Policy-based Lending and Poverty Reduction: An Overview of Processes, Assessment, and Options

7/28/2019 Policy-based Lending and Poverty Reduction: An Overview of Processes, Assessment, and Options

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ECONOMICS AND RESEARCH DEPARTMENT

ERD WORKING PAPER SERIES NO. 2

Richard BoltManabu Fujimura

January 2002

Asian Development Bank

Policy-based Lending

and Poverty Reduction:

An Overview of Processes

Assessment, and Options


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ERD Working Paper No. 2

POLICY-BASED LENDINGAND POVERTY REDUCTION:

AN OVERVIEWOF PROCESSES, ASSESSMENT, AND OPTIONS

Richard Bolt

Manabu Fujimura

January 2002

Richar d B olt a nd Ma nabu Fujimura a re Economists a t t he P roject E conomic Eva luation Division, Economics

and Resource Development Center , Asian D evelopment B ank. The aut hors wish to tha nk Da vid Edw ards ,

former Assis tant Chief Economist , EDEV, who provided overall guidance and support . Nigel Rayner,

Tumur da vaa B ay ar saih a n, an d Vo Van Cuong contributed t o Appendix 1. Section II.B benefit ed from a report

by G eorge Abonyi. The paper a lso benefited from helpful comments by Cha rles Ada ms, Ch ristopher Edm onds,

Eunkyung Kw on, Gustav P apan ek, and J ohn Weiss. Anneli Lagma n a nd Virginita Ca pulong ass is ted with

the literat ure search an d compilation of supporting documents. Regina Siba l assisted wit h report presenta tion.

The views and opinions expressed in the paper are those of the authors and not of ADB.


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POLICY-BASED LENDINGAND POVERTY REDUCTION: AN OVERVIEWOF PROCESSES, ASSESSMENT, AND OPTIONS

74

Asian Development Bank

P.O. B ox 789

0980 Ma nila

Philippines

2002 by Asian Development B an k

J anuary 2002

IS S N 1655-5252

The views expressed in this paper

a re those of the a uthor(s) an d do not

necessarily reflect the views or policies

of the Asian Development Bank.


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Foreword

The ERD Working Paper Series is a forum for ongoing and recently

completed resear ch an d policy st udies underta ken in the Asia n D evelopment B a nk

or on its behalf. The Series is a quick-disseminat ing, informal publica tion mean t

to stimula te discussion a nd elicit feedback. P a pers published under th is Series

could subsequ ently be r evised for publica tion a s a rt icles in professiona l journa ls

or chapters in books.


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Contents

Page

Abbreviations vi i

Executive Summa ry i x

I . In t roduct ion a nd Overview 1

A. Int roduct ion 1

B. Overview of Reforms, Adjust ment , a nd P overty Reduct ion 2

I I . D im en sion s of AD B s P olicy -ba s ed Len din g a n d P over t y R ed uct ion 6

A. Adjustment a nd P overt y 7

B . P olit ica l E conomy P rocesses a nd Inst it ut iona l Ca pa cit y 15

C. Addressing P overty Reduct ion in P olicy-ba sed Loa ns 24

D. Implica t ions for P olicy-ba sed Lending 33

I I I . Conclusion 35

Appen dix 1: Over view of Sect or P olicies a nd P ov er t y R ed uct ion 38

Appendix 2: Macro-meso a nd Meso-micro Linkages of AdjustmentP rogra ms 56

References 69


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I. INTRODUCTION AND OVERVIEW

A. Introduction

The Asian Development B a nk (ADB ) has long a ddressed wa ys t o reduce poverty in i ts

operat ions a nd h a s now esta blished poverty reduction a s i ts overa rching objective. The

intensified focus on poverty reduction n eeds to be a ddressed in conjunction w ith questions

in development that remain on the agenda, for example, economic structural change (both

intersectora l a nd intra sectoral), industria l izat ion, urba nizat ion, a nd demographic changes.

The genera l a s soc i a t i on be t ween econom i c g rowt h and pover t y reduc t i on i s we l l

documented.1 However, the nature of economic growth is influenced by numerous and constantly

chan ging noneconomic factors, w hich in tur n w ill influence the n a tur e of poverty reducing effects.

In fluences include a countr ys resource base, t he sectoral composition a nd st ructur e of th e economy,

the political and policy environment, the legal and regulatory environment, institutional structures,

governance, social structures, and human capital. Combined, these features determine the nature

a nd performan ce of t he economy in a ggrega te a nd the economys sectors, including productivity

and equity, resulting in different levels of benefit outcomes for different groups including the

poor. A ba sic stra tegy in ADB opera tions ha s been to enha nce reduction of poverty th rough economic

growth. However, the renewed concern under the poverty reduction mandate relates to the

distributional impact of economic growth that may not adequately benefit the poor, or in some

cases negatively affect the poor. This realization has motivated a global reexamination of thea ppropriat e development policy m ix tha t does not leave th e poor behind.

Rodrik (2000) observes th a t the now w ell-documented correlat ion betw een gr owth a nd

poverty reduction is compa tible w ith va rious a rgument s tha t spa n th e entire spectru m of views

on the growt hpoverty deba te. B ut t he question of w hether growt h is good for poverty r eduction,

or vice versa, provides little guidance for operational purposes or policy analysis. The currently

a va ilable cross-count ry evidence does not help much beyond w ha t w e alrea dy know in general:

that macroeconomic imbalance is bad for growth; and that economic growth and good institutions

are a necessary condition for poverty reduction. Cross-country evidence also does not help much

in understanding the factors underlying changes in income distribution that make growth more

or less pro-poor. Country-specific and institutional analyses provide a more nuanced picture,

highlighting a complex set of reinforcing a nd count erva iling forces.

1 Em pirical studies on poverty in t he economic literat ure ar e main ly limited t o income or, a t best, consumption

poverty. While this treatment does not cover all dimensions of poverty, it is often justified from the purpose

of policy a pplication th at requires some level of consistency in measurement (for example, Lipton a nd Rava llion

1995, 25-53).


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The focus on poverty reduction ha s implicat ions for th e design an d st ructure of loa n a nd

technica l assista nce (the kinds of moda lities ADB supports), an d th e wa y in w hich ADB a na lyzes

and evaluates its operations. This paper discusses preliminary implications of ADBs poverty

reduction goal for t he policy a spects of ADB opera tions. I t considers t he importa nce of th e processes

involved in the preparation of PBLs, and issues in weighing policy alternatives and assessing

the impact of P B Lon economic grow th a nd poverty reduction. It is intended tha t more in-depth

stu dies of th e processes outlined, good practice ana lytical t echniq ues, a nd specific recommenda tions

for PBL will follow this paper.

