The effect of IMF and World Bank programs on poverty

Structural adjustment, as measured by the number of adjustment loans from the IMF and World Bank, reduces the growth elasticity of poverty reduction. I find no evidence for a direct effect of structural adjustment on growth. The poor benefit less from output expansion in countries with many adjustment loans than in countries with few adjustment loans. By the same token, the poor suffer less from an output contraction in countries with many adjustment loans than in countries with few adjustment loans. Why would this be? One hypothesis that adjustment lending is counter-cyclical in ways that smooth consumption for the poor. There is evidence that some policy variables under adjustment lending are counter-cyclical, but there is no evidence that the cyclical component of those policy variables affects poverty. I speculate that the poor may be illplaced to take advantage of new opportunities created by structural adjustment reforms, just as they may suffer less from the loss of old opportunities in sectors that were artificially protected prior to reforms. 1 Views expressed here are not necessarily those of the World Bank. I am grateful to Martin Ravallion and Shaohua Chen for making their poverty spells database available. I am also grateful for discussions with David Dollar, Peter Lanjouw, and Martin Ravallion, and for comments by Nora Lustig, Aart Kraay, and Sergio Schmukler, and by participants in the NBER Pre-Conference on Management of Currency Crises in Cambridge MA July 2000. Poverty reduction is in the news for both the IMF and the World Bank. The IMF web-site 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). 2 For its part, the World Bank headquarters has built into its lobby wall the slogan "our dream is a world free of poverty." The recent East Asian currency crisis and its aftershocks in other countries generated intense concern about how the poor were faring under structural adjustment programs supported by the Bank and the Fund. The poverty issue is so red-hot that IMF and World Bank staff began to feel that every action inside these organizations, from reviewing public expenditure to vacuuming the office carpet, should be justified by its effect on poverty reduction. At the same time, there has been a long standing criticism from the left of Bank and Fund structural adjustment programs as disproportionately hurting the poor: When the International Monetary Fund (IMF) and World Bank arrive in southern countries, corporate profits go up, but so do poverty and suffering. Decades of promises that just a little more "short-term" pain will bring long-term gain have exposed the IMF and World Bank as false prophets whose mission is to protect those who already control too much wealth and power. A report published today by the World Development Movement (WDM) shows that the International Monetary Fund’s (IMF) new Poverty Reduction Strategies are acting as barriers to policies benefiting the 4 Many developing countries suffered ... sustained increases in prosperity, accompanied by dramatic increases in inequality and child poverty ... under the auspices of IMF and World Bank adjustment programmes. In country after country, structural adjustment programs (SAPs) have reversed the development successes of the 1960s and 1970s, with ... millions sliding into poverty every year. Even the World Bank has had to accept that SAPs have failed the poor, with a special burden falling on women and children. Yet together with the IMF it still demands that developing countries persist with SAPs. 2 http://www.imf.org/external/np/exr/facts/prgf.htm 3 http://www.oneworld.net/campaigns/imf&wb/index.html under "50 years is enough" 4 http://www.oneworld.net/anydoc2.cgi?url=http://www.wdm.org.uk/presrel/current/PRSPcritique.htm 5 http://www.oneworld.net/anydoc2.cgi?url=http://www.oxfam.org.uk 6 http://www.oneworld.org/guides/sap/index.html This paper examines the effect of IMF and World Bank adjustment lending on poverty reduction. I briefly examine the effect of IMF and World Bank adjustment lending on growth and find no effect (suitably instrumenting for adjustment lending), which is in line with the previous long and inconclusive literature. My main result is that IMF and World Bank adjustment lending lowers the growth elasticity of poverty, that is the amount of change in poverty rates for a given amount of growth. This means that economic expansions benefit the poor less under structural adjustment, but at the same time economic contractions hurt the poor less. What could be the mechanisms for such a result? There could be several possible explanations. I first speculate that IMF and World Bank conditionality may be less austere when lending occurs during an economic contraction, while conditionality may require more macro adjustment during an expansion. If macro adjustment disproportionately hurts the poor -say because fiscal adjustment, for example, is implemented through increasing regressive taxes like sales taxes or decreasing progressive spending like transfers -then we get the result that IMF and World Bank adjustment lending lowers the growth elasticity of poverty. Adjustment lending could even include an explicit fiscal insurance mechanism such as an increase in subsidies that cushions the effect of contractions on the poor, but accompanied by a reduction in subsidies in times of expansion. We can test this hypothesis explicitly by evaluating the behavior of fiscal policy and macro policy variables during expansions and contractions, with or without adjustment lending. A nearly opposite