Sept. 1999 : World Bank and IMF adopt Poverty Reduction Strategy Papers (PRSPs) as basis for concessional lending to low-income countries, including resources under the enhanced initiative for debt relief for Heavily Indebted Poor Countries (HIPC).
PRSP : in principle, formulated and written by national authorities in consultation with civil societ y; aims to describe the poverty conditions in the country and to set out a medium-term action plan to reduce the incidence of poverty and strengthen economic growth.
Design of PRSPs: involves considering the nature of policy tradeoffs that policymakers may face in allocating (scarce) public resources.
Understanding the nature of these trade-offs requires to
take into account the key linkages between micro and macro factors in designing a poverty reduction strategy;
use appropriate policy tools to prepare and compare consistent, quantitative assessments of alternative strategies.
More generally, poverty reduction has become an overriding objective of economic policy in low- and middle-income countries alike.
Poverty is as much an issue in Chile, Brazil, or Morocco, as it is in Burkina Faso.
Eradication of poverty is the first among the Millenium Development Goals (MDGs), adopted by the UN in Sept. 2000.
Monitoring poverty trends and providing advice on poverty reduction strategies: key responsibilities of the World Bank.
Issues for macroeconomists:
Macroeconomic and financial stability is not an end in itself; putting poverty explicitly in the “welfare” function requires renewed effort to better understand analytically the micro-macro linkages that matter when designing poverty reduction strategies.
Existing policy tools must be amended, and new ones must be developed, in order account quantitatively for those channels that are deemed important in determining how adjustment policies affect the poor.
IMMPA : an integrated quantitative macro-economic framework developed at the World Bank for analyzing the impact of policy and external shocks on income distribution, employment and poverty in both low-income, highly-indebted countries and middle-income developing economies.
Dwells on the analytical and applied research conducted in academic and policy circles over the past two decades on macro- economic and structural adjustment issues in developing economies.
Why build a (relatively) complex model?
Issue is complex; it serves no good purpose to pretend that it is not.
Existing, commonly-used policy tools do not come anywhere close to capturing some of the most important channels through which exogenous and policy shocks are transmitted to the poor.
Models are issue-specific; trying to “force” a model to answer questions that it is not designed to address hampers our ability to address relevant policy questions.
Models are not built only to produce numbers but also to provide qualitative insights (general equilibrium effects).
Before looking for “shortcuts”, one needs a conceptual roadmap to understand the costs and benefits of simplification.
Lack of skills is indeed a constraint in many cases; but many middle-income countries, and some low-income countries, have the capacity to implement the model.
Lack of adequate data: also a problem. But do you wait until the data have improved sufficiently, or do you start with existing data, no matter how imperfect, and improve the database gradually?
IMMPA: Main Features
Treatment of the production structure and the labor market (wage formation and sources of segmentation, skills acquisition, rural-urban migration).
The financial system and the credit market (portfolio structure--stock decisions--and the treatment of credit market imperfections).
Adverse effect of external debt on domestic private investment (foreign exchange constraint, confiscation risk, or other channels).
Allocation of public expenditure (to current transfers, infrastructure, education, health).
Systematic link with a household income and expenditure survey ; allows a more accurate assessment of poverty effects of shocks.
Dynamic structure allows the analysis of dynamic tradeoffs that poverty-reduction strategies may entail regarding the sequencing of policy reforms—particularly between short-term stabilization policies and structural measures.
Structure of IMMPA
Rural Production . Two agricultural goods, traded and non-traded.
Informal sector: produces non-traded goods.
Private traded and nontraded goods.
Public non-traded good.
Production Process Urban production Aggregate production Rural production Nontraded good Traded good Formal Informal Private Public Traded good Nontraded good Nontraded good Nontraded good
The Labor Market
Rural Unskilled Workers: employed in production of traded or non-traded agricultural goods.
Urban Unskilled Workers: employed in private sector, public sector or in informal economy.
Skilled Workers: employed in formal urban sector (public or private), or unemployed.
Flexible in informal sector and nontraded good sector in agriculture.
Fixed in real terms in traded good sector in agriculture and for urban unskilled (minimum wage).
Efficiency wage for urban skilled workers (wage-productivity link).
