Social Dimensions of the IMF's Policy Dialogue

Social Dimensions of IMF Policy Advice

Policy Advice: Surveillance and Program Support

The IMF provides policy advice to member countries primarily in the context of its "surveillance" of their economic policies and its financial support for their adjustment programs. IMF surveillance is rooted in its Articles of Agreement and aims at promoting international monetary cooperation, balanced growth of international trade, and a stable system of exchange rates, as well as regional and global coordination of growth-oriented policies. The objective of IMF policy advice to member countries is to contribute to the promotion and maintenance of high levels of employment and real income and to the development of their productive resources. An important element of this advice in the surveillance process is to encourage the initiation of appropriate policy measures before serious macroeconomic imbalances surface. In this way, surveillance helps to identify emerging issues and problems of importance to member countries and the world community to facilitate an early policy response.3

Whenever a country faces macroeconomic imbalances that arise from lax financial policies or external shocks and requests the IMF's financial support, the IMF's policy advice aims at restoring domestic and external balance and price stability while removing structural rigidities, thereby paving the way for sustained economic growth, gains in employment, and reduction in poverty in the medium term. By catalyzing substantial amounts of external assistance in the form of creditor/donor support and debt relief, IMF-supported programs help attract financing for higher investment and domestic consumption, including consumption by the poor. Experience suggests that failure to adjust to serious macroeconomic imbalances has high social costs in various forms, including through implicit loss in agricultural income, loss from rising inflation, and cuts in social expenditures. The rural poor suffer when attempts are made to repress inflation through price controls on their agricultural output, or when overvalued exchange rates depress prices of export goods produced by them. In addition, the poor are often left to buy consumer goods at substantially higher prices on parallel markets. Generalized consumer subsidies, ostensibly given to protect the poor, have been found to be of greater benefit to the relatively better-off consumers. High inflation often hurts the poorest the most, as their limited income and financial saving are quickly eroded. And very high inflation can result in a collapse of tax revenues, thereby disrupting governments' ability to provide basic services and particularly hurting the poor. Weak economic policies also tend to reduce foreign financing from both official and private sources.

Social Policy Issues in Surveillance Activities

The IMF's policy advice during Article IV consultation discussions with individual countries has given consideration to social policy issues, taking into account each country's circumstances. The major issues discussed with member countries have included unemployment and various types of social expenditures.

High levels of unemployment have been an important concern in many European countries, since failure to reduce unemployment to acceptable levels, namely, compatible with low inflation, entails large economic and social costs. The IMF has therefore advocated comprehensive labor market reforms to reduce the incidence of high unemployment, together with policies for better education and training to improve skills and productivity. The IMF has also emphasized that labor market reforms have to be accompanied by appropriate adjustments to tax and expenditure policies in order to address social concerns.

In other areas of public expenditures, the IMF has paid increasing attention to health and social security spending, in particular in many industrialized countries where such spending has increased rapidly. While this increase can mainly be explained by a pronounced trend toward population aging and higher levels of service and unit costs, it is often difficult to sustain. Consequently, the IMF has explored with country authorities options for streamlining such expenditure and safeguarding medium-term sustainability (see, for example, Box 2 on Italy).

Box 2. Italy: Reforming the Health Care System
Whereas the level of public health care expenditures in Italy is similar to that of other OECD countries, there has been a widespread perception that the quality of public health care has been declining as costs have increased. Furthermore, the weakness of Italy's fiscal position has raised questions regarding the sustainability of health care and other social security expenditures (notably pensions).

In its discussions with the Italian authorities, the IMF has drawn attention to the importance of controlling entitlement spending, including public health care. The IMF counseled that reforms of health care spending should avoid untargeted across-the-board cuts and should aim for long-lasting savings. The reform strategy should focus on increasing local responsibility for expenditure decisions, reinforcing the managerial authority and financial accountability of local health administrators, and giving patients a greater degree of choice. While much of the financial effects of the reform efforts undertaken since 1992 will only materialize over the next several years, the improved quality of some of the fiscal measures--in terms of their more permanent impact and the planned structural reforms--were welcomed by the IMF.

