themselves against the explicit and implicit taxes associated with unsustainable policies. In particular, the wealthy can often avoid these taxes by shifting their assets abroad, thereby eroding the tax base in the process, or by switching to real assets. The less well-off, in contrast, cannot move their assets, including their human capital, abroad. They therefore bear most of the explicit and implicit tax burdens, including inflation, that are associated with unsustainable macroeconomic policies.
  • The least skilled are the first to be laid off or to suffer declines in earnings in the informal sector, if wages in the formal sector remain at unsustainably high levels incompatible with internal balance, or if net capital inflows fall in response to unsustainable policies. They, therefore, suffer most from unemployment, which may not only reduce their incomes in the short run but also adversely affect their human capital.
  • Unsustainable policies provide the wrong economic signals. They misdirect the productive resources of the economy, including those of poverty groups, by locking economic agents into unsustainable (often nontradable) activities.64
  • Political interventions that become necessary in the absence of orderly adjustment tend to favor politically powerful groups. They divert resources into rent-seeking activities and raise rents based on political privilege rather than on economic performance.
  • The poor are often the hardest hit by the high prices prevailing on black markets, since they lack access to goods at official prices. Major exchange rate changes may result in large increases in officially measured prices, but the impact on market prices (and on the poor) may be small (and even negative).

The Poverty Effects of Adjustment Depend on the Structure of Poverty and on the Policy Mix

The arguments in the previous subsection suggest that adjustment programs, besides being necessary to establish macroeconomic equilibria, may also turn out to protect the interests of the poor if properly designed and implemented. It has been argued that adjustment programs should attempt to protect the least well-off groups from adverse external and domestic shocks. Therefore, the position of the poor should be compared not only with the counterfactual case but also with the situation before the program came into effect. None-theless, some of the macroeconomic policies that aimed at restructuring production aggravated the plight of some vulnerable groups in the short run and did not help to alleviate the poverty of some groups in the longer run. Unfortunately, compensatory policy measures were not always sufficient to offset these adverse effects.

Examples of adjustment policies that had significant adverse short-run effects on important vulnerable groups 65 or failed to assist poverty groups in the longer run are:

  • Devaluation in countries with large urban poverty groups imposed immediate costs on the urban poor who were locked into the production of nontradables (Chile, the Dominican Republic, and the Philippines).66
  • Devaluation was rather ineffective in improving the plight of the rural poor in those countries in which land ownership was concentrated, labor was mobile between urban and rural sectors, and nontradable production was labor intensive (Chile, the Philippines, and the Dominican Republic).
  • Devaluation was ineffective in improving the shor-trun position of those poor farmers whose short-run supply elasticities were small relative to those of rich farmers. Low elasticities of supply could reflect supply bottlenecks (such as inadequate or insufficiently maintained infrastructure), production of nontradable food-stuffs for the domestic market, or concentration on subsistence agriculture (Kenya and the Philippines).
  • Sharp cuts in capital expenditures may have hurt the poor both in the short and the long run.67 In the short run, such cutbacks reduced real wages and employment opportunities for the poor. In the long run, they may have adversely affected the services provided to the poor by the social and economic infrastructure.68 Cuts in expenditure on rural infrastructure may have prevented poor farmers from responding to improved price incentives, thereby negatively affecting the value of their assets (Kenya, Sri Lanka, and the Philippines).
  • Cuts in health and education expenditures accruing to the poor adversely affected poverty groups, in both the short and the long run. In the short run, the cuts reduced consumption benefits. In the long run, they may have hurt the productive capacity of the poor (Sri Lanka and the Philippines).
  • Some selective increases in excises, such as those on beer, adversely affected the poor (Ghana and Kenya) in terms of real income (though not perhaps in welfare terms).
  • Through their impact on the real exchange rate, import duties hurt the value of the assets owned by the poor engaged in export production (Sri Lanka and Thailand).
  • Restrictive monetary policies adversely affected both employment opportunities and earnings for urban poverty groups in the short run (the Philippines).