Both wages and employment of skilled workers are determined by firms in the urban private sector.
Other assumptions are (of course) possible.
Rural to urban migration
Depends on expected relative wages.
Human capital accumulation
Decision to acquire skills by unskilled workers is endogenous.
Depends on a ) the ratio of the cost of acquiring education relative to the initial wealth of unskilled workers (decision is subject to credit constraints );
b ) relative wages, and c ) the stock of public capital in education.
Population growth rate : inversely related to the composition of the labor force (ratio of skilled to unskilled labor); fertility effect.
Modeling the informal economy and labor market segmentation is essential for understanding the short-run dynamics of employment and urban poverty.
Modeling the decisions to migrate and acquire skills is essential for understanding the medium- and long-run dynamics of poverty and the role of public policy.
Employment and Skills Rural unskilled Unemployment Labor force migration Urban unskilled skills acquisition Skilled Formal Informal Non-traded Traded Rural production Urban production Labor demand
Household savings are allocated to financial wealth accumulation.
Currency . Depends on income, interest rates and inflation.
Bank deposits . Allocation between domestic and foreign-currency deposits (held abroad) depends on relative rate of return on these assets.
No real assets.
Monetary base Household savings World interest rate and deposit rate Real currency balances Financial Assets and the Money Market Domestic deposits Foreign deposits Balance of payments Credit to government Financial wealth Endogenous Exogenous
The Credit Market
Households : deposits in banks (domestic source of funding).
borrow for both physical capital accumulation and financing of working capital needs.
Given retained profits and foreign loans, borrow from domestic banks.
Collect domestic deposits. Reserve requirements determine funds available for lending to domestic firms.
Lending to government is exogenous.
If domestic funds are not sufficient to satisfy demand, they borrow on world markets.
Alternatively: with exogenous foreign borrowing, excess liquid reserves adjust to clear the credit market.
Lending rate is set as a markup over the cost of funds (domestic and external).
Markup rate (premium): Two possible under-lying explanations.
A . Markup depends inversely on the ratio of the stock of private capital to total loans. Collateral (or net worth ) effect .
B . Markup is a function of monitoring and enforcement costs of loan contracts. Costs are a positive function of the amount of loans (scaled by total bank assets) due to congestion in courts.
Both are consistent with recent models of credit market imperfections.
Dependence of the cost of funds on net worth: a critical aspect of the model.
For instance, a nominal exchange rate devaluation will reduce firms’ net worth and may dampen private investment by increasing the cost of capital.
Worsening of the real burden of debtors,and increase in lending rates, may offset the expansionary effect due to capital gain for net creditors in foreign currency (households).
Devaluation may be contractionary; longer-run effect also due to impact on capital formation.
Foreign borrowing by commercial banks Working capital and Investment Firms’ borrowing (net of retained earnings) Foreign borrowing by firms Loan rate Domestic funds for bank lending Domestic deposits World interest rate and deposit rate The Credit Market Reserve requirement Lending to government Demand for credit Endogenous Exogenous Premium Net worth
Prototype: CB sets both the exchange rate and the bank deposit rate.
Nominal supply of currency: changes in the monetary base.
Counterparts to the monetary base: official foreign reserves and (exogenous) credit to government.
Alternatively, model can be solved with a flexible exchange rate.
Sets tax rates on domestic sales, imports, income and profits.
Allocates public expenditure to current consumption and investment (infrastructure, health, education).
Public spending has three types of effects.
Conventional aggregate demand effects (impact on consumption);
Effect on private investment ( complementarity between public investment in infrastructure and private capital formation);
Supply-side effect . Private production (agriculture and urban formal sectors) depends on the stock of government capital in infrastructure and health.
Various options are possible.
Prototype: financing is given from “below the line.”
Implications: focus on the income effects of induced changes in the budget;
no changes in distortionary taxes and incentives.
Aggregate demand Private disposable income Credit from central bank Commercial bank loans to government Financeable Government deficit Lump-sum transfers Foreign borrowing by government Interest payments on debt Non-interest expenditure Distortionary tax revenues Endogenous Exogenous Public Enterprise Net Revenues Public Sector
Balance of Payments
Imports, exports and debt service are endogenous.