hypothesis is that IMF and World Bank conditionality may itself cause an expansion or contraction in aggregate output -depending on the composition of the structural adjustment package -but not affect the poor very much. This view would see the poor as mainly deriving their income from informal sector and subsistence activities, which are not affected much by fiscal policy changes or adjustments in macro policies. Structural adjustment packages usually imply some previously favored formal sector activities must contract while other formal sector activities newly favored can expand. The net effect may be overall contraction or expansion, depending on the initial sizes of the declining and expanding sectors and the specific policy measures in the structural adjustment package. However, if the poor are not tightly linked to either the expanding or the contracting formal sector, then the amount of poverty change for a given amount of output change may not be very high under structural adjustment. An expansion or contraction in the absence of adjustment lending, on the other hand, may reflect economywide factors that lift or sink all boats. I will not be able to test this hypothesis directly because of lack of comparable data on the size of the informal sector and its incidence among the poor, but I offer it as a backup hypothesis in case the first hypothesis fails. I. Data and concepts for paper I have data for 1980-98 on all types of IMF lending and on World Bank adjustment lending. IMF lending includes stand-bys, extended arrangements, structural adjustment facilities, and enhanced structural adjustment facilities (recently renamed Poverty Reduction and Growth Facilities). The latter two kinds of operations are concessional for low-income countries. World Bank adjustment lending includes structural adjustment loans, sectoral structural adjustment loans, and structural adjustment credits (the latter is concessional for low-income countries). The data are reported in the year that the loans are approved. Hence, my data take the form of number of new Bank and Fund adjustment loans approved each year. It would be preferable to have data that record also how long these loans are in effect, but the data are unfortunately not available in this format. For any time period I consider in this paper, I consider the average number of new Bank and Fund adjustment loans per year. Conditionality associated with these loans is well-known: macroeconomic conditions like reducing budget deficits, devaluation, and reducing domestic credit expansion, and structural conditions like freeing controlled prices and interest rates, reducing trade barriers, and privatizing state enterprises. Although the Fund is associated more with the former and the Bank with the latter, in practice neither will proceed with an adjustment loan unless the other is satisfied with progress on "its" area of responsibility. For data on poverty, I use an updated version of Ravallion and Chen's (1997) database on poverty spells. These authors were careful to choose spells and countries where the definition of poverty was constant and comparable over time and across countries. The source of the data is household surveys. They report the proportion of the population that is poor at the poverty line of $2 per day at the beginning of the spell and the end of the spell (they also report the poverty rates for a poverty line of $1 per day, but I choose to use the former because many countries have a 0 initial value at $1 per day). They also report the Gini coefficients at the beginning and the end, and the mean income in the household survey at the beginning and the end. They report data on 155 spells for 65 developing countries (the Appendix table gives the countries and numbers of spells each). The spells are quite short (median length 3 years), and so I interpret them more as cyclical fluctuations in mean consumption and poverty rather than as long-run tendencies in growth and poverty reduction. Table 1 gives the descriptive statistics for all the data: Table 1: Descriptive Statistics on Variables Used Change in poverty Mean consumption Growth Initial Gini Initial poverty rate Adjustment loans per year Mean 6.0% -1.1% 39.5 41.2 0.62 Median -0.1% 0.0% 39.5 36.3 0.50 Std. Dev. 31.5% 11.1% 11.1 29.6 0.60 Observations 149 155 155 154 150 II. Results on Adjustment Lending and Poverty Reduction Following Ravallion 1997, I regress the change in poverty rate on growth of mean income and the interaction of growth of mean income with the Gini coefficient. The idea of this specification is that if the poor have a low share in existing income (high Gini), they will likely have a low share in newly created income (low growth elasticity of poverty reduction). I also include the level of the initial Gini for completeness. To test the effect of IMF and World Bank adjustment lending, I include the variable measuring number of adjustment loans per year during the poverty spell and also interact this variable with growth. There is the well known selection bias problem with World Bank and IMF lending. This lending goes to countries that are in trouble, and this trouble could include initial high poverty rates. We could even imagine that World Bank and IMF programs go to countries who are more likely to reduce poverty rapidly. With these concerns in mind, I instrument for World Bank and IMF lending. I follow the practice of the foreign aid literature in using dummies that measure friends of influential donors, including a dummy for Central America, one for Egypt, and one for Franc Zone countries. I also include continent