B. Overview of Reforms, Adjustment, and Poverty Reduction

Reforms can be described as a change in the way aspects of an economy are managed to

better enable the economy and its institutions to meet immediate and longer-term needs and

respond to changing international and domestic circumstances.2 The motiva tion for reform t ypically

a rises dur ing a period of economic or inst itut iona l difficulty to cope wit h chronic poor performa nce,external shocks, or systemic transition.

Ca uses of difficulty ma y include a ra nge of economic an d noneconomic fa ctors:

external shocks and ins tabi li ty result ing f rom, for example, adverse changes in key

world prices and terms of trade, and natural disasters;

in ternal shocks and ins tabi li ty result ing f rom domest ic ac t ion such a s an excess ive

increa se in money supply, events lea ding to a sudden devalua tion such a s capita l flight,

unsu sta ina ble publ ic spending, a high level of import s an d low export s, loss of

confidence due to political risk, pervasive corruption, low ability to enforce law and

order, and open conflict;

l ow product i vi t y and product i on o f goods and serv ices, and weak a nd con t r ac t i ng

ma rkets a nd competitiveness, due to perva sive and chronic economic a nd inst itut iona l

inefficiency a nd ma rket imperfections.

Ea ch of these difficulties can cont ribute t o the contr a ction of economic a ctivities a nd low

or negative economic growth with implications for all groups including the poor.

At t he ma cro level, short-run a nd chronic imbala nce and inst a bili ty a re the ma in sources

of pressure for ma croeconomic adjustment . This is r eflected t hrough un susta ina ble bala nce of

paym ents deficits, fisca l deficits, a nd a high ra te of infla tion. Cha nges in th e key ma croeconomic

determinan ts such as excha nge rat es and int erest ra tes an d in the fisca l situa tion occur consta ntly,

2 At an an a lytical level, a precise definition of policy reform is h ar d to find. While a (public sector) project can

be considered as a change in the pa ttern of production of the public sector with the a im of enhancing consumer

welfa re, policy reform could also directly affect th e patt ern of public production and could be ana lyzed in th e

sam e benefit-cost fra mework. At a n opera tiona l level for development ba nks, projects associated w ith invest ment

loan s an d policy reforms associated w ith program loans ma inly differ in th eir nat ure an d speed of disbursement

(see for exa mple, Ka nbur 1991).


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and management of these changes routinely occupies governments agendas. When changes have

a significant negative effect on key economic variables that undermine economic performance

and social development, then reform-type corrective action may be warranted.

At th e sector a nd microeconomic level, pressure for reform can stem from ma croeconomic

level imbala nce, inefficiencies in fa ctor use and r elat ed low productivity, or ma rket a nd inst itut iona l

inefficiencies specific to the sector. For example, a protracted tight fiscal situation may pressure

a governm ent t o control public expenditures or ra ise revenues thr ough sector-specific ta x meas ures,

reduction of sector subsidies, and adjustment in the provision of public services to specific sectors.

Chronic inefficiencies may pressure the government to retract from the provision of key services

(e.g., due to lack of resources to sustain loss-making public enterprises) requiring reforms at the

subsector level . Examples include publ ic enterprise reforms, deregulat ion of markets and

institut ions, improvement of the ena bling regulatory environment for priva te sector opera tors,

a nd t a ri f f pol icy adjustment .

In a ddition to ma croeconomic an d st ructura l economic problems, mu ltilat eral development

ba nk (MDB ) experience wit h P B Ls3 shows a ra nge of outcomes tha t can be tr a ced to the influenceof noneconomic fa ctors (ADB 2000d). G overna nce, a nd the performa nce an d a bsorptive ca pacity

of institutions substantially affect the impact of reforms and have increasingly become reform

issues in th eir ow n righ t. The World B a nk (2000c) highligh ts t he importa nce of governa nce, the

distribut ion of opportu nities, environmenta l susta ina bility, and t he ma na gement of global risks

as elements that directly contribute to development and shape the desirable and undesirable

featur es of growth . Addressing these aspects w ill support growth by a dding to the impact of growth

on welfar e, boosting investor confidence, a nd helping ma ke grow th m ore sust a ined an d less volat ile.

Political ideology has a major bearing on the acceptabili ty and choice of approach and

policy priorities. Political economy factors are especially evident in PBL and help to explain why,

in some ca ses, reform mea sures ga in the support to implement fa r-reaching cha nges a nd result

in the intended impa ct. In other cases reform efforts fa il to ga ther t he moment um needed to begin

th e cha nge process or a re short -lived, r everting t o their pre-reform position. A sometimes import a nt

perception in both macro and sector level reforms is that where there is a pre-reform fall in income

then the reforms themselves may be seen as the cause of the problems. This can resul t in

implementa tion difficulties.

F igure 1 presents t he va r ious levels , ra nge , a nd in f luences on development pol icy

formulation. Aside from economic influences, pervasive cross-cutting influences include the

prevai l ing pol i t i ca l ideology, government s t r ucture a nd procedures , legal f r a mework, a nd

institutional capacity. As the figure shows, reforms are influenced by many direct and indirect

economic and noneconomic factors at a number of levels that need to be explicitly considered.

3 Policy-based lending, generically known as program loans in ADB, has at its core policy changes or reforms

(e.g. , price changes , inst i tut ional reform). The disbursement of policy loans , or t ranching, is t ied to the

implementa t ion of specif ied policy a ct ions a f ter w hich funds release may be rela t ively quick and with less

restriction on t heir use compared with project loans. P olicy loans can be combined w ith investment an d capacity

building components through sector development programs.

Section IIntroduction and Overview


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Therefore, a focus on poverty reduction requires no less than a greater understanding of these

fa ctors t ha n before a s th e basis for policy a nd st ra tegy development. Ident ificat ion of influences

a t a ll levels must be syst emat ica lly assessed for t heir possible causes a nd effects on poverty a nd

its reduction.

