The Impact of Macroeconomic Policies on Poverty and Income Distribution

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But they reinforce the point that economic growth alone is not sufficient for poverty reduction and that complementary redistributional policies may be needed to ensure that the poor benefit from growth. Finally, while issues regarding the composition of growth also go beyond strict macroeconomics, several general policy observations can be made. There is a general consensus that policies that introduce distortions in order to influence growth in a particular sector can hamper overall growth. The industrial policies pursued by many African developing countries in the s have long been discredited World Bank, Instead, strategies for sector specific growth should focus on removing distortions that impede growth in a particular sector.

In addition, policymakers should implement policies that will empower the poor and create the conditions that would permit them to move into new as well as existing areas of opportunity, thereby allowing them to better share in the fruits of economic growth. The objectives of such policies should include creating a stable environment and level playing field conducive to private sector investment and broad-based economic growth; removing the cultural, social, and economic constraints that prevent the poor from making full use of their existing asset base and accessing markets; and increasing the human capital base of the poor through the provision of basic health and education services.

Macroeconomic Stability and Economic Growth. Broadly speaking, two considerations underlie macroeconomic policy recommendations. First, there needs to be an assessment of the appropriate policy stance to adopt in a given set of circumstances i. Second, there is the choice of specific macroeconomic policy instruments that would be beneficial for a country to adopt e.

In practice, these two considerations are closely linked.

Adjusting a policy stance is often done via the adoption of a new instrument or the modification of an existing one. These situations can be put into three broad classes: This Section briefly discusses how macroeconomic policies can contribute to stability. For countries that enjoy stable macroeconomic conditions, there is somewhat greater flexibility in the choice of appropriate stance for macroeconomic policy.

The central issue for these countries will be to ensure that the financing of their poverty reduction strategies does not jeopardize macroeconomic stability, which will be discussed in the last section of this pamphlet. There are two main sources of economic instability, namely exogenous shocks and inappropriate policies. For example, many low income countries have a narrow export base, often centered on one or two key commodities. Even diversified economies, however, are routinely hit by exogenous shocks, although, reflecting their greater diversification, shocks usually need to be particularly large or long-lasting to destabilize such an economy.

At times, economic crises are the result of both external shocks and poor management. In most cases, addressing instability i. However, if the source of instability can be clearly identified as a temporary shock e. Since there is often a considerable degree of uncertainty surrounding such a judgment, it is usually wise to err somewhat on the side of caution by assuming that the shock will largely persist and by basing the corresponding policy response on the appropriate adjustment.

In most circumstances where adjustment is necessary, both monetary or exchange rate and fiscal instruments will have to be used. In particular, successful adjustment to a permanent unfavorable shock that worsens the balance of payments will often require a sustained tightening of the fiscal stance, as this is the most immediate and effective way to increase domestic savings and to reduce domestic demand—two objectives typically at the center of stabilization programs.

Adjustment policies may contribute to a temporary contraction of economic activity, but this contingency should not be used to argue against implementing adjustment policies altogether, as the alternative may be worse. Attempting to sustain aggregate demand through unsustainable policies will almost certainly aggravate the long-run cost of a shock, and could even fail in the short run to the extent that it undermines confidence.

In the long run, greater benefits to the poor are to be had as a result of the restoration of macroeconomic stability. The appropriate policies to protect the poor during adjustment are to maintain, or even increase, social expenditures and to adopt, where feasible, compensatory measures that would insulate or offset temporary adverse impacts to the fullest extent possible.

In some cases, a lack of financing will drive the pace of stabilization. Where financing is not a constraint, however, policymakers will need to assess and carefully weigh various factors on a case-by-case basis in choosing the most appropriate pace of stabilization. Macroeconomic policies influence and contribute to the attainment of rapid, sustainable economic growth aimed at poverty reduction in a variety of ways. By pursuing sound economic policies, policymakers send clear signals to the private sector. The extent to which policymakers are able to establish a track record of policy implementation will influence private sector confidence, which will, in turn, impact upon investment, economic growth, and poverty outcomes.

Prudent macroeconomic policies can result in low and stable inflation. Inflation hurts the poor by lowering growth and by redistributing real incomes and wealth to the detriment of those in society least able to defend their economic interests. High inflation can also introduce high volatility in relative prices and make investment a risky decision. Unless inflation starts at very high levels, rapid disinflation can also have short-run output costs, which need to be weighed against the costs of continuing inflation. By moving toward debt sustainability , policymakers will help create the conditions for steady and continuous progress on growth and poverty reduction by removing uncertainty as to whether a government will be able to service new debt.

By keeping domestic and external debt at levels that can be serviced in a sustainable manner without unduly squeezing nondebt expenditure, policymakers can also ensure that adequate domestic resources are available to finance essential social programs. Inappropriate exchange rate policies distort the composition of growth by influencing the price of tradable versus nontradable goods.

Household survey data for a number of countries indicate that the poor tend to consume higher amounts of nontradable goods while generating relatively more of their income from tradable goods Sahn, Dorosh, and Younger, Hence, in addition to distorting trade and inhibiting growth, an overly appreciated exchange rate can impair the relative incomes and purchasing power of the poor.