Poverty Alleviation Requires Supply-Side Policies and Adjustment Assistance (or Compensatory Measures)

Most programs succeeded in achieving macroeconomic equilibrium, partly through structural adjustment measures on the supply side. These growth-oriented adjustment programs, therefore, could rely less on demand restraint.69 Moreover, the structural elements of the program could incorporate positive steps to assist the poor more efficiently by raising their productive capacity. The following examples may be cited:

  • Financial reform generally increased the supply of loanable funds available to the poor by reducing the role of rationing in allocating credit and by raising foreign and domestic saving (Ghana, Kenya, and Chile). Some programs supported an increase in credit to agriculture (the Dominican Republic and Sri Lanka).
  • Depreciating the exchange rate raised the real value of earnings for many of the rural poor engaged in export production (Ghana, and, to a lesser extent, Kenya and the Philippines).
  • Removing price controls contributed to more efficient resource allocation and a reduction of rents based on political privilege (Ghana and the Philippines).
  • From the sources of income side, shifting the composition of public expenditures toward those expenditures that utilize the skills of the poor by expanding labor-intensive investment programs improved the position of vulnerable groups in the short run and protected the quality of their human capital (Chile and the Dominican Republic).
  • From the uses of income side, shifting the composition of public expenditures to those expenditures that are better targeted toward the poor and more efficient in yielding public services benefiting the poor enhanced the real consumption of the poor (Ghana, Kenya, and Chile).

For those poverty groups that cannot be drawn into the restructuring of production in the short run, other compensatory measures may constitute the only effective means of adjustment assistance. Whereas compensatory measures were not an explicit part of the adjustment programs, the authorities in some countries took steps to protect some of the poor who suffered immediate adverse effects from unfavorable external shocks or from policy measures aimed at restructuring production. In some cases such measures may have required more gradual adjustment and additional financing. In other cases, in contrast, these measures may have facilitated more forceful adjustment by making the adjustment politically feasible and by freeing macroeconomic policy tools to achieve macroeconomic stabilization. Moreover, some adjustment programs may have acted as a catalyst for governments to find more efficient and better targeted instruments to protect vulnerable groups.

Some examples of compensatory measures are:

  • When removing price subsidies or increasing indirect taxes, the authorities protected the poor from adverse short-run effects by introducing rationing schemes targeted at the poor (Sri Lanka and Chile).
  • Employment schemes helped to protect both the income position and the human capital of vulnerable groups (Chile), although such programs had been in existence for many years.
  • Changing the composition of social expenditures (such as on health and education) toward those expenditures benefiting poverty groups protected many of the poor (Kenya and Chile).

Since the adoption of effective compensatory programs requires time and probably experimentation, the best way to protect the poor is by designing and developing a set of instruments not under the pressure of a crisis but through a conscious, long-term plan that will protect the most vulnerable groups.

Concluding Thoughts

While useful in providing a perspective on the impact on poverty groups of Fund-supported programs, this study also highlights the difficulties involved in carrying out analyses of this kind and is suggestive of the priorities for future research. Section III clearly suggests the serious limitations in methodology that are obstacles to identifying the distributional impact of individual or combined policy measures. While one may attempt to intuit particular effects, it is clear that there are numerous and complex channels through which the poor are affected. The uncertainties in analysis become greater the longer the time horizon involved. This is a particularly serious limitation in that the benefits of the types of policies supported by the Fund are more likely to emerge over the medium to longer term. In the shorter term, the costs are far more visible than the benefits. The difficulties of providing a measure of the costs likely to emerge from the counterfactual situation further complicate analysis.

Lack of data is another major obstacle, restricting analysis in most cases to impressionistic views on the sources and uses of income of the poor, of their holdings of assets, or of their likely potential to participate actively in the adjustment process. While this study has attempted to provide an economic characterization of the poor, other perspectives may be equally illuminating and of policy significance. For example, an understanding of the share of the poor in dependent age groups (young children or the elderly), or of the household structure of poverty may yield additional important insights on the impact of particular policy measures or of critical policy options, which this study was unable to address owing to the lack of the required data base.

Finally, while the emphasis in this paper has been largely one of identifying the impact of adjustment on the poor, one cannot forget that structural poverty persists, even in the absence of a need for adjustment. Even where successful macroeconomic adjustment takes place with concern for limiting the burden of adjustment borne by the poor, the core of poverty in a country may be large and an important source of concern for economic policymakers.

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