A detailed discussion of st ra tegies an d policies to a ddress ma croeconomic adjustment is

w ell beyond t he scope of th is paper. At t he risk of genera lization it is sufficient a t t his sta ge to

say that the intended effect of macroeconomic adjustment is to restore external and internal balance

and stabili ty as the prerequisite for reestablishing sustained growth. The subsequent positive

intended effects on poverty reduction from successful adjustment occur through an array of

chann els and a re largely indirect effects. These include, for example, adjustment s th a t r esult in

a n improved revenue ba se from wh ich government ca n fina nce the provision of services for t he

poor. Other adjustments may result in an increase in the real wages of the poor in a particular

sector, w hich also implies tha t subsequ ent economic growt h in t he sector th a t increases t he use

of labor will effect better distribution of the benefits of economic growth.

Sector/Micro Policy

Sector Specific Taxes and Subsidies

Public Goods and Services

Factor and Product Market Structure and Conduct

Technology Transfer and Diffusion

Macroeconomic Policy

Exchange Rate Policy, Monetary PolicyFiscal Policy

LEGALFRAMEWORK

INSTITUTIONALCAPACITY

PREVAILING

POLITICALIDEOLOGY

GOVERNMENT

STRUCTURE ANDPROCEDURE

Figure 1: Levels of Policy-Making and Influences


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Structural adjustment programs, typically carried out by the World Bank in the 1980s

and 1990s, covered a wide range of sector and microeconomic policy issues with considerable focus

on market l iberalization. Reform measures included:

t ra de pol icy (removal of t ar i f fs , quota s , and expor t t a xes);

ma rket deregula t ion (reduction of subsidies a nd price controls);

t a x reform;

improved financia l performa nce of stat e-owned enterprises including restructuring,

corporatization, privatization, and divestiture;

promot ion of fore ign direct investment (FDI); and

r ef or m of fin a n cia l a n d b a n kin g sy s tem s.

The underlying object ive in st ructura l a djustments is to a chieve eff iciency ga ins a nd

productivity improvements b y, for exam ple, reducing th e role of the public sector (due to lessons

learned on its relative inefficiency), and increasing the role of the private sector in the economy,

w ith empha sis on a ma rket-ba sed system. In t erms of poverty impa ct, an increa se in the poorsproductivity (e.g., ret urn s to la bor) should a llow t he poor to consum e an d sell more. This w ill

ha ve great er effect on the poor if reforms t a rget sectors tha t a re the ma in sources of income for

the poor (e.g., rura l industr ies, agriculture, urba n informa l sectors, etc.).

U ndersta nding th e dyna mic nat ure of reform is essential. The events lea ding up to reforms

a nd t he a djustment itself ar e part of a process. The situa tion itself is inherently dy na mic. While

reforms ma y be beneficial for the economy a s a wh ole over time, they ma y a lso ha ve a nega tive

short-run impact on specific groups. Reforms that result in price changes can cause a shift in

resource a llocat ion. An increas e in utility serv ice fees w ill ha ve implicat ions for curr ent users .

Either example can have positive or negative effects depending on the user response to changes.

Where the short-term n egat ive effects of a djustment a re a ssessed t o be less th a n t he cumulative

longer- term negat ive a f fec ts under no adjustment , then ac t ion i s pre ferable to no ac t ion .

Nevertheless, for the poor who may have a higher than average rate of t ime preference, the

immediat e har dships of reforms can be unbeara ble. Ident ifying such effects is necessa ry t o highlight

where policy trade-offs must be made, to assess alternative responses, and to make allowances

in reform design for sh ort-term m it iga t ion meas ures a nd/or wa ys t o enha nce access to new

opportu nities. It a lso suggests a flexible a pproa ch to implementa tion to a llow for r efinement of

policies consistent wit h developing circumsta nces. However, it is importa nt to distinguish between

mitigation and pro-active income distribution, and between equality and equity.

This overview raises three basic questions which are further discussed in this paper:

How does one predict a nd address any immediat e negat ive impacts ar i s ing f rom the

a djustment process on th e poor? How does one targe t and involve the poor in adjustment ef for t s , especia l ly a t t imes

w hen government is un der pressure to cont rol or even reduce redistributive expenditu re

to restore or maintain macroeconomic equilibrium?

Section IIntroduction and Overview


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I s the growthpover ty reduct ion re la t ionship and other qual it a t ively t raced impacts

an acceptable outcome where a reform indirectly impacts poverty and these effects

are difficult to predict or quantify?

The challenges of prediction and the political economy implications of these questions

imply the n eed for a na lysis of a l ternat ive options, consul ta t ion, a nd sha red understa nding a t

a n a ppropriat e level betw een ADB a nd key st a keholders of the client count ry, a nd selection a nd

commitm ent t o the a ppropria te option by t he client. It is not a ppropriat e for ADB to decide policy

emphasis on behalf of client government s.

Fina lly, for th e purposes of this pa per, policy r eforms a re broadly categorized a s:

macroeconomic adjustments (f iscal , monetary, a nd exchange ra te measures);

ma rket libera l izat ion (price decontrol, import l iberal izat ion, etc.); and

inst i tut iona l cha nge (public enterprise reform, civi l service reform, etc.).

While the first type is associated with first-generation reforms, the third type is associatedw ith second- generat ion r eforms. The ma rket l iberaliza tion ty pe ca n be considered a subset of

th e first-genera tion reforms a t sector level. First-generat ion r eforms, triggered by ma croeconomic

insta bility, ha ve normally focussed on restoring external bala nce, fisca l ba lance, reducing inflat ion,

a nd restoring growth . Second-generat ion reforms a re triggered by policy a nomalies tha t hinder

sustained and broad-based growth and overall inefficiency of the state institutions.4

II. DIMENSIONS OF ADBs POLICY-BASED LENDING

AND POVERTY REDUCTION

ADB operat ions in P B L ha ve lar gely focussed on t he micro and sector level reforms (except

perhaps for Paci f ic DMCs, and the Asian crisis loans) . Focus at this level st i l l requires an

understanding of the context of the macroeconomic situation and macro-level policy, related

a djustments, a nd t heir impact on t he poor. Furt hermore, as sector-level a djustments or reforms

of ten have macroeconomic e f fects (e .g . , f i sca l balance and in ter-sectoral publ ic spending

realloca tions), i t is import a nt for policyma kers to be aw a re of the tra nsmission of impa ct to the

poor t hrough ma cro-meso an d meso-micro linka ges.5 While a gr eat d eal ha s been w ritt en on the

first-generation reforms and their evaluations, l i t t le is known about the impact of the second-

generat ion r eforms primar ily beca use th ey a re count ry-specific, a nd it is difficult t o genera lize

on the a pproa ch to their eva lua tion. This pa rt outlines key considera tions for economic and social

4 For a distinction betw een first an d second-genera tion reforms, see, for example, World B an k (1997), page 152.5 The w ord meso can be understood t o cover an y int ermediate level between micro and ma cro. In the context

of the poors risk exposure, it a ppears t o refer to commun ity level. For exam ple, the World B an k (2000a, 136)

explains th at Risks can be classified by th e level at w hich they occur: micro, meso, and m acro. Micro shocks,

often referred to as idiosyncratic, affect specific individuals or households. Meso shocks strike groups of households

or an entire communit y or villag e. These shocks a re common (or covar ian t) to all h ouseholds in t he group. Shocks

can also occur at the national or international level (World Bank 2000c).