By building and maintaining an adequate level of net international reserves , a country can weather a temporary shock without having to reduce essential pro-poor spending. External shocks can be particularly detrimental to the poor because they can lower real wages, increase unemployment, reduce nonlabor income, and limit private and net government transfers.

Recent data indicate that many developing countries are presently in a state of macroeconomic stability see Tables 1—3 at the end of this pamphlet. Three key issues are discussed in this section: Once a country has developed a comprehensive and fully costed draft of its poverty reduction strategy, it will need to ensure that the strategy can be pursued and financed in a manner that does not jeopardize its macroeconomic stability and growth objectives. The following paragraphs present a conceptual framework that could be useful to policymakers in determining whether their poverty reduction strategy is consistent with their macroeconomic objectives.

Given that it is difficult to determine beforehand what the growth target should be, policymakers may wish to consider developing alternative macroeconomic scenarios that take into consideration possible variations in the rate of economic growth. Such scenarios could be usefully discussed with stakeholders and development partners with a view to assessing the impact of lower-than-projected economic growth on key macroeconomic targets and poverty outcomes and to developing appropriate contingencies.

Once this has been accomplished, similar exercises could be carried out regarding the other contingency scenarios for reference during the implementation stage of the strategy.

Figure 1 shows the various macroeconomic linkages and constraints within a country and highlights the main trade-offs facing policymakers. Ideally, these discussions will have resulted in the development of a comprehensive action plan that identifies priority sectoral policies to be pursued in support of poverty reduction, including in the areas of education, health, and rural infrastructure. Given that poverty is multidimensional, the action plan will also likely include priority measures with regard to governance, structural reform, and other relevant areas, each of which may have budgetary implications.

The first step will be to provide a full costing of the envisaged poverty reduction strategy. A comprehensive system for budget formulation of poverty reduction strategies requires the development of Medium-Term Expenditure Frameworks MTEF , which currently exist in only a limited number of countries e. In doing so, policymakers should consider the scope for reallocating existing government spending into priority areas and away from nonproductive, nonpriority spending, as well as from areas where a rationale for public intervention does not exist.

The third step involves an assessment of domestic and external sources of budget finance. This would include a review of 1 the existing tax and nontax revenue base, in-cluding the effect of any changes in the tax system envisaged under the poverty reduction strategy; 2 the scope for financing public spending through net domestic borrowing in light of the need to maintain macroeconomic stability and to ensure adequate availability of credit to the private sector in support of private sector development and economic growth; and 3 the scope for external financing e.

Rather, arriving at an appropriate, integrated poverty reduction and macroeconomic framework will require juggling a large number of parameters and weighing the trade-offs between multiple objectives. The linkages in Figure 1 are meant to illustrate that this is an iterative process. In this regard, quantitative frameworks that could assist policymakers in assessing the distributional implications of their macroeconomic policies would be particularly useful.

Such frameworks, however, are presently only at a nascent stage of development see Box 3.

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In developing poverty reduction strategies, policymakers would benefit from a quantitative framework that they could use to assess the distributional impact of the macroeconomic policy options under consideration. Such a framework would be useful because the links between macroeconomic policies and poverty are complex.

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A quantitative framework that identifies the critical relationships on which the outcome depends could therefore assist countries in assessing these trade-offs. What would be some of the desirable characteristics of such a quantitative framework? First, the framework should be capable of identifying some of the critical trade-offs in poverty-reducing macroeconomic policies. For example, how do the costs in terms of poverty of higher spending and higher fiscal deficits compare with the benefits of targeting that spending on the poor? Second, the framework should be consistent with economic theory on the one hand, and with basic data availability, such as national accounts and household income and expenditure surveys, on the other.

Otherwise, the frameworks will not be able to foster a dialogue between conflicting parties on these issues. Third, and most important, the framework should be simple enough that government officials can use it on their desktop computers. This means that it should not make undue demands on data, and it should be based on readily available software, such as Microsoft ExcelTM.

World Bank staff is presently developing alternative quantitative frameworks that could be used to evaluate some of the macroeconomic aspects of poverty reduction strategies. In developing this particular framework, the authors opted for a modular approach that allows different models to be incorporated as alternative sub-components of the overall framework. But, as discussed earlier, policymakers would need to assess the extent to which accommodating such expenditure could place pressure on the price of nontraded goods and jeopardize stability. Key questions would include: Is there further scope for domestic revenue mobilization?

Can discretionary nonpriority spending be cut back more? Is there scope for cutting back certain priority spending without undermining the poverty reduction objective? Can the domestic financing target be relaxed without jeopardizing macroeconomic stability or private sector development objectives? Can the macroeconomic targets be modified in a manner that would not undermine the interrelated objectives of rapid economic growth, low and stable inflation, and poverty reduction?

