Pro-Poor Macroeconomics

Since the mid-1990s, poverty reduction and the achievement of better living conditions in poor countries have slowly gained a place on the national policy agenda of developing countries, while, following the adoption of the Millennium Development Goals, the achievement of quantitative targets in these areas has become the main goal of international development.

The current phase of globalization has been characterized by increasing frequency of economic crises/downturns for developing countries. Several reasons can be advanced for this, including severe drought in agriculture-dependent economies, such as Zimbabwe, or a secular decline in the terms of trade for primary exporting countries, such as Zambia. However, the most important reason has been the inexorable march of the developing world to currency boards or dollarization — with consequent surrender of any semblance of an independent monetary policy — or, more likely, to flexible exchange rates preceded by long maintenance of unsustainable pegs.

Developing countries are frequently exposed to shocks that generate balance-of-payments problems, trigger bouts of inflation and disrupt incomes. These can cause the poverty ratio to rise, which is often further aggravated by inappropriate stabilization policies. A case in point is Indonesia, whose headcount ratio, i.e. the proportion of the population falling below the national poverty line, jumped from eight to 19 percentage points during the recent East Asian crisis. Another example is Mexico, for whom the poverty ratio rose from 15 to 21 percentage points at the time of its 1994/5 currency crisis. Similar episodes are to be found in many other countries.

In the early twenty-first century the background against which policy makers have to choose an exchange rate regime is characterized by global financial integration, the dominance of capital account over current account transactions, large unhedged foreign currency liabilities, unpredictable fluctuations between the three main currencies and frequent financial crises linked to financial reforms and volatile portfolio flows. Given all of this, the mainstream advice to developing countries has been to adopt one of the two ‘corner solutions’ — that is, a hard peg or a pure float. However, whether this suggestion is good for growth and poverty alleviation is not at all clear. In this regard, this chapter reviews the evolution of the exchange rate regimes, examines the impact of alternative exchange rate regimes on growth, inflation and the balance of payments and discusses the choice of the exchange rate regime that minimizes poverty under normal conditions and crisis periods.

Globalization has been one of the most pertinent and also most controversial economic forces of recent decades. Often referring to the opening of countries to more capital and trade flows, globalization has been praised as a crucial vehicle for faster growth and rising living standards in developing economies, but also criticized for increasing financial instability in emerging economies.

North-South capital flows are likely to allow countries in the South to grow independently from their (low) domestic saving rate, thereby reducing possible financial constraints to growth. They allow the financing of balance-of-payments deficits in the early stages of development, so that a country can import intermediate and capital-intensive goods, which are essential for productive capacity. They improve the allocation of domestic and foreign capital and facilitate the transfer of technology and know-how. Hence, private capital flows have the potential to boost growth and to contribute to improvements in the standard of living in developing countries. This potential does not seem to have been fully exploited yet, especially in African countries.1

Considerable attention has been given to the appropriate extent and form of safety nets for the poor in developing countries (see Chapter 3 of this volume). However, the literature on this subject has focused almost exclusively on domestic institutional arrangements which may protect the poor from adverse shocks. A question that has received insufficient consideration is whether international institutions and instruments can play a useful role in helping poor countries (and poor persons in poor countries) cope better with the shocks that they experience. That is the question addressed in this chapter.

Mauritius’ economic performance over the last two decades has been remarkable. During this period, real Gross Domestic Product (GDP) growth rate has averaged 5.4 per cent per year, inflation has declined from over 25 per cent in the early 1980s to less than 5 per cent in 2004 and per capita income has increased over the same period from around $1,166 to nearly $5,000. Social conditions have also improved; life expectancy at birth increased from 61 years in the 1960s to 71 in the 1990s, primary enrolment from 93 to 105 per cent, the Gini coefficient declined from 0.5 to 0.37 and the Human Development Index (HDI) increased from 0.626 in 1980 to 0.772 in 2000.

Malaysia’s management of its economy is often seen as being rather unconventional and inconsistent. Even before the controversial September 1998 imposition of capital controls, Malaysia’s economic management style was described as unorthodox. After the events of May 1969, the government formulated the New Economic Policy (NEP) to ‘eradicate’ (reduce) poverty and to ‘restructure society’ (reduce inter-ethnic economic disparities). Accordingly, the government sector grew with increased expenditure, budgetary deficits and public debt in the 1970s. The government initiated a heavy industrialization drive in the early 1980s, but in the mid-1980s it abruptly opted for a more restrictive fiscal policy and in the mid-1990s it even ran modest budget surpluses. Huge deficits were incurred again after the 1997–98 financial crisis, but these were justified as being pro-recovery, rather than pro-poor (Jomo 2001, 2003).