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policy du ring t he reform a nd a djustment process a nd t he effects on a nd implica tion for poverty.

Much of the discussion in Section II.A is in the context of first-generation reforms while the

discussion in Section II.B addresses second-generation reforms.

A. Adjustment and Poverty

1. Effects of Adjustment

In r esponding to an unsusta inable balan ce of payments situat ion governments ha ve three

general options:

fur ther in ternat ional borrowing to f inance the def ici t ,

decrease the defici t by restructuring internat ional tra de and capita l payments through

economic controls, and

r e st o r e a s u s t a i n a b l e b a l a n c e of pa y m e n t s s it u a t i on b y i n cr e a s in g ex por t s a n d

competitive import substit ution.

Ea ch of these mea sures is intended to restore ma croeconomic sta bility a nd economic growt h.

How ever, th ey require profoundly d ifferent ma croeconomic adjustm ent policy sta nces, with different

short-term effects on a ll groups, including th e poor, a nd implicat ions for long-term sust a ina bility

a nd r ecovery. Ames et a l. (2000) outline five genera l w a ys in w hich ma croeconomic policies can

affect economic growth and poverty reduction (Box 1). Economic controls will not be discussed

in detail here except to say that there is evidence showing that less distorted and more open

economies genera lly suffer less growt h contr a ction from nega tive terms of tra de shocks (e.g., Ba lassa

1981 and Mitra 1994).

Box 1:Macroeconomic Policies and Poverty Reduction

Overvalued exchange ra tes affect th e composition of growth thr ough the influence on the relative prices

of t radable and non-tradable goods and services . Real exchange ra te deprecia t ion can benefit net

producers of tradables (e.g. agricultural exports), but negatively affect those whose income is derived

mainly from non-traded goods and services or who consume products that are exported or imported.

Susta inable domest ic and external debt levels , and appropria te use of debt in bala nce with non-debt

resources, is necessary to increase the certainty of available finance, including new debt for social and

other program s th at can benefit the poor. Achieving this ba lance can be dif f icult in the ea rly s ta ges

of adjustment where fiscal deficits are severe.

Where macroeconomic instabili t ies are moderat e or temporary, including disequilibrium aris ing from

macroeconomic mismanagement, they can be absorbed through maintenance of adequate international

reserve levels and prudent f iscal management .

Use of a monetary policy s tance that results in low a nd s table infla t ion diminishes the negat ive impacton the poor of real income reduction that occurs with high inflation.

Sending clear s igna ls on a pro-private economic environment s ignificant ly builds private sector con-

fidence. Priva te sector capita l a ccumulat ion is a n essent ia l driver of growth given its proven great er

efficiency versus public sector capital expenditures.

Source: Ames et al. (2000)

Section IIDimensions of ADBs Policy-based Lending and Poverty Reduction


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The sectoral structure of economies has an important bearing on the composi t ion of

economic growt h a nd poverty reduction. In genera l, sectors th a t a re growing a nd a re significant

generators of production and income to a significant proportion of the poor, will l ikely have a

positive and direct impact on poverty reduction (Weiss 2000). On the other hand sectors that

a re underperforming a nd inefficient in t erms of production, income generat ion, a nd delivery of

goods a nd services, w ill have nega tive implicat ions for a ll groups relat ed to th e sector including

the poor.

By identifying the linkages and effects of macroeconomic policy changes on production,

income, and consumption, the effects on different sectors and among different groups can be

identified. Tw o aspects provide a sta rting point:

assessing the impact of adjustment on the rela t ive prices of nontra dables (i .e. , goods

a nd services only tra ded w ithin t he economy) and tr a da bles (i .e., goods an d services

that can be exported and imported); and

assess ing the impact o f public expenditure on the poor.

a . Pr ice Impact

In the ca se of a djustment involving currency deprecia tion, for exam ple, groups wh o should

gain will include net producers of traded goods, for example, export crops, the relative price of

w hich should fa ll on t he w orld mar ket in foreign currency terms a nd r ise in local currency. Net

consumers of nontraded goods such as local staple foods will also gain, as their relative price

should fa ll in local currency t erms compa red t o import ed foods. P roducer a nd consumer cat egories

may include farmer famil ies and rural workers in an export production sector. Workers in

unprotected a nd r ela tively competitive import -substitu ting indust ries ca n a lso ga in from domestic

currency depreciat ion t hrough increased dema nd, subst itution effects, a nd production st imulat ion.

In this sense the traded sectors upon which the poor rely could be seen as a safety net during

times of adjustment.

Categories of producers and consumers who are at risk of being negatively affected are

those whose income is obtained primari ly from nontraded goods and services, and who are

significant consumers of products that are also exported or imported (the relative price of which

w ill rise). Typical gr oups include, for exa mple, public sector workers w ho ma y be la id off due to

governm ent expenditure cuts, a nd, for example, workers employed in protected import -subst itut ing

industries tha t a re subject to ma rket libera lizat ion polices ca using unemployment a nd lower w a ges.

In this sense, nontraded sectors are likely to be adversely affected during periods of exchange

ra te a djustment, a nd poor w orkers w ho ar e dependent on these sectors w ill be more vulnerable.

However, as adjustment wi l l lead to relat ive price and income changes, the combined effectw ill determine the net impact on different groups. As labor a nd resources flow to a ctivities w ith

great er returns, a nd a s consumers subst itute t o chea per nontr a ded goods, there should be more

ga iners th a n losers. Nonetheless, th is is complex to a na lyze an d predict in th e short run (Weiss

et al. 2001).