Capital flows and the capital account
Net borrowing by firms and government is exogenous.
Borrowing by domestic banks and deposits abroad by households are endogenous.
Movements in official reserves determine the monetary base.
Balance of payments (official reserves) Monetary base Current account Foreign deposits by households Imports Balance of Payments Total foreign borrowing Capital account Exports Debt service Firms Banks Government Endogenous Exogenous
Standard CGE specifications for
production functions (e.g. intermediate inputs: Leontief specification);
consumption (linear expenditure system);
composite goods and prices;
consumer price index is an average of composite prices.
Savings rate . Depends positively on the real deposit rate and thus inversely on inflation.
Private investment and external debt.
Inverse and possibly nonlinear relation (inclusion of a quadratic term for external debt service to tax revenues).
May capture various factors: foreign exchange constraint, crowding-out effect of high indebtedness, confiscation risk.
Poverty and Income Distribution Analysis
A . Measures of income distribution :
Gini coefficient and Theil index.
Based on six households categories: workers in the rural traded sector, rural non-traded sector, urban unskilled informal economy, urban unskilled formal sector, urban skilled formal sector; and capitalists.
Other measures can be added.
B . Link with household surveys :
IMMPA simulation results can be linked to survey data on income and expenditure…
...to estimate the impact of shocks on income within each group as well as average income variations among groups.
This allows us to calculate measures of poverty and changes in income distribution across groups.
Step 1 . Use the information provided in the household survey to classify the available sample into IMMPA’s six categories of households, so as to establish an interface between the model’s simulation results and actual household income and expenses.
Step 2 . Following a shock to the model, calculate real growth rates in per capita consumption and disposable income for the six categories of households.
Step 3 . Apply these growth rates separately to each individual per capita (disposable) income and consumption expenditure observation in each of the six groups of households in the survey…
… this gives absolute income and consumption levels for each household, in each group, following the shock.
Step 4 . Given rural and urban poverty lines (expressed in monetary units and rising at the rural and urban unskilled CPI growth rates), and using the new absolute levels of income and consumption in each group, calculate
post-shock poverty indicators (headcount index and poverty gap index);
income distribution indicators (Gini coefficient and Theil inequality index).
Step 5 . Compare post-shock indicators with baseline values to assess impact of the shock on poverty and income distribution.
For all indicators, IMMPA generates three measures: short-term measure (first two periods following a shock); medium-term measure (between 3 and five periods); and long-term measure (6 and 10 periods).
Choice of intervals is somewhat arbitrary and can be changed.
These measures allow the analyst to identify and discuss possible Dynamic tradeoffs in the analysis of policy choices, by contrasting their short- and longer-run effects on the poor and income distribution.
Note I: limitations of Headcount index
1. Does not indicate how poor the poor really are (it remains unchanged even if all people with incomes below the poverty line were to experience e.g. a 50% drop in income).
Put differently: when a poor person become poorer, the index will not increase.
2. Implies that income distribution among the poor is homogeneous (no distinction between a poor person who earns one monetary unit less than the poverty line and one who earns 100 monetary units less than the poverty line).
Link IMMPA-Household Survey Survey Shock to IMMPA Aggregate data in 6 IMMPA categories Growth rates of income and consumption for 6 categories Apply to each individual in 6 categories (new absolute levels) Rural poverty line Urban poverty line Poverty indicators (short, medium and long term) Comparison with baseline scenario Urban price index Rural price index
Poverty Sheet - Consumption Based
Procedure above: assumes that the user matches households as defined in the macro component of IMMPA and a household survey using information on the main source of income of household heads .
Alternative treatment: possible if the household survey provides sufficient detail regarding the composition of income among individual members of each household.
“ Light surveys” tend to concentrate on the household head, whereas more in-depth surveys provide richer information.
If the information is detailed enough, and if each member of a household can be “allocated” to one of the six IMMPA income groups, model-generated growth rates of income and consumption can be applied separately to each individual income-earner (as in Step 3 above).
Poverty and income indicators can be generated using either “individual” income earners or “composite” households.
