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Policy Issues of EDRC Models Ex-ante Poverty Impact Assessment of Macroeconomic Policies International Workshop Washington, D.C. October 14-15, 2003 Aghasi.

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Presentation on theme: "Policy Issues of EDRC Models Ex-ante Poverty Impact Assessment of Macroeconomic Policies International Workshop Washington, D.C. October 14-15, 2003 Aghasi."— Presentation transcript:

1 Policy Issues of EDRC Models Ex-ante Poverty Impact Assessment of Macroeconomic Policies International Workshop Washington, D.C. October 14-15, 2003 Aghasi Mkrtchyan Economic Development and Research Center, Armenia

2 Contents Why EDRC participates in PRSP and modeling processes and how it contributed to the development of PRSP in Armenia? Why EDRC participates in PRSP and modeling processes and how it contributed to the development of PRSP in Armenia? What are the Criteria that a Model Dealing with Poverty Issues should meet? What are the Criteria that a Model Dealing with Poverty Issues should meet? What Environment EDRC’s Models are Developed for? What Environment EDRC’s Models are Developed for? Ideas underlying the model: Political economics of the Model Ideas underlying the model: Political economics of the Model The Set of The Models The Set of The Models Policy Implications Policy Implications

3 Why EDRC Participates in PRSP and Modeling Processes and how It Contributed to the Development of PRSP in Armenia? To contribute to a comprehensive understanding of poverty and possibilities of poverty reduction in Armenia To contribute to a comprehensive understanding of poverty and possibilities of poverty reduction in Armenia To design independent domestic policy programs To design independent domestic policy programs To provide a tool to Civil Society Organizations (CSO-s) for policy evaluation To provide a tool to Civil Society Organizations (CSO-s) for policy evaluation To create institutional basis for strengthening alternative macro-modeling capacities of the non-governmental sector To create institutional basis for strengthening alternative macro-modeling capacities of the non-governmental sector To promote CSO-s participation in public policy making To promote CSO-s participation in public policy making

4 PRSP Processes in Armenia: EDRC Contribution EDRC conducted the “Policy Choice for Poverty Reduction” project to develop policy recommendations for PRSP EDRC conducted the “Policy Choice for Poverty Reduction” project to develop policy recommendations for PRSP Using EDRC’s models, our experts developed the macroeconomic strategy and analysis of the macroeconomic policy impact on poverty for the first draft of PRSP for Armenia Using EDRC’s models, our experts developed the macroeconomic strategy and analysis of the macroeconomic policy impact on poverty for the first draft of PRSP for Armenia However in the final PRSP it was replaced by the macroeconomic framework of the IMF’s PRGF program with Armenia However in the final PRSP it was replaced by the macroeconomic framework of the IMF’s PRGF program with Armenia In the final PRSP the tools that were used to derive the policy impact on distribution and poverty incidence are not transparent and have not been disclosed In the final PRSP the tools that were used to derive the policy impact on distribution and poverty incidence are not transparent and have not been disclosed

5 What are the Criteria that a Model Dealing with Poverty Issues Should Meet? Ability to estimate policy impact on economic welfare Ability to estimate policy impact on economic welfare The model needs to produce a macroeconomic framework, to forecast income distribution and poverty incidence The model needs to produce a macroeconomic framework, to forecast income distribution and poverty incidence For participatory policy making, models also should be transparent and user-friendly For participatory policy making, models also should be transparent and user-friendly Data availability constraint should be properly taken into account Data availability constraint should be properly taken into account

6 What Environment EDRC’s Models are Developed for? Low income transition economy Low income transition economy High level of “transitional” polarization High level of “transitional” polarization Corruption and resulting market distortions Corruption and resulting market distortions Openness to trade and capital account liberalization Openness to trade and capital account liberalization Low level of resource utilization Low level of resource utilization Stable prices Stable prices

7 Ideas Underlying the Model : Political Economics of the Model (1) Conventional theory says that active income redistribution policy will create distortions thus negatively affecting long- term growth perspectives Conventional theory says that active income redistribution policy will create distortions thus negatively affecting long- term growth perspectives Critics of the conventional view usually admit that there is such a cost, however they argue that the urgent social issues cannot be sacrificed for long term benefits Critics of the conventional view usually admit that there is such a cost, however they argue that the urgent social issues cannot be sacrificed for long term benefits In our model we see smoother income distribution as a prerequisite for long term growth and prosperity In our model we see smoother income distribution as a prerequisite for long term growth and prosperity Are there short-term benefits but long term losses from more active income redistribution policies? Or something else is true for Armenia?