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Tra da ble sectors a lso face substa nt ia l r isks in t imes of adjustment . For example, the

production of goods such as a griculture or new ca pita l-intensive industr ies will tend t o lag behind

chan ges in prices. The speed w ith w hich the economy a djusts depends to a lar ge extent on options

for production an d consumpt ion subst itut ion. Well-known cases w here subst itut ions w ill be more

difficult include retrenched low -income and unskilled urba n w orkers a nd a griculture, due t o the

sectors inherent supply response limita tions. Subst itut ions w ill also be difficult w hen t he cost

of capita l is h igh a nd/or investors la ck confidence in economic recovery, a s w a s evidenced in

Indonesia and to a lesser extent Thai land in the period fol lowing the Asian f inancial crisis .

Consequently, sudden liberalizat ion for producers a nd workers in import-substitut ing industr ies

ma y result in reduced incomes, especia lly wh ere short-term a lterna tives ha ve not been considered

or identified. Policymakers will need to weigh the effects of market l iberalization of protected

industries as a short-term strategy to address a balance of payments problem. Macroeconomic

a djustment tha t includes a t ightening o f moneta ry pol icy to f ight in f l a t ion w i ll reduce the

a vailabili ty a nd a ccess to ban k loa ns, especia lly for sma ll business a nd poor fa milies with limited

or no collateral . In addition, the marginal impact of depreciation on assets during periods ofeconomic downturn may be greater. This will reduce their spending and consumption earlier and

more sharply under adjustment than without adjustment (Ames et al . 2000).

Furthermore, unless the demand for labor increases in sectors that respond favorably

to adjustments, workers will not benefit directly from the adjustment, and owners of land and

capita l w ill become the ma in beneficia ries of renewed gr ow th. This depends on a number of fa ctors

including a countrys stage of development and related policy (e.g., progression from agrarian

to industr ial ba se and consequently la bor reloca tion), an d th e elast icity of input substitu tion (e.g.,

price and productivity of labor compared to the price and productivity of capital). Economic

adjustment that leads to an increase in the demand for labor, especial ly for labor intensive

industries requiring unskilled workers (e.g., rural-based production), is more likely to be pro-

poor. Thus, labor intensity is desirable for unskilled worker employment creation. Caution is

nevertheless required in inadvertently encouraging a wage-productivi ty trade-off that could

undermine competitiveness in, for example, export markets (see Lall 2001).

b. Publ i c Expendi tur e Impact

A reduction in government expenditure as a result of fiscal constraints and the need to

restore ma croeconomic bala nce ca n be especially serious for th e poor. H owever, th is a ssumes t ha t

pre-a djustment expenditures rea ched t he poor (subsidies int ended for the poor m a y h a ve been

biased towa rd t he middle classes) a nd t ha t t he services were effectively provided to and dema nded

by t he poor. Where expenditure a llocations a nd dema nd w ere both low prior t o adjustment, t henthe effect is l ikely to be less severe, but i t a lso indicat es government fa ilure in the first place.

The lat ter sit ua tion is a more onerous sta rt ing point for providing t a rgeted services to the poor

in times of crisis a nd imba lan ce. P ublic expenditure reviews a nd incidence an a lysis supported

by the World Bank and other donors are providing insights in this regard.



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Tra cing t he price an d government spending impact of reforms indicat es the limita tions

in generalizing about the positive and negative effects of adjustment and reform strategies. A

study by Mundle a nd Tulasidha r (1998) on India concludes th a t t he distributional impa ct of the

a djustment progra m up to the first ha lf of 1990s is on t he whole quite limited, and t ha t t he ma in

concern for Indias adjustment program is that i t remains incomplete. As far as possible each

case should be a na lyzed on i t s own terms both for unders ta nding the context under w hich

adjustment and reforms wil l be implemented, as wel l as planning the design of the reforms

themselves. H owever, the funda menta l implications for economic sectors a re t ha t policy reforms

tha t seek to address poverty, as w ell a s growt h a nd efficiency, should aim a t reforming or elimina ting

institut ions a nd policies tha t a re counterproductive to the economy a s a w hole on t he one ha nd,

a nd building t he coping capa bility of the poor on t he other.

2. Response Considerations for Adjustment and Poverty

a . Social I mpact of Pol icy Change

ADBs concerns over possible negative impacts of policy lending on poor and vulnerable

groups were first ra ised in th e early 1990s. In 1994 ADB carr ied out a technica l a ssista nce (TA)

to assess the social impact of program lending. This study (Papanek 1994) included a discussion

of the linkages betw een t he ma croeconomic cha nges a nd t he consequences for poor a nd vu lnerable

groups. The study assessed that up to the mid-1990s the International Monetary Fund (IMF)

and World Bank (WB) macroeconomic adjustment and structural adjustment programs had set

instrumental goals such as inflat ion rate and fiscal defici t level , but had made no at tempt to

qua ntify t he effects policy loans h a d on na tional or per ca pita income, let a lone its impact on a

pa rt icula r gr oup such a s t he poor. A focus on th e impact on t he poor could be rea lized by ident ifying

economic variables tha t change w ith a djustment a nd t heir t ra nsmission cha nnels, including price

and transfer effects discussed above. The approach identified four major channels through which

policies a ffect t he poor, specifica lly:

t h e d em a n d f or un sk illed la b or ;

pr ices of inputs bought and outputs sold by the poor ;

n et t ra n sf er s t o t h e poor ; a n d

access to publ ic and ra t ioned goods an d services to the poor (ADB 1994).

Recognizing tha t t he a djustment process is dyna mic, th e study a lso distinguished t he ma jor

ty pes of effects: direct, indirect, ma cro, a nd t he nea r poor w ho might fa ll into povert y due t o reform.

The currently used poverty impa ct a ssessment (P IA) ma trix is a wa y of organizing this informat ionand logic (see Section II.C.2). Admittedly distinction between these groups was not clear-cut.

How ever, a s discussed further in S ection C.2, to da te the P IA ma trix ha s not been used for P B L

design itself or for targeting program inputs, but more as a means of tracing effects.


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b. Fi scal Poli cy, Soci al Devel opment , and Pover ty Reducti on

Fiscal pol icy and related design are clearly central to ensuring that key services are

provided to the poor. Yet Nixson and Evers (2000) point out that a definition for pro-poor

macroeconomic pol icies has not been adequately explained in the l i terature. This does not

necessa rily mea n t ha t such policies do not exist. I n t he context of fiscal policy, th ey expla in t ha t

wh en under pressure to reduce their public sector borrowing requirement a s pa rt of a n orthodox

sta bilizat ion program , tr a de-offs a nd choices must be mad e in th e ar ea of fisca l policy in part icular.