In some developing economies, the task is one of expanding social security arrangements in light of rapid economic growth and increasing urbanization, which undermine traditional, family-based security arrangements. The IMF's policy discussions in such countries have therefore focused on economical ways to retain basic elements of equity in the new social security arrangements within a sustainable fiscal policy framework.

In the IMF's cross-country surveillance--its half-yearly World Economic Outlook exercise--the IMF has drawn attention to a broad range of social policy issues, including, for example, unemployment and labor market issues in industrial countries, the economic benefits of reducing unproductive expenditures, institution building and human capital investment in developing countries, and labor market policies and social safety nets in transition economies. To a large extent, these issues reflect the concerns brought to the IMF's attention in the context of the annual discussions with member countries.

Social Policy Issues in Program Design

Policy Mix

As noted above, achievement of macroeconomic stability is a key objective of IMF-supported programs. The mix of policies incorporated in a member's program that is supported by the IMF is developed in close consultation among the authorities, the IMF, and other agencies. Because various mixes and phasing of policies can be consistent with macroeconomic objectives but have different effects on the poor, programs have increasingly given attention to the issues of mix and phasing of policy instruments, with a view to minimizing possible adverse effects on the poor.

Fiscal policy is a key avenue for dealing with social aspects of adjustment. On the expenditure side, the fiscal package often includes reducing consumer and public enterprise subsidies, and nonpriority and wasteful expenditures. Phasing these reductions over time has allowed consumers and producers time to adjust. And reducing unproductive spending has helped safeguard a certain level of social spending. Moreover, certain elements of incomes policy can be tailored to help the poor. Protecting real incomes of less-well-off groups has been feasible, for example, when government wage increases could be differentiated according to salary level, with higher wage increases for low-salary groups and freezing of nonwage benefits for high-salary groups. However, in many circumstances, a compression of wage scales may be considered undesirable, given the need for appropriate incentives for highly qualified workers. Furthermore, programs have allowed temporary tax reductions or maintenance of subsidies for basic foodstuffs and medicines to protect vulnerable groups (such as in several CFA franc countries).

Programs have also typically included tax reforms aimed at enlarging the revenue base, improving compliance, and reducing distortions and fraud stemming from complex and inefficient tax systems. Besides spreading the tax burden more equitably across different income groups, these reforms have generated additional resources for governments to support social programs targeted to the poor during critical periods of economic adjustment.

Public sector reform is a further area where social implications could be addressed. In IMF-supported programs, civil service reforms are directed at improving administrative capacity and cost-effectiveness, while public enterprise restructuring and privatization aim at exposing management to market principles, thus fostering conditions for sustainable growth and job creation in the medium term. As these measures often imply layoffs of public sector employees, programs have attempted within their macroeconomic constraints to spread retrenchment over time and to provide severance pay while promoting alternative job opportunities through a more flexible labor market, as well as retraining schemes.

Exchange rate policy also bears directly on social issues. In many developing countries where external imbalances and exchange rate overvaluation made currency depreciation unavoidable, programs have often emphasized the need for improving the agricultural terms of trade (that is, the relationship between agricultural producer prices and consumer prices), on which the livelihood of rural populations depends. For instance, in many sub-Saharan African countries, the large majority of the population and more than 80 percent of the poor live in rural areas. Their incomes are to a large extent based on agricultural exports and are largely spent on domestic goods. Therefore, more realistic exchange rates, if accompanied by tight macroeconomic and incomes policies, tend to improve real output, income, and employment in rural areas, laying the basis for poverty reduction.

To ensure that the potential benefits of currency depreciation reach a broad group of producers, programs in low-income countries have often incorporated comprehensive reforms of the agricultural sector. These reforms have aimed at further stimulating agricultural production through a reduction of implicit and explicit export taxation; producer price increases; improved access to imported inputs; and a liberalization of marketing arrangements, including the eventual elimination of state monopolies in the purchase, transportation, processing, and marketing of export commodities. In several African countries, where state marketing boards were temporarily maintained, agricultural policies included flexible producer-pricing policies in line with world market developments (for example, in Côte d'Ivoire, Mali, and Senegal). These policies, inter alia, aimed at reducing economic rents from monopolistic marketing boards to the benefit of farmers and the government.