8 High inequality does not lead to sustainable growth High inequality does not lead to sustainable growth High inequality does not lead to high investments High inequality does not lead to high investments There is no trade-off between economic growth and more active income redistribution There is no trade-off between economic growth and more active income redistribution Smoother distribution will have positive long term implications for sustainable economic growth Smoother distribution will have positive long term implications for sustainable economic growth Ideas Underlying the Model : Political Economics of the Model (2)

9 Why Modest Income Redistribution Does Not Have a Positive Impact on Long-term Economic Growth in Armenia? Modest redistribution ability of the government No decline in transitional poverty Structural poverty, Loosing human capital Very low effective tax rates No significant efforts to improve taxation Higher level of investment Another highly non- egalitarian poor state with structural poverty, stagnated economy Corruption, cronyism, unequal treatment of taxpayers Further polarization of income, without any increase in investments

10 Why the Impact of Active Redistribution Policy on Sustainable Economic Growth Can Be Positive? Aggregate Demand Effects of Redistributive Policy More active redistribution policy will not cause distortions in incentives, since effective redistribution is possible only through equal treatment of taxpayers and overcoming of corruption More active redistribution policy will not cause distortions in incentives, since effective redistribution is possible only through equal treatment of taxpayers and overcoming of corruption Consumption behavior differs by income groups, in particular the propensity to consume is higher for low income groups, with a larger share of consumption of domestically produced goods. Thus active redistribution policy will promote aggregate demand and domestic production Consumption behavior differs by income groups, in particular the propensity to consume is higher for low income groups, with a larger share of consumption of domestically produced goods. Thus active redistribution policy will promote aggregate demand and domestic production Higher demand will promote higher investments, including foreign direct investments Higher demand will promote higher investments, including foreign direct investments

11 Evidence on the Supply Curve in Armenia Real growths and corresponding deflators of non- agricultural sectors (1998-2002)

12 The Set of The Models (1) Growth and Distribution Model Growth and Distribution Model Estimates poverty incidence for different combinations of Gini coefficient and economic growth Estimates poverty incidence for different combinations of Gini coefficient and economic growth Macroeconomic Adjustments and Growth Model for Armenia (MAGMA) Macroeconomic Adjustments and Growth Model for Armenia (MAGMA) Forecasts macroeconomic framework producing endogenous economic growth based on behavioral equations of income groups and policy assumptions Forecasts macroeconomic framework producing endogenous economic growth based on behavioral equations of income groups and policy assumptions Income Distribution Matrix Income Distribution Matrix Estimates income distribution by income sources and derives Lorents curve and Gini coefficient Estimates income distribution by income sources and derives Lorents curve and Gini coefficient

13 The Set of the models (2) “MAGMA” Macroeconomic framework “Income Distribution Matrix” Income Distribution and GINI “Growth and Distribution Model” Poverty Incidence Household Survey Data Policy Exogenous variables GINI Growth Policy Revision

14 Policy Implications Addressing income inequality is crucial for poverty reduction: the outcome of the model shows that if Gini coefficient were 0.37 instead of current 0.55 poverty incidence would be 25% instead of current 50%; at the same time 80% economic growth would be required to reduce poverty by half if Gini coefficient is unchanged Addressing income inequality is crucial for poverty reduction: the outcome of the model shows that if Gini coefficient were 0.37 instead of current 0.55 poverty incidence would be 25% instead of current 50%; at the same time 80% economic growth would be required to reduce poverty by half if Gini coefficient is unchanged Active redistribution policy will lead to higher levels of economic growth up to an estimated level of Gini coefficient of 0.35 Active redistribution policy will lead to higher levels of economic growth up to an estimated level of Gini coefficient of 0.35 In contrast to final version of PRSP which sees a trade-off between higher redistributive capacity and economic efficiency, we find that reduction in inequality can be achieved without distorting (and in fact enhancing) main economic incentives. Moreover, the current modest redistribution capacity and high inequality are results of distortions, particularly, highly inefficient tax policy In contrast to final version of PRSP which sees a trade-off between higher redistributive capacity and economic efficiency, we find that reduction in inequality can be achieved without distorting (and in fact enhancing) main economic incentives. Moreover, the current modest redistribution capacity and high inequality are results of distortions, particularly, highly inefficient tax policy

15 Growth and Distribution Model : Calculation of Poverty Incidence for Various Combinations of Gini and Income Growth Index

16 Economic Development and Research Center www.edrc.am info@edrc.am www.edrc.am info@edrc.am www.edrc.am info@edrc.am


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