A new study by OED dispels some popular myths about adjustment lending and poverty. 1/ The study looks at all the evaluated adjustment operations that the World Bank supported in 1980-93--144 operations in 53 countries--and tracks what happened to poverty and income distribution. The results show that countries that successfully implemented the adjustment policies agreed with the Bank have achieved growth in per capita income and reduced the proportion of their populations in poverty. The study stresses the need for the Bank to improve the success rate of its adjustment operations, to promote reforms that bring the poor into the growth process, and to improve the quality of public expenditure, so as to safeguard vulnerable people. It draws policy recommendations for the Bank and its borrowers.
The study shows that adjustment lending is a valuable instrument of reform: two thirds of the 53 borrower countries implemented the adjustment programs agreed with the Bank with a substantial measure of success. They reduced price distortions and inflation, improved their resource balances, stabilized their foreign exchange reserves, and achieved growth in per capita income. They reduced their restrictions on trade and capital flows, integrating themselves more fully into the world economy, and became better able to use their resources efficiently. The success rate of adjustment operations broadly compares with that for the Bank's operations at large, and has improved in recent years.
Further improvement in outcomes is possible and desirable through greater selectivity, nurturing of borrower ownership, and improved efforts in public expenditure management, design of safety nets, and sector policy reform.
Effects on incomes
The overall finding of the study is that countries that successfully implemented adjustment reduced poverty.
For 23 countries that borrowed for adjustment, enough poverty data are available for reliable "before and after" comparisons (see box). Two thirds of these countries successfully implemented adjustment, achieved per capita income growth, and all but one (Kenya) reduced the percentage of their populations living in poverty. The findings affirm that well-managed adjustment can help to remedy social distress.
This said, rates of poverty reduction varied widely. Over the adjustment period, reductions in the proportion of population in poverty ranged from more than 3 percent a year in Indonesia and Thailand to 0.2 percent in Chile and Senegal. Poverty declined in all countries studied in Asia, but only in half those studied in Latin America. Countries that delayed or postponed adjustment, such as Argentina, Brazil, Peru, and Venezuela, saw poverty worsen further in the 1980s. In Africa, Ghana and rural Tanzania displayed clear signs of economic recovery and poverty reduction, while in rural Kenya and Cote d'Ivoire growth was sluggish and poverty increased.
Income distribution improved in 60 percent of the countries that achieved growth and poverty reduction, including Ghana, Indonesia, Jamaica, Pakistan, and the Philippines, but remained constant or worsened in the rest. Income distribution is of concern because the more inequitable it is, the higher the growth rate that is needed to reduce poverty. Among the largely successful adjustors that reduced poverty, income disparities remained unchanged or widened in Bangladesh, Bolivia, Guatemala, Mexico, and Thailand. Adjustment operations left no appreciable impact on growth or on income disparities in Argentina, Brazil, and Cote d'Ivoire.
The findings for Africa are of special concern. Though some countries have achieved clear successes in adjustment and poverty reduction, most still lag behind those in other regions on all measures: concentration of poverty, rising inequality, limited and declining access to public transfers, and poor initial capacity and responsiveness to reform.
Experience confirms that consistently implemented macroeconomic stabilization policies are an important prerequisite for enhancing savings and stimulating the investment and production needed for growth.
Successful stabilizers achieved quicker recovery. Where macro-economic stabilization polices were consistently implemented, they helped to speed growth and reduce inflation.
Most of the successfully adjusting countries reduced their fiscal deficits and lowered inflation; in the few countries where government discretionary spending (spending on items other than interest) rose, inflation also rose. More than 80 percent of the countries raised their real interest rates closer to the cost of capital and of these three fourths also improved their foreign exchange positions. Real devaluation reduced current account deficits, helping to make external debt burdens more manageable.
In the successful adjustors, increases in uncertainty inhibited investment during the adjustment period, but investment recovered thereafter. Experience shows that the confidence of private savers and investors is important in restoring investment, growth, and employment. Hence the need for predictability in introducing and following through on policy changes.
Sound macroeconomic management helped create conditions for reducing poverty. Countries that reduced poverty tended to be those that achieved macro-economic stability--at least over the short and medium run--and tended to be those with low inflation. Countries that did not reduce poverty tended to be those with high inflation.
While macroeconomic stabilization processes are needed for growth, they are not sufficient for a poverty reduction strategy. Macroeconomic policies need to be supplemented by measures to make the conditions for agriculture, business, and industry more transparent and competitive, to widen and deepen the resources available for productive use, and to raise the productivity of resources, both human and material.