This includes t he ba lan ce a nd content of expenditure reduction a nd r evenue ra ising. A feat ure

of adjustment is that although the government is l ikely to be facing a tight fiscal situation, i t

will be under political pressure to at least maintain expenditure as well as sometimes select

incompa tible policy a lterna tives.

It is also sometimes perceived that shifting fiscal instruments (tax and expenditure) in

favor of the poor is an obvious pro-poor policy. This is not necessarily so. First, the change in

the public spending incidence across different income groups ma y h a ve a negat ive impa ct on t hesubsequent economic growth (e.g., adverse incentive effect on entrepreneurs), which in turn

decrease the subsequent growth-induced poverty reduction. Second, if the efficiency of service

delivery does not improve, i t is unlikely t ha t the increa sed government expenditure a llocat ion

ta rgeted to th e poor will ha ve positive impa ct on the poor. Such situa tions can a rise where, for

example, alloca tion of funds t o government services ar e often la rgely on sala ries wit h insufficient

expenditure on opera tional costs. Assessment of the current spending patt erns a nd inst itutional

capaci ty is needed, as wel l as the scope for real locat ing exist ing government spending into

new priori ty a reas a nd a wa y from currently nonproductive areas i f inefficiency a nd w ast e are

to be avoided.

This point is a lso reflected in Ames et a l. (2000), w hich indica tes t ha t ma croeconomic policy

can have a direct impact on poverty through the effect on the aggregate fiscal stance, and through

the d is t r ibut ional impl ica t ions o f public spending a nd t a x pol icy. In weighing t he current

composition of public expenditure and its financing, a countrys policymakers will need to consider

the growth, equi ty, and equal i ty impact of spending intended to meet various development

objectives. Nevertheless, given the heterogeneity of households and firms and diverse transmission

channels of relative price changes, i t would be unrealistic to design and put in place a policy

reform t ha t leav es no single individua l worse off. Even th e requirement th a t no household should

fa ll even t empora rily int o poverty is likely t o be extr emely restr ictive in poor countries. The more

utili tarian view that the number of households in poverty should not increase may be realistic

(e.g., Wint ers 2000, 5-6). A governm ent s s ocia l development a nd poverty redu ction objectives w ill

a lso ha ve a bea ring on their defense of expenditure levels and consequent ly fisca l an d moneta rypol icy as i t re l a tes to borrowing . However , excess ive and improper ly t arge ted borrowing ,

domestica lly a nd internat iona lly, is also not a lwa ys a n a nswer a nd a cts to delay n eeded adjustments.

Policymakers often cannot escape trade-offs (Box 2).



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t imefra me for each sta ge. Una nticipated setbacks an d exogenous fa ctors may a rise which ma y

require more tha n one genera tion of reforms. In t his sense, the process of policy cha nge a nd

reform is very much one of hitting a moving and often erratic target.

b. Economywi de Eff ects of Pr o-poor Poli ces

J ust a s economyw ide policies ha ve effects on th e poor, poverty -ta rget ed policies ha ve

economywide effects in the short and long run. The latter effects will depend on the mode of

financing and the response of the economy. At one extreme, if the economy is small and open

producing only traded goods, and if the additional demand for food is met entirely by imports

finan ced by externa l gran ts, expanded distr ibution of subsidized foodgrain t o the rura l poor would

ha ve no economyw ide effects in t he short or long r un. Welfa re of the ru ra l poor would increase.

At the other extreme, if the economy is closed and the food subsidy is financed through a reduction

in public investment, say, irrigation, then there could be significant macroeconomic effects. In

the short run, the rural poor would be better off and the urban population would be worse off.In the long run, a gricultura l growth a nd t herefore rura l income growth will be reduced, possibly

lea ding to a n increase in rura l poverty. If t he government fina nces th e subsidy through domestic

borrowing or printing of money, a different macroeconomic situation will emerge (Srinivasan 1993,

119-20).

c. L onger -term Ef fects of N o Adj ustment

It would not be ad visable to use the possibili ty of negat ive short -term effects a s a reas on

to a void r eform measur es. This is especially t he case w here th e short-term negat ive effects of

a djustment a re a ssessed t o be less tha n t he cumulat ive longer-term n egat ive ef fects o f no

a djustment. First -generat ion r eforms often la y t he ba sis for subsequent m icro-level adjustments

focusing on, for example, efficiency. It would also be self-defeating if the financing of poverty

reduction mea sures becam e a cont ributing fa ctor to ma croeconomic insta bility. Ames et a l. (2000,

13-14) caution against careless pursuit of budget allocation to poverty reduction programs at

the expense of ma croeconomic sta bility, wh ich w ill eventua lly undermine grow th . The more sta ble

the m a croeconomic conditions, t he grea ter t he choice a nd flexibility a count ry generally ha s in

terms o f the nature and scope for pol ic ies that can expl ic i t l y address pover ty reduct ion .

Furthermore, during recovery and establishment of steady economic growth, policy strategies

can be developed that provide pro-active opportunity for the poor to be involved in the process.

However, the extent t o which a pro-a ctive redistributive policy st a nce should be ta ken is a more

profound public choice element. In th e cont ext of ADB opera tions, such positions sh ould be a m a tt erfor d i scuss ion dur ing preparat ion o f the Country St ra tegy and Program (CSP) and Pover ty

Partnership Agreement (PPA), and the medium to long-term feasibility of alternative approaches

must be carefully considered.



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4. Helping the Poor Manage Adjustment7

a . Avoid Cr i ses Fi r st

Clearly avoiding crises should be a top policy priority. Governments should avoid profligate

fiscal and monetary pol icies, overvalued exchange rates, and unsustainable current account

deficitsall problems in the 1970s and 1980s that invoked adjustment loans by aid agencies.