dummies as instruments for lending, because both the World Bank and IMF have a different department for each continent, and these different departments may have different propensities to make loans. I also include initial income as an instrument of adjustment loan frequency. With the same set of instruments, I also tested the direct effect of adjustment lending on growth, not controlling for any other factors. In line with a long and inconclusive literature, I found no systematic effect of adjustment lending on growth. (A recent paper by Przeworski and Vreeland 2000 reviews the long inconclusive literature on the IMF, while they themselves find a negative effect controlling for selection bias. Some internal Bank and Fund studies have found positive effects of their programs on growth. I do not intend to make the effect of structural adjustment on growth a major focus of the paper, since structural adjustment would of course alleviate poverty if it raised growth and worsen it if it lowered growth.) Of course, behind this zero average result is concealed a set of expansions and contractions that depended in part on the particulars of the adjustment program in each country and time period. In general, we would expect that an adjustment program would disfavor some sectors that were previously artificially protected or subsidized, and favor other sectors that benefit from a change in relative prices in their favor. Whether expansion or decline dominates depends in part on the relative sizes of the expanding and declining sectors (as pointed out by Rauch 1997). The result on expansions strongly reducing the rate of poverty--or output crises raising the rate of poverty--is familiar from other studies (Ravallion and Chen 1997, Dollar and Kraay 2000, Bruno et al. 2000, Lustig 2000, Ravallion 2000). Without controlling for other variables, the mean growth elasticity of poverty is about 1.9 (Table 2). The significant coefficient on the interaction term between the Gini coefficient and the growth rate also confirms the Ravallion 1997 and Bruno et al. 2000 result (Table 2). Ten percentage points higher Gini will lower the growth elasticity of poverty by 0.6 percentage points. A not-often-noticed implication of this result is that the poor will be hurt less by output contraction in a highly unequal economy than in a relatively equal one, simply because the poor have a low share of output to begin with. The initial Gini also has a direct negative effect on the change in poverty, suggesting a reversion to greater equality if a country begins highly unequal. The new result in this paper is that, while adjustment lending has no direct effect on poverty reduction, it has a strong interaction effect with economic growth (Table 2). The absolute value of the growth elasticity of poverty declines by about 2 points for every additional IMF or World Bank adjustment loan per year. This means that the poor benefit less from expansions during a structural adjustment program than in expansions without an adjustment program, while they are at the same time hurt less by contractions. Expansion under adjustment lending is less pro-poor, while contraction under adjustment lending is less anti-poor. The welfare of the poor may have increased from the income smoothing effect of adjustment lending. On the other hand, it is disappointing that the poor do not share fully in growth in those cases where there are recoveries that accompany adjustment lending. Since the Bank and the Fund ultimately wish to restore growth in the economies to which they make adjustment loans, it is worrisome that positive growth has less of a poverty-reducing impact with high Bank-Fund involvement. 7 IMF (1999) found that "In seven SAF/ESAF countries for which data are available, poverty rates declined by an average of 20 percent under IMF-supported adjustment programs, implying an average annual reduction of 5.3 percent" This study did not control for mean growth. Table 2: Regression results on change in poverty, growth, and adjustment programs Dependent Variable: Log rate of change per annum in percent of population below $2/day Method: Two-stage Least Squares Regression 1 Regression 2 Variable Coefficient t-Statistic Coefficien t t-Statistic C 0.039 1.82 0.382 4.21 GROWTH -1.892 -8.24 -5.465 -4.61 GINI1 -0.006 -3.65 PROGRAM -0.116 -1.30 GROWTH*GINI1 0.057 2.68 GROWTH*PROGRAM 2.034 3.44 R-squared 0.316 0.453 Adjusted R-squared 0.311 0.430 Included observations: 149 126 Instruments for PROGRAM: CENTAM EASIA EGYPT FRZ SSA LAC ECA GROWTH*CENTAM GROWTH*EASIA GROWTH*FRZ GROWTH*EGYPT GROWTH*SSA GROWTH*GINI1 GROWTH*LAC GROWTH*ECA LGDPPC Variable definitions GROWTH Log rate of growth per annum in mean of household survey GINI1 Initial Gini coefficient PROGRAM Number of IMF/World Bank adjustment loans initiated per annum CENTAM Dummy for Central America FRZ Dummy for Franc Zone EGYPT Dummy for Egypt and Israel SSA Dummy for Sub-saharan Africa LAC Dummy for Latin America ECA Dummy for Eastern Europe and Central Asia EASIA Dummy for East Asia LGDPPC Log of initial per capita income (SummersHeston) Figure 1 illustrates the results. Countries with a low level of adjustment lending (AL) as measured by PROGRAM and low inequality have both greater increases in poverty during contraction and greater falls in poverty during expansions than do countries with a high level of IMF and World Bank lending and high inequality. (High and low AL here just mean the upper and lower 50% of the sample as measured by program; expansion is the average of all increases in mean income while contraction is the average of all decreases in