Trade liberalization is widely implemented in IMF-supported programs. In general, these measures entail the removal of trade distortions stemming from quotas, licenses, excessive export and import tariffs, complex administrative procedures, and foreign exchange rationing. Although removal of distortions should free the potential for output and employment in the export sector, the reallocation of resources induced by relative price changes takes time and is often accompanied by employment losses in previously protected sectors. With a view to minimizing transitory adjustment costs, and also to protecting fiscal revenue, IMF-supported programs generally provide for phasing the removal of trade restrictions and reduction of tariffs over a period of several years.

Financial sector reform is another element of IMF-supported programs, which have also recently emphasized improving rural financial institutions. To better channel rural savings to productive uses, programs have included measures to restructure agricultural credit banks and, in some cases, set up new institutions with adequate access for farmers (for example, in Cambodia and in Benin and other CFA franc countries). More generally, the increased access to formal credit at market-determined interest rates envisaged in most programs has helped to reduce reliance on informal credit markets at higher interest rates.

Labor market policy is another important instrument. In many countries, labor market rigidities--and, in some cases, high payroll taxation--have led to high labor costs, which have undermined competitiveness and employment. Programs supported by the IMF have incorporated the revision of labor codes and restrictive practices, with a view to enhancing labor mobility and employment, in particular in the formal sector (including in several CFA franc countries, the Kyrgyz Republic, and Nicaragua). In Côte d'Ivoire, labor policies sought to reverse the steady decline in private sector employment since the 1980s through a revision of collective bargaining procedures, so that labor contracts reflect branch- and firm-specific circumstances. In Senegal and other countries, programs incorporated the elimination of state-run labor placement and hiring monopolies, which had often curtailed employment.

The mix and phasing of policy instruments have helped insulate the poor against possible adverse effects of reform. Nevertheless, in many cases, such effects were unavoidable, and there was a need for targeted social safety net measures.

Short-Term Social Effects and Social Safety Nets

In the short term, reform policies can affect certain poor groups in several ways. Removal of generalized price subsidies on basic necessities or exchange rate devaluation can cause real incomes of domestic consumers, including the poor, to decline in the short term. A reduction in budgetary subsidies to state-owned enterprises and their restructuring, a lowering of protection following trade liberalization, and a downsizing of the government may result in job losses. Consequently, IMF-supported programs have sought to include social safety net measures to mitigate anticipated adverse short-term effects on vulnerable population groups. In this area, the IMF's policy advice has focused on the cost-effectiveness and financial viability of social policy options.

In practice, it has been difficult, especially in poorer countries, to identify and target the most vulnerable groups affected by adjustment measures because of a lack of household data. Integration of social safety nets into programs is also constrained by weak administration, particularly at local levels, inadequate political support, shortfalls in expected external financing, and the absence of adequate social protection instruments. Notwithstanding these difficulties, reform programs have increasingly provided for a range of social safety net instruments, depending on a country's mix of reform policies, existing institutions, administrative capacity, the composition of target groups, and available financing. Social safety net measures have comprised targeted subsidies, cash compensation in lieu of subsidies, improved distribution of essentials such as medicines, temporary price controls for essential commodities, severance pay and retraining for retrenched public sector employees, employment through public works, and adaptation of permanent social security arrangements to protect the poorest. Targeted subsidies and cash compensation have allowed reforming countries to shield the consumption of basic food items by the vulnerable groups in the face of rising prices, and at the same time have permitted a strengthened budgetary position (for example, in Mozambique and Zambia; also, see Boxes 3 and 4 on Jordan and the Kyrgyz Republic, respectively).

Box 3. Jordan: Subsidy Targeting Through a Coupon Scheme
Under the IMF-supported program, fiscal adjustment has entailed, inter alia, enhancing the efficiency of expenditures through a better targeting of generalized consumer subsidies for basic food items. The subsidy for selected food items was retained, but targeting was improved through a food coupon scheme. This scheme, introduced in September 1990, allowed coupon recipients to purchase fixed quantities of subsidized sugar, rice, and powdered milk, equal to quantities consumed, on average, by the poorest 10 percent of the population. Consumers were allowed to purchase additional quantities at higher liberalized prices but were no longer able to buy unlimited subsidized quantities. The budgetary subsidy costs declined from 3.4 percent of GDP in 1990 to 1 percent of GDP in 1994, while the real consumption of the poor was shielded. A large decline in world market prices of grains also contributed to the fall in budgetary costs. However, the generalized subsidy on wheat, and therefore bread, was maintained.

