This pamphlet is a revised version of a paper prepared for the Development
Assistance Committee's Forum on Key Elements for Poverty Reduction
Strategies, held in Paris on December 4-5, 1997. The authors would like to
thank Peter S. Heller and Louis Dicks-Mireaux for their very helpful
comments on an earlier draft. Elisa Diehl of the IMF's External Relations
Department edited the pamphlet and coordinated its production.
The mandate of the IMF, as laid out in its Articles of Agreement, is to promote international monetary cooperation, balanced growth of international trade, and a stable system of exchange rates.1 Since the late 1970s, some elements of the IMF's operational policy advice have evolved significantly.
In earlier periods, the IMF's policy advice emphasized the management of aggregate demand with the aim of creating conditions for macroeconomic stability. In recent years, the focus and the scope of the IMF's work have broadened, and the structural and social aspects of fiscal policy have become increasingly important, both in programs that the IMF supports in members undertaking reforms (IMF-supported programs) and in its general policy advice (Tanzi, 1997). A major element of this advice now is how to facilitate "high-quality growth" (International Monetary Fund, 1995). High-quality growth can be defined as growth that (1) can be sustained and does not collapse in the face of the slightest external shock; (2) is accompanied by appropriate domestic and external balances as well as by adequate investment, including in human capital, so as to lay the foundation for future growth; (3) is accompanied by policies that protect the environment; and (4) is accompanied by policies that attempt to reduce poverty and improve the equality of opportunity (Camdessus, 1990). This paper focuses on the last component of high-quality growth––reducing poverty and improving equity––and describes how the IMF works to achieve these objectives in its three core activities of surveillance over member countries' economic policies, financial support for adjustment programs, and technical assistance.
IMF policy advice can benefit the poor by influencing a country's macroeconomic policies, design of social safety nets, and public expenditures.
Sound Macroeconomic Policies
Through its policy advice, the IMF seeks to promote sound monetary, fiscal, and exchange rate policies to help countries achieve macroeconomic stability. Even in the short term, such macroeconomic stability directly benefits the poor because it implies low inflation and realistic exchange rates. More important, a sustainable macroeconomic framework is critical for achieving broad-based growth over the long term, which is necessary for alleviating poverty (Squire, 1993; Ravallion and Chen, 1996).
A country that fails to correct serious macroeconomic imbalances often suffers serious social costs. When inflation is high and variable, the poor and those in middle-income groups are affected the most because they usually have limited access to mechanisms that can protect consumption levels, such as interest-bearing checking accounts or other deposit accounts in stable foreign currencies, and a limited ability to purchase goods on credit. High inflation can also erode the tax base––and consequently affect the government's ability to maintain social expenditures––and has an adverse impact on investment decisions. Increasing evidence shows that countries with high inflation rates have lower investment ratios and slower economic growth. Even intermediate levels of inflation (10-40 percent) have been shown to hamper growth (International Monetary Fund, 1997a).
The source of inflation in many countries is excessive borrowing from banks by government to finance its spending. An important element of IMF policy advice, particularly in the context of IMF-supported programs, is therefore to limit the government's access to bank credit while ensuring that the private sector receives an adequate share of total credit. The quality of fiscal adjustment is also critical: changes in government spending or tax policy should be sustainable and have a lasting impact on the fiscal balance over the medium term.
Exchange rate policy is an important element of the policy mix designed to achieve macroeconomic stability. An overvalued exchange rate is likely to negatively affect the incomes of the rural poor, whose livelihood is often dependent on agricultural exports. Correcting exchange rate overvaluation should eventually lead to an increase in output and employment in the export sector. However, the reallocation of resources induced by changes in the prices of goods and services that are internationally traded relative to those that are not takes time and is often accompanied by employment and welfare losses in sectors that the government had previously protected.