As developing count ries proceeded tow a rd open economy direction, th e 1990s sa w v a rious ty pes

of crises associat ed with w eak ba nking systems and w eak financial regulation in a w orld of large

a nd volat i le internat iona l capita l f lows.

b. Publ ic Choice M ust be M ade Once Cr i sis H it s

In comparison to the crisis response in Latin America, there are some indications that

the response to the Asian crisis was overshooting toward austerity. Admitting the uncertaintyof the precise scenario of the counterfactual, once adjustment policies are accepted as inevitable,

the way governments introduce fiscal and monetary austeri ty can worsen the adverse effects

on the poor a nd nea r-poor. Poor people may prefer a n a djustment t ha t lea ds t o the sma llest drop

in G DP a t a ny point in time even if i t implies a slower recovery, w hile nonpoor people are likely

to prefer more severe adjustment in the short run but tha t yields higher grow th in t he medium

run . This is due to divergence in ra tes of time preference. When a count ry in tr oduces ad justment

measures early on, the government may have more freedom to choose among different policy

combinations and thus be more likely to manage a soft landing.

c. Pover ty-sensit i ve Response to Cr i si s and Ad ju stment

By explicitly considering the implications for poverty reduction, sector-level policy lending

offers the potential for micro-level improvement in efficiency and at the same time well-targeted

mitigat ion mea sures tha t m a y a rise from t he negat ive short-term effects of a djustments. A poverty-

sensitive response to crisis needs to consider: w a ys t o help th e poor households ma inta in th eir

consumption; identifying opportunities for sustainable income gains for the poor; increasing

government spending on services and infrastructure that can be accessed by the poor; preventing

perman ent reversa ls in the poors huma n a nd physical capita l ; averting self-defeating beha vior

thr ough th e erosion of socia l capita l (e.g., crime, prostitution, child exploita tion, etc.); a nd w a ys

of improving the poors access to opportunities under a restructured economy (Box 3).

7 This subsection relies on World Bank (2000a).


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Box 3:

Considerations for Safety Nets and Social Assistance

Safety nets and social assistance programs targeted to poor people need to be protected if not expanded

as a short-term response by adequately identifying the groups most vulnerable to the shocks and evaluatingthe cost-effectiveness of different social protection options. For example, common considerations that arose

for MDBs, including ADB, during the Asian financial crisis include:

graduat ion s tra tegies from a ssis tance once the immediate problems have diminished and a voiding

creation of dependency (or moral hazard);

increasing resource a llocat ion to investments in , for exam ple, infras t ructure and socia l capita l

development for the poor;

the ma in tenance of s a fe ty net programs dur ing normal t imes , which can opera te a s a form of

insurance in times of economic distress (e.g., World Bank 2000c, pp. 165-170);

publ ic inves tment in the remova l o f cons t ra in t s to product ion in t ra dable sec tors a s a wa y o f

facilitating adjustment, including, infrastructure to boost access to markets, improved access to

technology, and improvements in the enabling environment to help facilitate production expansion

and raise productivity.

d. Avoid Gener ali zations

Different sectors and subsectors, by their nature, let alone contextual circumstances, vary

in the channels through which they affect poverty reduction as well as the directness of their

impact. Sectors w ith indirect l inkages an d effects can h a ve an essentia l role in poverty reduction

a s a means t o an end. Importa nt a nd sometimes contra dictory considera t ions a re their cost a nd

efficiency in impa cting on the poor. Individua l sector performa nce ca n a lso va ry considerably w ithin

a nd a cross economies, and ca ution is required in genera lizing a bout the sector feat ures, including

in t he context of poverty reduction. ADB s sector policies a nd stra tegies, w hile ha ving a ddressed

elements of poverty from the outset, a re being updat ed to reflect r ecent a nd gr owing knowledge

and experience with sector-specific dimensions of poverty. Appendix 1 summarizes the general

role of specific sectors in poverty reduction, lessons learned from ADB and other development

efforts, a nd current ADB a nd other st ra tegies to reduce poverty t hrough th e sector. Implica tions

such a s ma croeconomic issues an d political economy a re a lso considered in th e a ppendix.

B. Political Economy Processes and Institutional Capacity

B etw een 1987 an d 2000, ADB ma de 67 program loa ns a nd 22 sector development progra m

loa ns. I n a ddition, project lending a nd TAs h a ve a lso increas ingly involved policy-relat ed dia logue

and activities. PBL deals with complex socioeconomic and politically sensitive issues and it isnot surprising that ADB would f ind PBL chal lenging. A fundamental problem in PBL design

involves th e extent of underst a nding of t he policy context, in pa rt icula r, politica l economy fa ctors.

A review of ADB experience (Abonyi 2001) suggests that supporting policy reform effectively

through P B L requires extensive prepara t ion a nd country knowledge in a reas such a s sectoral



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c. Tim e Di mensions

P olitical t ime dimensions a nd st a bili ty can a ffect P B L in severa l wa ys. P eriods of political

change or reforms intr oduced towa rd th e end of a n a dministra tion ca n slow or sta ll the politica l

decision ma king process, especia lly w here t he reform is perceived to bring short -term cost s over

the longer term and less certain benefits. A similar situation can affect the commitment to follow

through with reforms, especial ly at the second tranche stage where costs are clearly being

experienced and benefits ha ve yet t o be rea lized. At t he other extreme a new government , eager

to dista nce itself from the a ctions of the previous a dministra tion, ma y effect r a pid policy reversa ls.

On the other hand an administration that was elected to effect needed reforms can become the

n e ce s s a r y a d v o ca t e , a n d d e pe n d i n g on t h e c on s t i t u t i on a l t i m e h o r i z on p r o v i d ed t o t h e

administration can provide considerable scope and opportunity for a variety of reforms. This also

increases th e possibility t ha t t he benefits of successful and significa nt reforms w ill be seen dur ing

the life of the administration, further enhancing its credibili ty.

d. Pol i t ical Stabi l i ty and Wi l l

Pol i t i ca l s t abi l i ty c lear ly a f fec ts the pol i t i ca l wi l l to proceed wi th needed re forms.