Box 4. The Kyrgyz Republic: Replacing Generalized Subsidies with Cash Compensation
Before initiation of the IMF-supported program in May 1993, untargeted consumer subsidies and cash benefits to households constituted a significant burden on the budget. As part of the objective to reduce the fiscal deficit, the Government developed a schedule for phased increases in bread prices and replaced the consumer subsidy for bread with targeted cash transfers to pensioners and families with three or more children under the age of 16.

Until 1992, all families with children were eligible for child allowances irrespective of income. Means testing for determining child allowance eligibility was introduced in January 1993. In 1994, outlays on cash benefits were projected to decline, reflecting mainly reduced benefits to the better-off. Under the 1995 budget, a single, better-targeted cash benefit is to replace the current system of support.

Different options have been adopted in different countries. One option has been to limit the amount of subsidized commodities to the quantity consumed by the lowest income group; another has been to provide full or partial cash compensation in lieu of the subsidy to selected population groups. The composition of vulnerable groups has been an important consideration in targeting subsidies or cash compensation (for instance, families with three or more children and pensioners in the Kyrgyz Republic). Social safety nets have included severance payments to workers who lost jobs as a consequence of public sector downsizing, trade policy reforms, and public enterprise reforms (see Boxes 5 and 6 on Ghana and Sri Lanka, respectively). In many instances, severance payments have been combined with the retraining of unemployed workers and initiation of targeted public works programs to provide income support to jobless individuals.

Box 5. Ghana: Severance Payments to Retrenched Workers
During 1983-91, Ghana pursued a comprehensive program of economic and structural reforms supported by the IMF. One aim of this program was to remove structural weaknesses in the budget by rationalizing civil service employment. Consequently, between 1987 and 1991, the size of the civil service was reduced by 10 percent, or 32,000 positions.

To alleviate the impact of income loss on retrenched civil servants and their dependents, this program included (i) severance payments to departing workers of two months of salary for every year of service; (ii) employment counseling, retraining, and courses in entrepreneurial development; (iii) credit facilities; and (iv) food-for-work programs for those unable to secure alternative employment opportunities. The take-up rate for (ii) and (iii) was low in the initial years. Recent evidence indicates that retrenched workers invested a large proportion of their severance payments, thereby contributing to the establishment of small businesses and farms. However, because of severance payments and the need to raise wages for skilled civil servants, the net budgetary savings from the civil service reform have been negligible in the short term. Nevertheless, budgetary savings are anticipated in the medium term with concomitant improvement in government efficiency.

Existing permanent social security arrangements (such as pensions and unemployment insurance) have been adapted to shield two groups usually considered vulnerable: the pensioners and the unemployed. The adaptation has meant a tightening of eligibility and restructuring of pensions and unemployment benefits to ensure that the average benefit is not only fiscally sustainable but also fair and adequate (for example, in Latvia). IMF-supported programs have also sought to improve the cost-effectiveness of existing poverty alleviation programs (see Box 6 on Sri Lanka).

Box 6. Sri Lanka: Rationalization of Poverty Alleviation Programs and Civil Service Reform
The successive programs supported by the IMF and the World Bank during 1989-94 were aimed, inter alia, at restructuring government expenditures through a rationalization of poverty alleviation programs and civil service reform.

The main poverty alleviation programs in Sri Lanka are the JanaSaviya, the Midday Meal, and the Food Stamp Programs. These programs were poorly targeted, and they cost some 3 percent of GDP in 1989. After reform, and without reducing assistance to the vulnerable, government expenditures on these three programs were projected to decline to 1.9 percent of GDP in 1994.

The JanaSaviya Program, which was introduced in 1989, aims at assisting near-subsistence households in establishing a permanent earning potential. Since 1990, the Government has sought to improve the targeting for this program, for example, through community screening, inspections, community meetings, and a check of ownership, such as of consumer durables, and through participation in productive activities, such as public works programs and self-employment projects.

The Midday Meal Program was also established in 1989 with the objective of improving nutrition among children and increasing the returns to education. The program covered the entire population until 1994 when the program was to be restricted mostly to food stamp program recipients with school-age children and to those who applied.

