How best to link poverty reduction and debt sustainability in IMF–World Bank models?

Abstract

This paper attempts to provide an economic model in the context of developing countries to address the policy strategies related to poverty reduction. With a view to deal with the shortcomings of the existing approaches as regards poverty reduction, this paper develops a model on the basis of the policy framework of the IMF and the World Bank to show how demand growth can be a crucial mechanism in determining the potential rate of growth, and then to suggest ways in which poverty—conceptualised officially in absolute terms with a subjective cut‐off point (e.g. US $1/$2 a day), and a new objective measure in terms of consumption deprivation—can be linked with the key policy variables contained in the adjustment programmes. A strategy of investment in infrastructure and in human development, and improving access to credit markets, particularly in rural areas to encourage or ‘crowd in’ private investment is a precondition for growth and poverty alleviation. Debt relief can only provide a temporary, not a sustainable, solution to the problem of reducing poverty.

Keywords:

• Stabilisation
• growth
• poverty reduction
• debt sustainability

Acknowledgements

This is a revised version of the paper presented at the UK Development Studies Association Annual Conference, organised by the Department of Economics, Strathclyde University, Glasgow, 10–12 September 2003. Thanks are due to Ayse Evrensel, T. Krishna Kumar, S. Mansoob Murshed, Peter Oppenheimer and Eric Pentecost for their helpful comments on an earlier version of this paper. We are also grateful to two anonymous referees of this journal and the editor, Malcolm Sawyer, for their useful comments. The usual disclaimer applies.

Notes

See Easterly (2000, p. 1). Easterly also quotes the IMF web‐site which says: ‘In September 1999, the objectives of the IMF's concessional lending were broadened to include an explicit focus on poverty reduction in the context of a growth oriented strategy. The IMF will support, along with the World Bank, strategies elaborated by the borrowing country in a Poverty Reduction Strategy Paper (PRSP).’ http://www.imf.org/external/np/exr/facts/prgf.htm. See also www.imf.org for a fact‐sheet on Poverty Reduction Strategy Papers.

Przeworski & Vreeland (2000, p. 403). On p. 386 the authors review some of the literature on whether the IMF programmes have positive effects on growth.

Dagdeviren et al. (2002) find that redistribution, either of current income or of the growth increment of income, is more effective in reducing poverty for a majority of countries than growth alone.

See Easterly (2000): the author takes the example of Zambia and Burkina Faso where he shows that ‘self‐unemployment is extremely important for the poorest deciles in Zambia. The bias is less extreme in Burkina Faso, but the poorest still have their earnings skewed towards self‐employment income. These surveys are suggestive of the importance of the informal sector for the poorest households, lending credence to the relative insulation of the poor from structural adjustment measures.’

Das & Mohapatra (2003) find no evidence of any statistical association between financial liberalisation and lowest income quintile's share of mean income.

Pooling information from 87 countries for the years 1970–1990, Sarel (1996) discovered a structural break in the relationship between rates of economic growth and inflation. The break is estimated to occur when the annual inflation rate is 8%. Between 0 and 8%, Sarel found that the inflation rate either has no effect or even has a slight positive effect on economic growth. Once inflation rises above 8% per annum, a significant negative effect on growth rates emerges. Easterly et al. (1995) found the costs more seriously and lastingly damaging when inflation is above 40% a year. Whether inflation is a result of wage‐push or demand pressures requires investigation before examining its effects. Historically, high inflation in developing countries has been mainly the result of either excess money creation to finance fiscal deficits or currency devaluation to finance external deficits (for the case of India, see Mallick, 2004). For the sake of simplicity, in this paper, we focus on the overall domestic inflation without distinguishing its sources.

Blank & Blinder (1986) found that inflation increases poverty rates, but also slightly increases the income shares of the bottom two quintiles. On balance they found little evidence that inflation hits the poor harder than the rich. Cardoso (1992) found that in Latin America the inflation tax does not affect those already below the poverty line, because they hold little cash. Cardoso also found that higher inflation is associated with lower real wages. In Granville et al. (1996), high inflation in early transition Russia seems to increase poverty through the inflation tax on cash and also wages and pensions, since they were not systematically indexed to inflation. Agenor (1999) finds that inflation always increases the poverty rate, using a cross‐section of 38 countries. Easterly & Fischer (2000) found that the poor tend to rate inflation as a top concern, using survey data on 31,869 households in 38 countries. Using data for Indian states, Ravallion & Datt (2002) find some evidence that inflation is significant in explaining poverty.

See Addison et al. (2002).

See Edwards (1989) and for a survey of the controversial analytical issues in the design of IMF programmes, see Killick (1995, ch. 4).

See Polak (1998) for a comprehensive description of the FP framework and IMF (1977, 1987).

Here the symbol d is used to denote the change in a variable from the last period (y ₀) to the present (y); that is, dy = Δy = y − y ₀ and so on.

Recently, emerging market economies such as Brazil, when faced with credibility problems, have abandoned their fixed exchange rate (currency board) arrangements and have moved to a flexible system (in some countries with implicit inflation targets). The question remains as to how to adapt the traditional quantitative monetary conditionality (a ceiling on domestic credit) to the specific features of monetary policy under inflation targeting. When inflation is the overriding objective, having a credit ceiling may be considered somewhat superfluous, or at least, a non‐binding constraint (see Blejer et al., 2002).