The Bank has assisted such "supply-side" reforms through adjustment lending, investment lending, and technical assistance.
Countries that implemented 70 percent or more of a core cluster of supply-side reforms tended to be those that stabilized their economies, increased savings and investment, and took steps to strengthen the capacity of institutions.
Trade liberalization, relaxation of entry and exit barriers to investment, and other sectoral reforms in industry, agriculture, and finance directly helped to reduce poverty in three ways:
- by improving the environment for savings and investment, they contributed to economic growth;
- by improving factor mobility and access to assets for the poor, they helped smooth the transition;
- by helping expand social and economic infrastructure and institutional capabilities, they laid the foundation for sustainable growth and poverty reduction, as well as better income distribution.
Sources of growth
For the poor to benefit from growth, growth must take place in activities in which the poor participate. Hence the need for adjustment efforts to give deliberate attention to the sources of growth.
To give the poor better job opportunities, governments need to adopt policies and investment programs that encourage expansion in agriculture, labor-intensive exports, and the informal economy, which are the main sources of jobs for the poor. And social sector investments, for example in basic education, are needed to enhance opportunities for the poor over the long run.
Trends in public spending emphasize the need for selectivity when budgets are to be cut, giving priority to essential services to producers and to basic health, education, and social security/welfare services.
In most of the countries borrowing for adjustment, governments sought to reduce their budget deficits, and reduced their discretionary spending as a share of GDP. Most of the burden of the cuts fell on services to producers, including investments and maintenance of facilities in transport, communications, and energy. These declines are a matter for serious concern, especially in countries with galloping population growth. The trends have yet to be reversed in many countries. This highlights the need for a sharper focus on population issues and on public expenditure management.
Changes in social spending, though not reflected in poverty trends over the short term, can greatly affect the lives of the poor and their prospects for improving their incomes. As a share of GDP, social spending fell in half the 34 adjustment borrowers for which data are available (see figure). And per capita social spending fell in real terms in more than half these countries. Yet, in most of the successful adjustors, real per capita spending on health, education, and social security/welfare programs either rose during the adjustment period or rebounded quickly thereafter.
Patterns varied across regions. In most of the Asian countries that borrowed for adjustment, government social spending rose consistently throughout the adjustment period, both as a share of GDP and on a per capita basis. In Latin America, social spending rose in half the countries and fell in half. Social spending fell in most of the Middle East and North African countries. In Sub-Saharan Africa, spending cuts and rapid population growth caused sharp declines in per capita social spending in three fourths of the countries, a decline that could be eroding the gains in human development achieved before the 1980s.
In many countries, public expenditure reductions worsened existing biases and inefficiencies. Very few adjusting countries have made enough progress in public expenditure reform. For example, strong biases toward university--not primary--education, and hospital--not preventive--health care remain in place. Experience suggests that expenditure switching in favor of the social sectors should accompany the reduction in fiscal outlays that is usually associated with adjustment.
Experience emphasizes that good and timely public expenditure reviews, and specific conditions in loans for adjustment operations, help to protect countries' overall level of social expenditures and to ensure that allocations to poverty programs do not decline. Successful public expenditure reform requires not only sustained political commitment, but also strong institutional capacity and data collection and monitoring abilities.
Social safety nets
There is no doubt that certain groups have suffered during adjustment where proper safety nets were not in place. Few of the Bank's early adjustment loans provided for safety net programs, but such programs have become more common, especially since the late 1980s. Experience offers lessons for their design.
By compensating people displaced by reforms and by meeting the basic needs of groups excluded from growth, safety nets address humanitarian concerns and temper the immediate political costs to governments implementing radical reforms. Over the long term, safety nets can strengthen human capital development, especially among the most deprived parts of society.
But not all social safety nets are replicable or sustainable. They run the risk of entrenching themselves in a government's social development strategy and burdening public finances and institutions. Thus the strategy should be to seek an appropriate balance, consistent with the needs of broadly based growth and long-term investment in the social sectors. More systematic piloting is needed to develop appropriate policy prescriptions for the design of cost-effective safety nets.
Safety net instruments that the Bank has supported include direct cash transfers, subsidies on basic goods and services, social infrastructure development in deprived areas, employment-generating public works schemes, targeted nutrition programs, employment services and retraining programs, and direct delivery of basic goods and services to the poor.