The Food Stamp Program was introduced in 1979 to improve the nutrition of poor households. Since then, it has been restructured twice in order to remove ineligible households and add newly eligible households, and to use the savings to raise the nominal benefits, which were being eroded by inflation.

The civil service reform of 1990-91 led to an employment reduction of about 44,000 employees, or 13 percent of the total civil service. The restructuring effort in the civil service is continuing--although with mixed results--and included the planned elimination in 1994 of 60,000 vacant positions. The departing civil servants received generous severance payments from the Government.

The available financing is critical in the actual coverage of social safety nets and in the choice of instruments used to shield the vulnerable. In this context, IMF-supported programs have emphasized the importance of reducing or eliminating unproductive expenditures to generate financing for safety nets and other social expenditures. In some low-income countries, temporary financing for safety nets from external donors has also been helpful and has been included in the external financing assurances that the IMF has helped countries obtain. In such instances, the target for the fiscal deficit is set so as to ensure that the pattern of fiscal adjustment in the medium term is consistent with a sustainable level of external debt.

Longer-Term Social Policy Measures

While social safety net measures help alleviate possible adverse effects during the adjustment period, long-term poverty reduction is best achieved by sustained and broad-based economic growth, coupled with improvements in the level and quality of government spending on social services. Consequently, the IMF--in collaboration with the World Bank and other institutions--has paid increasing attention to the composition of public expenditure and the need for improving the efficiency of different expenditure programs to generate savings for well-targeted social spending. While significant progress has been achieved, more needs to be done in this area.

In recent years, IMF-supported programs in low-income countries have increasingly sought to achieve significant real growth in social expenditures, including primary education and health, since such expenditures often were cut by the authorities in the past when budgets came under pressure (see Boxes 7, 8, and 9 on the CFA franc zone, Peru, and Uganda, respectively). In other cases, programs have sought to protect social sectors from the deep expenditure cuts that were made elsewhere and to improve the cost-effectiveness of social programs.

Box 7. CFA Franc Zone: Promoting Economic Growth and Shielding the Poor Through Appropriate Program Design
After the devaluation of January 12, 1994, each of the 14 CFA franc countries initiated adjustment programs supported by the IMF and the World Bank. These programs aim at striking an appropriate balance between fiscal adjustment, financing, and structural reform, but special measures were also incorporated to protect the poor against possibly adverse effects from adjustment, including reduction of producer subsidies and public sector retrenchment. At the same time, substantial increases in agricultural producer prices--for example, of cocoa, coffee, and cotton--facilitated by the exchange rate devaluation benefited the majority of the poor living in rural areas.

All programs aim at limiting price increases--through temporary subsidies and tax or tariff reductions--for goods essential to the poor, in particular rice, sugar, flour, kerosene, and generic drugs. Moreover, shortly after the devaluation, most countries imposed selected price controls to avoid panic and excessive profit margins on stocks. As inflationary pressures abated in the first half year after the devaluation, most of these controls were removed. In the meantime, minimum wages and salaries of low-income public sector workers have been increased, with a view to partially compensating income earners for devaluation-induced price increases (for example, in Burkina Faso and Côte d'Ivoire).

In addition, many programs include severance payments under voluntary departure schemes. Moreover, budgetary allocations provide for social funds aimed at creating employment through public works, such as in Burkina Faso, Cameroon, Côte d'Ivoire, Gabon, and Togo; public housing, such as in Benin; and the promotion of small businesses, such as in Benin, Cameroon, and Niger. Finally, all programs envisage increased real expenditures for primary health and education, in some cases with quantified targets--for example, in Cameroon, Mali, Niger, and Senegal--and in others through earmarked donor financing, such as in Benin.

Box 8. Uganda: Peace Dividend in a Stable Macroeconomic Environment
After almost a decade of war and civil strife, Uganda found its infrastructure devastated, agricultural lands widely abandoned, public services paralyzed, and its population largely impoverished. Real GDP fell by 8 percent between 1983 and 1986, external financing declined, and inflation rates were very high. A series of IMF-supported adjustment programs starting in 1987 restored economic stability and reduced inflation to single-digit levels in 1993. Since the onset of the reform in 1987, economic growth has averaged over 5 percent per annum.

