UNDP RBA MDG Based Planning Dar-es-Salaam Feb 27 – 3 March 2006 Training Modules

Module 1: Pro-Poor Growth: Equity and Poverty Reduction [abridged copy distributed] This module defines pro-poor growth as: Growth is pro-poor when the incomes of the poor rise proportionately more than the incomes of the non-poor. If the income share of the poor (headcount) is H and the growth rates for the poor and non-poor are gp and gnp, then aggregate growth is: g = Hgp + (1 – H)gnp Growth is pro-poor when gp > gnp

Necessary conditions for Pro-poor Growth are 1. Political stability and government commitment to poverty reduction; 2. Resources to increase public expenditure, especially public investment (fiscal space), via development assistance debt relief domestic revenue restructuring (including cancellation) of domestic debt domestic borrowing 3. Overcoming orthodox policy ideology (aka ‘sound policy’, ‘good business climate’, ‘realistic policies’)

Overcoming the Ideological Blinders of Policy Making There are two broad theoretical approaches to macroeconomic analysis. A price determined economy, which either in a unique full employment general equilibrium, or prevented from achieving that by private or public price ‘distortions’. An economy is demand determined when output is limited by one or more of the components of aggregate demand: consumption, private investment, government expenditure, or exports.

Policy making is ideological when one or the other of these frameworks is used contrary to empirical evidence to support its basic presumption. Example: ODA conditionality sets a numerical limit to the fiscal deficit (however defined), on the arguments that a larger deficit would 1) increase borrowing rates and crowd out private investment; 2) would create inflationary pressures.

Ideological or technical argument? To be true, the argument requires: 1. the economy is at full employment (if not any type of expenditure can increase without impact on interest rates; 2. the structural component of inflation is minor; 3. the deficit is funded by ‘printing money’, and there is a stable relationship between the quantity of money and the price level (Fisher’s Law)

This example demonstrates a general theoretical point: A price determined economy is either in a unique full employment general equilibrium, or prevented from achieving this by private or public price ‘distortions’. A demand determined economy is one whose output is limited by one or all of the components of aggregate demand: consumption, private investment, government expenditure, or exports.

In brief, a demand determined economy is inside its production possibilities frontier. As a result: Relative prices are not ‘efficient’ (they are not the prices that would prevail if the economy realised its potential). Government interventions cannot be judged as ‘distortionary’ compared to prices prevailing in their absence; Therefore, each government action (or inaction) must be judged pragmatically, not on the basis of an abstract, irrelevant full employment general equilibrium benchmark.

The economic justification of the UNDP’s approach to economic policy and poverty reduction is that economies are demand determined. Otherwise, inequality and poverty would reflect allocative efficiency, so that interventions to promote equity would be ‘distortionary’.

The demand determined framework predicts and accounts for unemployment, it concludes some inequalities to be inefficient, and it calls for effective public sector intervention to achieve social objectives. fosters the social objective of poverty reduction through sustained growth by the public sector providing the residual stimulus to maintain the economy near its productive potential. In the short & medium run this involves counter-cyclical policies, and in the long run investment that increases aggregate supply.

A pro-poor growth programme based on the demand determined framework would have the following components: 1. an expansionary fiscal budget, consistent with the rule that the overall deficit not exceed public investment; 2. an accommodating monetary policy that tolerates moderate inflation to achieve higher growth, by a) targeting the ‘Golden Rule’ real interest rate (equal to the sustainable growth rate of per capita income), b) expansion of the money supply to accommodate growth and monetary deepening, and c) providing subsidised credit for poverty reduction programmes; and 3. a managed exchange rate that is expansionary by promoting tradeables.

Growth and Distribution for Poverty Reduction A robust rate of growth is a necessary condition to achieve the MDG targets in sub-Saharan countries. However, growth alone, at historically high rates for each country, will mean that most sub-Saharan countries will not achieve the MDG targets. Thus, the redistribution of income at the margin (pro- poor growth as defined above) is also necessary condition for most sub-Saharan countries to achieve the MDG targets by 2015.

If feasible, redistribution always beats growth. Redistribution at the margin (pro-poor growth) is a more effective, faster, and cheaper method of reducing poverty and achieving the MDG targets than raising the growth rate with unchanged income inequality (all the more if inequality is increasing).

Note: A larger value for  (Pareto coefficient) indicates greater inequality.

Brief explanation: Each time period, pro-poor growth increases the elasticity of poverty reduction with respect to growth, for all subsequent time periods; The elasticity of poverty reduction is increased for every feasible rate of growth; Therefore, an redistribution of income at the margin of any percentage will always reduced poverty more than an increase in growth of the same percentage; for example, in Zambia redistribution of one percent of personal income would reduce income poverty by as much as an increase in growth of three percent.

Poverty reduction through pro-poor growth should always be cheaper in resource requirement than increasing the growth rate. Proof through general example: Stylised country characteristics: 1. Elasticity of poverty with respect to growth =.5 (Gini coefficient of ) 2. Incremental capital output ratio = 3.5 (Rather low estimate) The necessary increment in net investment to increase poverty reduction by one percentage point (growth by 2 percentage points)  In = 7 (= 3.5 x 2)

Therefore, if the cost of redistributing ONE percentage point of GDP is less than SEVEN percent of GDP, pro-poor growth is cheaper in real resources than increasing the growth rate.

Designing effective redistribution The effectiveness of a redistribution measuring is determined primarily by the social structure of the society.

Broad categories of measures Current expenditure & taxation a. progressive (or, at least, non- regressive) tax structure; b. direct public provision of goods & services (e.g., school meals, general medical care)

Capital expenditure a. social infrastructure (schools, hospitals) b. regionally targeted infrastructure; c. economic infrastructure - social cost reducing - export promoting - asset creating

Concluding Comments The development agenda that focuses on MDGs requires fostering policies of redistribution if it will prove successful. Required is a growth policy that incorporates equity as a fore-thought, rather than an after-thought. This implies shifting the policy debate so that the costs and limits of growth are viewed as sceptically as the costs and limits of redistribution.