Easterly (2002a) finds that the assumption of constant velocity fails in the data and velocity is found to be non‐stationary.

See Polak (1998).

There have been several attempts of extending the standard growth models by incorporating dynamics and building more economic structure, but very few of these have been reflected so far in the Bank model (Easterly, 1999).

See ‘Key features of IMF's PRGF supported programs’ at http://www.imf.org/external/np/prgf/2000/eng/key.htm

By the end of 2001, only 20 emerging economies had outstanding domestic government bonds ranging from a maximum market capitalisation of US $340 billion in case of Brazil to a minimum of US $5 billion in Chile (source: JPMorgan Local Markets Guide, 2002).

A structural export relation can also be incorporated, with exports being a positive function of world output (y_w ) and a negative function of the terms of trade (p_x /p_m ).

We assume that private investment and public investment on infrastructure are complements, with private‐investment being bounded above by the level of public‐investment, with k as the ratio of private to public capital in the composite capital stock. Actual output will rise, through Keynesian demand effects via higher levels of both private and public investment, thereby bringing the economy closer to full capacity utilisation.

Reinikka & Svensson (2002) find that the private investment response to date has been mixed, even among the strongest reformers. This disappointing result can be partly explained by the continued poor provision of public capital and services.

Levine (1997) and Levine et al. (2000) have documented a positive long‐run relationship between financial development and economic growth. Moreover, Jalilian & Kirkpatrick (2002) suggest that financial sector development policy can contribute to poverty reduction in developing countries via growth.

Young (1995) provides evidence of the role played by factor accumulation in explaining the post‐war growth of Hong Kong, Singapore, South Korea, and Taiwan. Young finds that while the growth of output and manufacturing exports in the newly industrialising countries of East Asia is virtually unprecedented, the growth of TFP in these economies is not. In contrast, Chand & Sen (2002), in the context of Indian manufacturing, find that trade liberalisation has raised TFP growth.

See Arestis & Sawyer (1998) for the role of aggregate demand in setting the level of economic activity, and Setterfield (2002) for a detailed exposition on demand‐led growth models.

Kumar et al. (1996, p. 55): ‘The standard approach which goes as far back as Rowntree (1901) is to define a poverty line in terms of a minimum level of income needed to purchase the basic necessities of life and use the income distribution to see what percentage of the people have an income less than such a poverty line. This measure is called Head Count Ratio (H).’

Kumar et al. (1996, p. 54): ‘Poverty connotes the notion of a poor state of economic well‐being or a state of economic ill‐being. It connotes a state of economic deprivation. Deprivation can be based on comparing an individual's economic state with either an absolute norm, in which case it is called an absolute deprivation, or a normative or relative norm, in which case it is called a relative deprivation.’

See Ravallion (1994) for a discussion on measures of poverty.

In general, since the income‐based method falls short in situations where for some attributes, markets do not exist, Mukherjee (2001) examined analytically the problem of measuring deprivation in an economy with more than one attribute. However, given the importance of nutritional needs for survival, we focus on the deprivation of essential food‐grains as a proxy for poverty.

Sen (1976) introduced the notion of deprivation in the income distribution literature, but focused on the head‐count ratio as a measure of poverty. Rao (1981) suggested broadening the scope of poverty measurement to nutritional norms as opposed to monetary measures. Rao suggested that data on the proportion spent on food (PSF) per capita can be exploited to measure the incidence of deprivation and poverty; and until the food needs are satisfied, people spend relatively more of their incremental income on food and this behaviour reveals itself as increasing or invariant PSF, as income (or expenditure) increases up to a critical level. In other words, the proportion of people up to that critical level are deprived of the required food and the proportion constitutes the incidence of deprivation and the average expenditure at the deprivation point can be used to develop a poverty line.

Kumar et al. (1996, pp. 68–69): ‘The real problem with poverty, is not the mean level of consumption deprivation, but it is the variability of the consumption deprivation. The lower income persons are more susceptible for deprivation as the spread of actual consumption is so wide due to high variance that it can go below the consumption requirements more frequently. Even if the variability is same at different income levels the probability that a person's consumption falls below the minimum required consumption is more for a lower income person than for a higher income person. This is because the mean deprivation is a decreasing function of incomes at all levels of income. It is the variability in the consumption deprivation, and that too the possibility of differential variability at different income levels, that causes a major problem for the poor.’

For details on the HIPC initiative, see Abrego & Ross (2001).

See Mallick (1999) for detailed evidence on this issue.

See Mallick (2001) for the policy simulations of this effect. For example, in the case of India, compression of government consumption expenditure over the years has been made difficult by the contractual nature of much of current expenditures and rigidities in the expenditure pattern (Economic Survey 2001–2002, Government of India: www.finmin.nic.in). Ghatak & Ghatak (1997) find significant crowding‐out effects of government consumption on private consumption.

Easterly (2000) notes that the urban informal sector is documented to be very large in most developing countries especially the very poor ones, one can deduce that the rural informal sector is even larger.