However, whether accounting for heteroge-neity in the sources of income among individual household members makes a difference or not is generally case specific; it depends on
the characteristics of the intra-household distribution of income (which depends on risk diversification strategies);
the extent to which growth rates of income and consumption generated by IMMPA following a shock differ among the various income groups.
If, for instance, the intra-household distribution as given in the survey is such that most of the income of each composite unit is generated by the household head…
… treating the household as a homogeneous unit and applying the same growth rate of income to each member should not result in significant errors.
Approach remains subject to the assumption of a stable within-group distribution (relative income and consumption levels--and positions--within each group do not change because same growth rate is applied to each individual).
Alternative approach: include individual data directly in the model and use micro simulation techniques to exploit intra-group information.
Benefit: allows the analyst to distinguish, in the evolution of poverty indicators, the specific contribution of three factors: changes in the poverty line (when it is treated as endogenous), across-group variations, and changes in intra-group distribution.
However, complex and costly to implement.
Existing studies: not obvious that changes in intra-group distribution are large compared to inter-group distribution (results appear to be shock-specific).
Solution and Calibration
Prototype: Initial values (and shares) selected to represent a low-income country.
Parameter values (elasticities) are consistent with existing CGE models.
Computer programs used for solution: Excel and Eviews ; emphasis on ease of use.
Model is solved iteratively using either a Gauss-Seidel algorithm or the Newton-Raphson technique.
The equilibrium condition of the money market is omitted due to Walras Law , but used for consistency check.
Existing operational manual (see Chen et al. (2001)):
Procedures for building the financial SAM that underlies IMMPA;
How to estimate econometrically some key behavioral functions (private investment, skills acquisition, migration function, asset demand equations);
How to solve IMMPA and simulate policy and exogenous shocks.
Endogenous Variable File Exogenous Variable File Eviews Simulation Program Output File Stage 1 Stage 2 Stage 3 Stage 4 Stage 5 Graphs (Excel File) Plots of current-base run values for endogenous variables are generated Household Survey Data File Stage 4 IMMPA Simulation Package Setup
Domestic Credit Shock
Simulation Exercise: Debt Relief, Public Expenditure Allocation, and Poverty Reduction
Savings from debt relief.
Reallocation of government expenditures (at a given level of the overall deficit) to
Investment in infrastructure;
Investment in education.
Simulation captures possible effect of lower external debt on private investment.
Reminder : public spending has three types of effects:
Conventional aggregate demand effect (impact on consumption);
Effect on private investment,as a result of the complementarity between public investment in infrastructure and private capital formation;
Supply-side effect . Private production (agriculture and urban formal sectors) depends on the stock of government capital in infrastructure and health.
Investment in Education
Effect on incentives to acquire skills:
Unskilled urban workers invest in acquiring skills depending on relative wages, the stock of public capital in education, and initial wealth.
Increase in supply of skilled workers must be matched with increase in labor demand to avoid higher unemployment.
Effect on labor market and wages:
As unskilled urban workers become skilled, unskilled labor supply in the formal urban economy is replenished by workers previously employed in the informal economy.
Given a fixed minimum wage for unskilled labor in the formal urban economy, informal wages increase due to reduction in supply of labor in the informal economy.
Effect on migration:
Increase in average urban wage paid to unskilled labor is an incentive to migrate from the rural sector.
Increase in the supply of urban unskilled workers.
Puts downward pressure on informal sector wages and counteracts initial effects.
Increase in wages in the nontraded agricultural sector.
Investment in Infrastructure
Complementarity effect on private investment.
Infrastructure improvements have a positive aggregate effect on the economy:
they improve labor productivity by facilitating economic activity.
This increases labor demand in all sectors, and consequently reduces poverty (“crude” headcount index).
Better infrastructure also raises private investment, as it improves the productivity of private capital and returns on private capital. This further stimulates economic activity.
Combining public investment alternatives:
Infrastructure and private investment affect labor demand in all sectors, but especially the demand for skilled workers.
This is because private capital and skilled workers have a high degree of complementarity (or low net substitutability).
Thus, considering alternative public investment strategies is important.
Investment in education increases the supply of skilled workers, whereas investing in infrastructure stimulates private investment, which raises the demand for skilled labor.
Investment in Health
Investment in education primarily affects the urban economy, whereas investment in health benefits all workers and therefore has aggregate productivity effects.