Sound macroeconomic policies and a stable macroeconomic framework alone will not create the conditions necessary for economic growth. Usually, structural reforms––designed to ensure continued growth by promoting efficient resource use and providing incentives for competition and private initiative––are also needed. These reforms include eliminating distortions in tax and expenditure policies and their management; liberalizing prices and interest rates; restructuring public enterprises to foster conditions for sustainable growth and job creation in the medium term; reforming financial institutions to make it easier for people in rural areas to obtain credit; changing labor market policies to enhance competitiveness and increase employment; limiting administrative intervention in the economy; and reducing opportunities for corruption (International Monetary Fund, 1997b).
Social Safety Nets to Protect the Poor in the Short Term
Some reforms that are designed to achieve macroeconomic stability and remove impediments to long-term sustainable growth may hurt some of the poor in the short term. Examples are the removal of generalized price subsidies on basic products; an exchange rate devaluation, which typically hurts urban consumers of imported goods; the reduction of budgetary subsidies to state enterprises; civil service reform; and the lowering of protection associated with trade liberalization. These reforms can cause a decline in the real incomes of the poor and losses in employment. To mitigate these adverse short-term effects on the poor and other vulnerable groups, many IMF-supported programs incorporate budgetary outlays on temporary social safety nets to transfer income or protect consumption (Chu and Gupta, 1998).
Safety nets can enhance the political support for reforms. In helping governments design safety nets, the IMF considers their cost-effectiveness and financial viability. Safety nets may include subsidies directed at particular groups or cash compensation in lieu of subsidies; an improved distribution of essential commodities, such as medicine; temporary price controls on some essential commodities; severance pay and retraining for public sector employees who have lost their jobs; and employment through public works programs. Many of these elements can be found in the recent reform programs in Asia (see, for example, Gupta, McDonald, Schiller, Verhoeven, Bogeti´c, and Schwartz, 1998). When possible, existing social security arrangements, such as unemployment insurance and pensions, are modified to protect vulnerable groups from the adverse effects of economic reform. This was the case in countries making the transition from a centrally planned to a market economy (see, for example, Chu and Gupta, 1998).
Improved Composition of Public Expenditures
A reallocation of public expenditures can benefit the poor in the long term by shifting resources to (1) activities that promote growth (for example, productive investment spending) from expenditures that do not contribute to the goals of government policy (for example, untargeted, generalized subsidies and excessive military outlays); (2) basic education and health care, which build human capital and thus enhance growth and equity; and, of course, (3) targeted poverty alleviation programs.
A key step in reallocating expenditures toward growth-enhancing outlays is to reduce "unproductive" public expenditures––those that can be reduced without affecting the achievement of government's outputs or objectives, such as the provision of law and order or basic education and health care. Often, when the government pursues multiple objectives in its public expenditure programs––such as using the public sector as the employer of last resort––and when weak institutions or corruption exists, unproductive expenditures result (Chu and others, 1995).
In reorienting budgetary expenditures toward capital outlays, IMF-supported programs are intended to reflect realistic expectations of a country's ability to implement capital projects and the availability, on appropriate terms, of external financing during the program period. The objective is to ensure that capital projects add to the productive capacity of the economy and that adequate resources are allocated to operations and maintenance. Given that capital spending can also be affected by revenue shortfalls, IMF-supported programs recognize the importance of protecting critical public investment programs from budget cuts.
A shift in public expenditures to education and health care can increase growth, improve equity, and reduce poverty over the long run through the beneficial effects of these outlays on the accumulation of human capital (Harberger, 1998). Because the productivity and benefit incidence of these expenditures are highly dependent on their intrasectoral distribution, IMF policy advice increasingly emphasizes shifting the pattern of expenditures to accommodate higher spending on basic education and primary health care. In its work in these areas, IMF staff relies heavily on the expertise of other institutions. These include the World Bank, regional development banks, the United Nations Development Program, the International Labor Office, and other UN agencies.
1The purposes of the IMF, as laid out in its Articles of Agreement, are "(i) to promote international monetary cooperation...; (ii) to facilitate the expansion and balanced growth of international trade, and to contribute thereby to the promotion and maintenance of high levels of employment and real income...; (iii) to promote exchange stability, to maintain orderly exchange arrangements among members...; (iv) to assist in the establishment of a multilateral system of payments...; and (v) to give confidence to members by providing temporary financial resources to help them correct balance of payments disequilibria."
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