The adjustment strategy also focused on structural reform. For example, the liberalization of the foreign trade and exchange system and marketing of coffee and tea fostered an expansion of agricultural value added by more than 23 percent since the onset of reforms, largely to the benefit of the rural poor. Most farmers directly receive the fruits of cultivation, as there is little wage labor, and smallholder production is prevalent.

The Government's fiscal adjustment has focused on improving expenditure composition. More than 40,000 ghost workers have been eliminated from public payrolls, while public sector reorganization, combined with a system of mainly donor-financed severance payments, allowed the retrenchment of more than 66,000 temporary public employees and 14,000 civil servants. Moreover, more than 23,000 soldiers have been reintegrated into civilian life through the provision of a support package including a six-month subsistence allowance, construction materials and agricultural inputs, labor-intensive public works, and training programs. This has helped to halve the share of military expenditure in GDP during 1990-93 (to 1.9 percent of GDP). The peace dividend, in combination with the efficiency gains from public sector reorganization, has set free resources to effectively double the share of health expenditure and moderately increase the share of education in current government expenditure during the reform period, with further increases envisaged under the current IMF-supported program.

Box 9. Peru: Securing Macroeconomic Stability to Increase Pro-Poor Spending
As part of its efforts to stabilize and liberalize the economy, Peru entered into a series of programs supported by the IMF and the World Bank. The programs have been successful in reducing annual inflation to 16 percent by end-1994 from an annual average of 3,800 percent during 1988-90, and economic growth of 11 percent was estimated for 1994.

Fiscal policy has been a focus of these programs, with important consequences for the social sector of Peru. Hyperinflation had led to the virtual collapse of revenues and, consequently, real wages of civil servants and other critical public expenditures had declined dramatically. Thus, one of the cornerstones of the program was to increase tax yield. As a result, current revenues have climbed from 7 percent of GDP in 1989 to a projected 12 percent in 1994. This has allowed a gradual recovery in social and other expenditures, and has stopped the erosion of public sector wages, which had contributed to a sharp deterioration in the quality of public services.

The Government also stepped up its efforts to combat poverty. A social investment fund, FONCODES, was established in 1991 to finance community-based projects and improve the access of the poor to social services and infrastructure. A basic social program was launched in 1994 to coordinate efforts in five priority areas (education, health services, nutrition, justice, and employment generation). Social spending was increased, partly through the use of proceeds from the privatization of public enterprises. The effectiveness of social spending is also being improved, including through enhanced budgetary and expenditure management, and better targeting mechanisms.

Programs have also aimed at enhancing the poor's access to these services. Measures incorporated in adjustment programs supported by the World Bank and the IMF have included increasing the number of school teachers and health personnel; redeploying staff from urban to rural institutions; increasing access of women to health,education, and population-planning services; enhancing the availability of teaching materials through textbook-lending schemes; and improving the supply of medicines through demonopolization and other regulatory reform. Infrastructure programs have in several cases emphasized improved transportation and access to markets for the poor and the provision of irrigation facilities to small landholders (including in Côte d'Ivoire, Mali, and Cambodia).

In addition, social policies in some cases have sought a better targeting of the most vulnerable by shifting resources away from university education or advanced medical care, accessible only to privileged groups, to primary education and health care (such as in Burkina Faso, Cambodia, Honduras, Jamaica, Lesotho, Mali, and Senegal). In some cases, resources have been made available to sustain the public provision of services by introducing appropriate user fees, which also induced their efficient use. Reorganization of ministries and decentralization of administrative responsibilities to improve targeting has appeared frequently in IMF-supported programs (for example, in Burkina Faso, Ghana, and Guyana). With World Bank support, many programs have included administrative reforms to facilitate monitoring of social expenditures and services, as well as their impact on key social indicators. In many cases, however, the cost-effectiveness, targeting, and monitoring need further strengthening.

3 The IMF carries out its surveillance role mainly through the regular Article IV consultation discussions with all member countries. IMF surveillance over the exchange rate policies of members includes analyses of all policies affecting exchange rates and is based on principles for the guidance of members' exchange rate policies that respect the domestic social and political policies of members (The IMF's Articles of Agreement, Article IV, Section 3(b)).