Investment in health has similar effects as investment in infrastructure; acts as a complement to spending in education and infrastructure.
“ Crude” poverty measure: rural non-traded and urban informal workers.
Evidence of poverty concentration in these sectors (65-90% in rural areas for sub-Saharan Africa).
Associated with concept of poverty reduction as access to higher quality jobs.
Policy Rankings - Infrastructure is PPF enhancing - Education increases the supply of skilled labor but there may be unemployment - Has direct effects in urban areas - Policy mix? Better than Education only Why?
Modifications and Extensions
IMMPA: a flexible tool that can be amended or extended in various ways.
The credit market
If banks cannot borrow on world capital markets, excess liquid reserves may be the equilibrating variable.
Alternatively, credit rationing can be introduced.
Informal credit market
Important in some countries.
But it adds another layer of complexity.
Real assets (livestock, land) can be added.
May be important for rural households.
Some assets are held in “unproductive” form.
But even if household expenditure is independent of total wealth: reallocation of assets would affect spending (through interest income on deposits).
However: serious measurement problems.
Cost of foreign borrowing : can be made endogenous (risk premium).
Depends negatively on inflation due to the rate-of-return effect.
But it may also depend positively on inflation ( precautionary motive ).
TFP growth: accounts for a large share of output growth in many countries (see Agénor (2000)).
Can be endogenized by using government policy variables that affect incentives to adopt new technologies or to use resources efficiently.
Alternative financing rules are easily implemented.
Endogenous domestic borrowing (from commercial banks or the central bank) or foreign borrowing.
Endogenous current expenditure.
Endogenous tax rates.
Exchange rate regime
Flexible exchange rate regime can be easily implemented.
Possibly large effect on bank balance sheets and household wealth ( valuation effects ).
Adverse effect of external debt
High public external debt may also lead to private capital flight.
Debt reduction may not only stimulate private investment but also private capital inflows (treated as exogenous in the prototype model).
Another source of positive externalities.
Model: urban informal labor market is characterized by free entry and high degree of wage flexibility.
Adverse shocks to the formal economy translate into lower (average) productivity in the informal sector.
However, despite the absence of entry restrictions, urban open unemployment is often high for unskilled workers.
Some evidence suggests that labor mobility between the formal and the informal sectors, although very high, is not perfect.
Analysis could be extended to account for unskilled unemployment
Argument: informational frictions may force unskilled workers to remain unemployed while they are searching for a job in the formal sector.
Harris-Todaro type mechanism.
See IMMPA applications for Brazil (Agénor, Fernandes and Haddad (2002)) and Morocco (Agénor and El Aynaoui (2002))
Agénor, Pierre-Richard, The Economics of Adjustment and Growth , Academic Press (San Diego, Cal.: 2000).
-----, “Business Cycles, Economic Crises, and the Poor: Testing for Asymmetric Effects,” unpublished, the World Bank (October 2001).
-----, “Macroeconomic Adjustment and the Poor: Analytical Issues and Cross-Country Evidence,” unpublished, the World Bank (January 2002 a ).
-----, “The Analytics of Micro-Macro Linkages for the Design of Growth and Poverty Reduction Strategies,” paper in progress, the World Bank (February 2002 b ).
Agénor, Pierre-Richard, Reynaldo Fernandes and Eduardo Haddad, “A nalyzing the Impact of Adjustment Policies on the Poor: An IMMPA Framework for Brazil, ” work in progress, the World Bank and University of Sao Paulo (January 2002).
Agénor, Pierre-Richard, Alejandro Izquierdo, and Hippolyte Fofack, “IMMPA: A Quantitative Macroeconomic Framework for the Analysis of Poverty Reduction Strategies ,” unpublished, the World Bank (December 2001).
Agénor, Pierre-Richard, Karim J. P. El Aynaoui, “ Labor Market Reforms, Unemployment and Poverty in Morocco: A Quantitative Analysis, ” work in progress, the World Bank (January 2002).
Chen, Derek, Hippolyte Fofack, Henning Jensen, Alejandro Izquierdo, and Daouda Sembene, “ IMMPA: Operational Manual,'' unpublished, the World Bank (November 2001).