VIII. Lessons from the Review

International Monetary Fund
Published Date:
September 1986
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At the start, attention was drawn to the fact that Fund-supported programs involve changes in the relative prices in both goods and factor markets. These are bound to affect the distribution of income between individuals, households, factors of production, and socioeconomic groups. The question is not whether the programs should affect redistribution but whether some other policies could achieve the same impetus to growth (within the context of restoring balance of payments viability) and at the same time result in some “more desirable” distributional pattern.

The issues have been discussed in many ways in this review. Although one lesson is that clear-cut conclusions regarding distributional issues are nearly impossible or at least hazardous to enunciate, a somewhat simplistic list of measures that would promote more equitable income distributions in the context of Fund-supported adjustment programs may nevertheless help focus the discussion. All these statements should be considered in the full context of the discussion in the body of the study.

(1) No single counterfactual argument is valid for any country or valid at different times; nevertheless the alternative to a Fund-supported program is an important measure of the redistributive impact of programs.

(2) In the external sector, more equitable distribution will result from exchange rate action, particularly if an overvalued exchange rate inhibits the establishment of producer prices which provide adequate incentives to an agricultural sector dominated by small farmers, and from elimination of exchange rate restrictions and other exchange practices that constrain imports and exports.

(3) In the monetary sector a more equitable income distribution can be facilitated by expanding access to credit markets. Other policies which support this objective include those which limit insider loans and those which promote the ability of each sector to compete for credit, such as fixing farm loan interest rates at free market levels instead of fixing them at such unrealistically low levels that little credit is available.

(4) Direct tax measures, and in particular corporate and personal income tax measures, are unlikely to have much effect on the distribution of income and wealth in the context of Fund-supported adjustment programs. This is primarily because changes in these taxes require complex changes in legislation; they work, usually, with substantial lags in collection. However, whereas in a one-year stand-by program direct tax measures have little relevance, over the longer run they are a crucial tool that can significantly affect distribution. Changes in direct taxation that are supportive of more equal income distributions include the abolition of schedular income categories and movement toward the global taxation of income; the expansion of tax registration to include all professional incomes and large farm incomes; and the establishment of a property cadastre and the taxation of immovable property.

(5) Indirect taxes, and in particular taxes on goods and services, may affect distribution in undesirable ways but are used frequently because of the urgent demands for revenue to meet the fiscal deficit. It is possible to design more desirable sales taxes than the crude excises often employed, such as those on alcohol and tobacco, but again broad-based taxes on sales of goods and services cannot be introduced overnight. Typically, they require two-to-three years’ organization and need the support of an enthusiastic and cooperative administration. Should more explicit emphasis be put on distributional issues the supportive indirect tax measures would include the establishment of a truly general broad-based tax on goods and services; higher differential rates of tax on goods and services consumed by higher-income households, especially cars, household “white goods,” petroleum, electricity, telecommunications, hotels, restaurants, and air travel; import duties that replace quantitative restrictions (licensing and quotas) on imports; and the reduction of export duties that infringe primarily on small farmers.

(6) Unquestionably a major, if not the main, problem of fiscal policy is that of poor expenditure control. If the Fund were to attempt to specify functional expenditures with a view to improving internal income distributions, the following might be considered: focusing educational outlays on basic skills and vocational training; focusing health outlays on the provision of basic health services and away from the doctor-hospital environment; limiting defense expenditure; limiting grandiose public works and “prestige” projects; and advocating much stricter budgetary controls by the Ministry of Finance over spending ministries. The views of the World Bank would be an important consideration in the first four of these items.

(7) The distributional characteristics of changes in the economic categories of expenditure are important in both the short and long run. More work is needed on how to de-link wages and salaries from full indexation to resist turning the public service into a guaranteed income system and how to limit overall subsidy levels by targeting subsidies more accurately.

(8) Although the distributional consequences of the budget demands of state enterprises are diffuse, they are important. To identify the distributional effects, these agencies should at the very least be fully accountable to the authorities and maintain up-to-date accounts which are submitted for review on a timely basis. Again these recommendations can have a significant impact in the short run but need to be pursued and maintained over a much longer time than usually available in Fund-supported programs.

(9) The distributional consequences of fiscal policy through the national debt are diffuse but typical programs recommend a limit on public sector borrowing; broadening the ownership of the public debt; and financing domestic borrowing at positive real rates of interest. Such policies should improve the allocation of capital, increase the long-term productive potential of the economy, and receive better funding for social security.

It is apparent from this review that most fiscal policy with desirable redistributive effects is difficult to enact within the context of a one-year stand-by program. This is not to say that fundamental fiscal reform is impossible within a Fund-supported program but that it needs sustained effort over a number of years, perhaps lasting well beyond the formal program. In turn, this suggests that much technical assistance which does have a longer-term perspective is a vital component of a sustained adjustment effort.

In conclusion, without adequate means to quantify the effects of Fund-supported adjustment programs it is not possible to specify conclusively their impact on internal income distributions, but the preceding discussion gives little reason to believe that these programs lead to any increase in income inequality. It is also unlikely that the programs lead to any significant decrease in the living standards of the poorest quartile. The only identifiable actions detrimental to the poor were those that increased the incomes of the wealthy. Specifically, devaluation would favor those with wealth held abroad and higher interest rates would favor debt holders. Moreover, it should be stressed that in the absence of quick and convincing actions by the authorities it is altogether likely that holders of wealth will protect their assets by transferring as much as possible, so that these issues may become academic in the context of policies over which the authorities can control. In the final analysis, it must also be recognized that the income distribution in a country with a chronic balance of payments deficit is unstable and will change whether or not the authorities undertake an adjustment program.

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