Experience shows that:
- Programs that were implemented quickly and served large numbers of people were associated with high-level political support, help with design from their targeted beneficiaries, strong motivation, good information, timely procurement, transparency, and public accountability.
- Programs that had difficulty getting started cited political interference, poor coordination, limited participation, inadequate staffing, and cumbersome bureaucratic procedures.
Implications for program design
- Lend for adjustment where governments are committed to reforms and likely to sustain them. The most common reason why adjustment operations failed was that the agreed policies were only partly adopted or were soon abandoned.
- Strive for better allocated and more efficient public spending, especially social spending. The Bank should insist on more thorough public expenditure reviews than are now the norm, and should make greater use of public expenditure conditionality in its lending.
- Safeguard the welfare of people who stand to lose during adjustment. At the design stage of operations, the Bank should study the likely impact on winners and losers, and advise accordingly on food policy, social spending allocations, and safety nets to protect groups who are vulnerable. During the early phases of adjustment, when investment normally slows down, programs should protect the consumption levels of the poorest parts of the population and help to sustain social services. Mid-course corrections will be needed once investment has started to recover.
- Make the program as transparent and credible as possible, so as to shorten the pause in investment and the resulting slow growth. The analysis of the problems and the proposed policy changes should be clear and agreed by the government and the Bank.
- Support data development. The Bank should do more poverty assessments and support the development of databases on poverty in the context of its country assistance strategies. It can help by supporting data collection efforts at the country level, by strengthening institutional capacities and financing surveys.
Bank management agrees with most of the recommendations of the study, which do not imply major changes in policy and practice. Recent experience is likely to substantiate further the benefits of adjustment. The Bank's current policy provides for a focus on the effects of adjustment programs on the most vulnerable groups, and protection of social service expenditures is often a key element of loan conditions in adjustment operations. SALs will be closely monitored to ensure they give adequate attention to social protection and poverty issues.
Management agrees that timely reviews of public spending are essential to the design of both country assistance strategies and adjustment operations. Loan conditionality on public spending should identify core priorities, but whether it is meaningful to set floors on social spending will vary from case to case. Increasingly, public expenditure reviews will scrutinize nonwage expenditures on operations and maintenance and recommend increases when warranted.
The Bank is committed to increasing its information base on poverty, both through its fast-growing program of poverty assessments and through the Living Standards Measurement Study, which includes support for capacity building in local statistical offices.
The Committee on Development Effectiveness of the Bank's board of executive directors reviewed the study and the management response on September 29, 1995. The committee stressed that since the reduction of poverty is the overarching goal of the Bank's work, every effort must be made to improve the Bank's record regarding the social impact of adjustment. It called for improvements in several areas: (1) Support for poverty-reducing growth and inequality-reducing social sector programs should be conceived as integral parts of the Bank's assistance to adjusting countries; (2) Public expenditure reviews, which are a useful means to bring about rational allocation of public expenditures, must be carried out taking account of the borrowing country's political economy and ability to generate revenues; (3) Safety nets, to be most effective, need to be planned with the participation of the intended beneficiaries; (4) Data collection on poverty and income distribution must be improved.
The committee saw the Bank's country assistance strategy as the appropriate policy instrument to be used by management, staff, and borrower to incorporate in-depth policy discussions on the social impact of economic reform and growth. The committee urged management to continue to strive for improvement in the areas highlighted and to keep it informed of progress made. It requested a joint OED-OPR follow-up review of the topic in 1997.
Box: Empirical basis for study
The operations studied are those for which performance audits or completion reports were available in OED by 1993. About two-thirds of these operations had been rated satisfactory by OED, indicating that the corrective policies and measures that they supported were generally carried out satisfactorily and that their goals were achieved.
For 23 of the 53 adjusting countries--ten in Latin America, five in East and South Asia, three in the Middle East and North Africa, and five in Sub-Saharan Africa--enough data were available from household expenditure surveys and poverty assessments to analyze changes in poverty levels and in income distribution during and after adjustment.
For the other countries analyzed, for which less complete data were available, the study explores the links between adjustment policy measures and outcomes (including growth), the available data on poverty and income distribution, the changes in public expenditure composition, and the presence of social safety nets. The findings are consistent with those for the 23 countries with the more complete data set.
Various measures are used to capture the incidence, depth, and severity of poverty within countries and to permit comparisons across countries and with the results of earlier poverty studies.
1/ The Social Impact of Adjustment Operations, by Carl Jayarajah and others, Operations Evaluation Study, World Bank, 1995 (forthcoming).