The Chilean economy is praised in international financial circles for combining an open, market-oriented economy with prudent macroeconomic management. Most of the policies of external opening, liberalization and privatization were undertaken under military rule in the mid-1970s and 1980s. The return to democracy in the early 1990s consolidated the prevailing economic model and placed more emphasis on poverty reduction and social protection. However, the persistence of inequality of income and wealth distribution has remained a stubborn feature of the Chilean model. As Chile faced a presidential and parliamentary election by the end of 2005, the inequalities of income, wealth and opportunities became the centrepiece of national debates on the future of the Chilean economy and society.

It is now commonplace to regard China and India as the two economies in the developing world that are the ‘success stories’ of globalization, emerging as economic giants of the twenty-first century. The success is defined by the high and sustained rates of growth of aggregate and per capita national income; the absence of major financial crises that have characterized a number of other emerging markets; and substantial reductions in income poverty. These results in turn are viewed as the consequences of a combination of a ‘prudent’, yet extensive programme of global economic integration and domestic deregulation, as well as sound macroeconomic management. Consequently, the presumed success of these two countries has been used to argue the case for globalization and to indicate the potential benefits that other developing countries can reap, provided they also follow ‘sensible’ macroeconomic policies. The importance of these two countries also spills over into discussions of international inequality.1 This makes a comparison of the nature of macroeconomic policies in India and China, and the extent to which these have been ‘pro-poor’, of particular current relevance. In this chapter, we attempt such an examination, assessing growth performance and its impact on poverty and inequality, and also specifically addressing the question of how the macro policies have contributed to observed outcomes.

The Central Asian Republics (CARs) offer an interesting comparative study in reform paths of formerly centrally planned economies. While the CARs share a considerable geographical, religious and cultural unity, and while they initiated the transition to the market economy from fairly similar conditions, they pursued different policies following the demise of the Soviet Union in December 1991. The Kyrgyz Republic has been most committed to the introduction of Washington Consensus-type reforms. Turkmenistan has been the least committed, with a regime concerned more with the distribution of oil rents than with creating a market-oriented economy. In turn, both Kazakhstan and Uzbekistan have made some progress with economic reforms, with the former increasingly following an orthodox approach, while the latter adopted a more controlled reform process. The specificity of the Uzbek approach has been evident throughout the heterodox macroeconomic stabilization of 1991–1995, the import-substitution-led recovery of 1996–2002/03, and the new and more liberal regime that started emerging in 2002–2003. This home-grown approach to policy making has been and remains the object of considerable controversy, and many predicted that it would have led sooner or later to a growth collapse.

With the adoption of the Millenium Development Goals, poverty reduction has been placed at the centre of international policy debates on economic development. The ability to achieve rapid poverty reduction critically depends upon the extent of economic growth and on its impact on poverty. This, in turn, depends on initial inequality and changes in inequality during the growth process (Klasen 2005). As can be shown analytically, the highest poverty impact will occur in an environment of low initial inequality and pro-poor distributional changes (World Bank 2000; Bourguignon 2003). As a result of these findings, the term ‘pro-poor growth’ (PPG) has been coined to describe growth that achieves high rates of poverty reduction (Klasen 2004; AfD et al. 2005).

Over the last 25 years, Brazil has experienced profound economic changes. Following the international economic instability of the late 1970s and the debt crisis of the early 1980s, Brazil launched structural adjustment programmes with the intention of solving external account imbalances and controlling high inflation rates. In 1990, Brazil undertook a major break from a century-long era of import-substitution strategy (ISI) that left its economy essentially closed towards the end of the 1980s, and introduced economic reforms involving trade and capital account liberalization, the privatization of state companies, the deregulation of markets and a successful stabilization plan. These reforms have been reshaping the economy very rapidly and are giving rise to economic transformations. Table 14.1 shows, however, that the pre-reform per capita output growth rate is significantly higher than that of the post-reform period (1990–2004). The social indicators are also disappointing. Poverty is at a very high level for a middle-income country and has been reduced only very slowly, while income inequality is not only at a very high level, but has also increased over time. To the extent that structural reforms are widely understood to be conducive to growth and be pro-poor, these statistics suggest that something went wrong.