The answers to these questions will determine the extent to which the desired poverty reduction programs can be pursued in the current period. Structural fiscal reforms in budget and treasury management, public administration, governance, transparency, and accountability can also benefit the poor in terms of more efficient and better targeted use of public resources.

As indicated above, there is no rigid, pre-determined limit on what would be an appropriate fiscal deficit. An assessment would need to be based on the particular circumstances facing the country, its medium-term macroeconomic outlook, and the scope for external budgetary assistance. The terms on which external assistance is available are also important.

There is a strong case, for instance, for allowing higher grants to translate into higher spending and deficits, to the extent that those grants can reasonably be expected to continue in the future, and provided that the resources can be used effectively. With regard to the composition of public expenditure, policymakers will need to assess not only the appropriateness of the proposed poverty reduction spending program, but also of planned nondiscretionary, and discretionary nonpriority, spending.

In so doing, they will need to take into particular consideration the distributional and growth impact of spending in each area and place due emphasis on spending programs that are pro-poor e. Policymakers must also ask themselves whether the envisaged public goods or services can be delivered efficiently e. Countries should begin by assessing in a frank manner their administrative capacity at both the national and subnational levels to deliver well-targeted, essential public services in support of poverty reduction.

In this regard, policymakers should consider the extent to which both technical assistance and the private sector can play a role in improving the delivery of these services. In the context of medium-term budget planning, policymakers should consider the scope for reallocating existing government spending into priority areas 23 and away from nonproductive spending, including areas where a rationale for public intervention does not exist. Operation and maintenance expenditure tied to capital spending should also be reviewed with a critical eye. Policymakers could then assess the new poverty reduction projects and activities that have been identified in the context of the poverty reduction strategy and integrate them into the preliminary spending program.

A key aspect of any poverty reduction strategy will be an assessment of the impact of the present tax and nontax system on the poor. An important medium-term objective for many developing countries will be to raise domestic revenue levels with a view to providing additional revenue in support of their poverty reduction strategies. Revenues should be raised in as economically neutral a manner as possible, while taking into consideration equity concerns and administrative capacities see Box 4.

In a developing country , taking account of allocational effects means that the tax system in particular should not attempt to affect savings and investment—experience indicates that aggregate savings and investment tend to be insensitive to taxes, with the result that the tax system typically only affects the allocation of those aggregates across alternative forms.

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As regards equity, the tax system should be assessed with respect to its direct and indirect impact on the poor. It is difficult to have a tax system that is both efficient and progressive, particularly in those countries without a well-developed tax administration. Therefore, governments should seek to determine a distribution of tax burdens seen as broadly fair rather than use the tax system to achieve a drastic income redistribution.



The use of a simplified regime for small businesses and the informal sector may complement these major taxes. Real property taxes may also be used if they can be administered appropriately, though this may be difficult in developing countries. Tax policy should aim at moving toward a system of easily administered taxes with broad bases and moderate marginal rates.

To the extent that some revenue provisions may be regressive, they should be offset through the expenditure system e. Finally, where revenue systems are being administered by a civil service that is highly constrained in terms of human resources, technical support, and funding, countries should rely heavily on final withholding, and keep to the absolute minimum any exemptions, special provisions, or multiple rates. The scope for domestic budgetary financing will depend on a number of factors, including the sustainable rate of monetary growth, the credit requirements of the private sector, the relative productivity of public investment, and the desired target for net international reserves.

Sacrificing low inflation through faster monetary growth to finance additional expenditure is generally not an effective means to reduce poverty because the poor are most vulnerable to price increases. Given that at any point in time there is a finite amount of credit available in an economy, policymakers must therefore assess the relative productivity of public investment versus private investment and determine the amount of domestic budgetary financing that would be consistent with the need to maintain low inflation and support sustainable economic growth.

The amount and type of available external resources to finance the budget will vary depending on the particular circumstances facing the country. Countries that have access to external grants need to consider what amount is available and sustainable under the present circumstances. The same is true in the case of external debt, but policymakers also need to determine whether the terms on such borrowing are appropriate and whether the added debt burden is sustainable.

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To the extent that a country is benefiting from, or may benefit from, external debt relief under the enhanced Heavily Indebted Poor Countries HIPC Initiative, net resource flows—flows that are predictable over the medium term—will be freed up to finance poverty-related budgetary expenditure.

Domestic debt reduction could also represent a viable use of additional concessional foreign assistance, since it would both free up government resources to be directed at priority poverty expenditure, as well as free up additional domestic credit for use by the private sector.

There may be a limit to the amount of additional external financing that a country would deem to be appropriate, however. The extent of such pressures will depend on how much of the additional aid is spent on imports versus domestic nontraded goods and services. There may also be uncertainty regarding aid flows, especially over the medium term, as well as considerations regarding long-term dependency on external official aid.

In the absence of medium-term commitments of aid, policymakers may therefore wish to be cautious in assuming what levels of assistance would be forthcoming in the future. Monetary and exchange rate policies can affect the poor primarily through three channels: Mon 17 Dec The impact of macroeconomic policies on poverty and income distribution: Pereira da Silva, editors.

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