Nevertheless, even st able governments ma y la ck the w i ll to underta ke or car ry through w ith

reforms, preferring to ma inta in the sta tus q uo. Similarly, a sta ble a nd a ccommoda ting government

w illing to proceed with a series of reforms may itself eventua lly face reform fat igue and cha nge

its stance. Assessing the interest and likely commitment to reform measures at an early stage

is necessar y. This is best a chieved through ea rly par ticipa tion by key law ma kers, in a ddition to

government a nd civil stakeholders, in t he concept a nd design pha se. Involvement in the design

ideally involves a consulta tive process tha t a llow s key decision ma kers to understa nd t he basis,

need, and rationale for reforms; assess options; and contribute to the design and final decision

ma king , resul t ing in great er own ership of the resul ta nt progra m. This ma y resul t in some

unexpected design outcomes, but on balance it is preferable to have a reform package that is

understood a nd ha s ownership and commitment t o follow through, tha n to ha ve a pa ckage tha t

is poorly understood, regard ed a s externa lly imposed, gives the impression of la ck of t ra nspa rency,

and lacks the required political will for implementation.

e. Ef fects of Cr i si s

A case in point is the existence of crisis, which is often an opportunity to bring about

necessa ry r eforms, especially w here inefficiencies, wa ste, a nd ina ppropriat e domestic policies area n un derlying cause of the crisis. During periods of crisis, government s a nd t he public ar e more

likely to understand the causes of the crisis and accept the necessary steps to effect recovery

a nd a vert futu re recurrence, especia lly when th e alterna tives ar e visibly bleak. Nevertheless, a

crisis period is usua lly fraugh t w ith political uncert a inty, and cau tion is still required in a ssessing


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an often volatile political situation with interest groups also looking for opportunities to gain

from and influence change in their own favor. In such a high stakes and dynamic si tuat ion,

a ssessment of th e political economy influences, involvement of a broa der ra nge of int erest groups

in the reform design process, a nd sw ift rea ction to chan ges in the politica l climat e and opportu nities

a re required. E xterna lly forced an d poorly un derstood reforms can be count erproductive in the

medium to longer t erm, especially if the crisis leads t o a cha nge of governm ent ea ger to disas sociat e

itself from the mistakes and misfortunes of former administrations.

f. Social Cohesi veness

A further political economy factor is social cohesiveness. The more socially cohesive a society

a nd t he more confident it s members a re of fa ir representa tion thr ough locally defined procedures,

then th e easier i t will be to a chieve a consensus. This a lso implies tha t these procedures should

be a cknow ledged, respected, a nd follow ed in t he reform process. C ircumvention of locally defined

consensus building mechanisms is likely to be viewed with suspicion and undermine well-intendedreforms. On t he other h a nd, a s w ith politica l insta bility, the presence of open socia l conflict is

likely to undermine a nd limit reform design an d implement a tion. In other ca ses, themes of common

interest t o different a nd competing social groups can be used a s a n opportunity to build consensus

on mutually beneficial policies.

g. Consultat i on and Cham pions

While effective two-way consultation with key government stakeholders is essential in

P B L, consulta tion with civil society in reform design is increa singly regarded a s a necessary step

to measure rea ct ion, a ssess impa ct , an d t o obta in input for the design of PB L. This includes

interacting with leadership to obtain input into reform design and gauge the level of support,

as well as identifying reformers who can act as champions during implementation (Knapman

a nd S a lda nha 1999). Furt hermore, despite the policy orienta tion of program lending, consulta tion

needs to extend beyond la wm a kers a nd executive a gencies. For reforms r equiring legal chan ges

and depending on the impact of changes, it is likely that legislators will consult their peers, local

a dvisors, a nd const ituents first a s w ell a s sound out possible opposition. Ba sed on the rea ction

th ey w ill decide how t o proceed. To the extent possible, reform progra m designer s need t o make

a similar broad-based assessment of reaction.

h . Donor N eutra l i ty

Reforms, policy cha nges, and implementa tion ar e usually cha llenging w ithin t he context

of a count rys own politica l, government , an d civic inst itut ions. This ta sk can be more deman ding

when the change is encouraged from outside, especially when it is possibly perceived as an external

a genda. While ADB policy requires th a t i ts opera tions a nd position sh ould be politica lly neutra l ,



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reforms by their nature, and consequently PBL, inevitably enter the arena of political process.

Consequ ently, it becomes a ma tt er a s to w heth er ADB opera tions implicitly or explicitly consider

politica l economy fa ctors. P olitical economy involves th e intera ction bet w een politica l science an d

economic management.

i. Cond i t iona l i ty

The purpose of conditionality in PBL is to help bring about effective and sustainable reform

in order to resolve perceived policy problems. Conditionalities link or intermediate the policy

problem and desired results by specifying key actions to be taken that are expected to lead to

improvements in economic performa nce or in q ua lity of life. From this perspective, condit ionalit ies

in PBL implicitly assume a great deal of knowledge about the policy problem, about effective

actions for resolving the problem, about implementation requirements and conditions, and about

desired results. As conditiona lities increase in number a nd deta il, so does th e assu med knowledge

about the policy problem, its context, and feasible means for its effective resolution.However, in practice, there is generally l imited knowledge and significant uncertainty

a bout mea ns/ends rela tionships a nd t herefore associa ted conditionalities requ ired for policy reform,

i.e., wh a t is l ikely t o work, and how. These limita tions ma y become a pparent a s difficulties arise

in implementation, or as desired results do not materialize even when conditionalities are complied

w ith. I n t his context, t oo ma ny conditionalities, excessive deta ils an d complexity, and inflexibility

in th eir formulat ion ha ve genera lly n ot proven to be the most effective means for P B L t o support

implementa ble and susta inable policy reform, a nd h a ve a t times unnecessarily complicated ADB /

DMC policy dialogue.

It is essential not to lose sight of the basic intent of PBL in the numbers and details of

condi t ional i t ies. The purpose of PBL is not formal compliance with a large set of detai led

conditionalities w hose relevance a nd fea sibili ty ma y be un certa in. The purpose is to contr ibute

to the process of policy reform. From this perspective, it may be more effective for PBL design

a nd a ssociat ed conditionalities to be more limited in number a nd more modest in scope, with a

read iness to ad a pt t o cha nging conditions. Conditiona lities ma y t herefore be more usefully seen

as working hypotheses than certainties in guiding policy reform in a complex, dynamic, and

uncerta in environment (Abonyi 2001). Neverth eless, defined conditiona lity is s ometimes needed

to preserve reform momentum , support a nd st rength en the position of a reform mind ed government,

and establish targets for monitoring purposes.

2. Institutional Capacity and Governance

Abonyi (2001) describes that in addition to political economy factors, the institutional

capacity of executing and implementing agencies to effectively put reforms into practice can greatly

affect the outcome of a reform program. Policy reform relates to basic changes in incentives,

behaviors, expectat ions, and power relat ions. PBL ini t iat ives usual ly require administrat ive,


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technica l , and orga nizat iona l ca pabilities tha t a re often in short supply in DMC s. Yet in genera l,

there is l imited recognition of the na tur e, role and r elevance of the inst itutiona l context of P B L.

The result is often a lack of rea lism in P B L a bout the institut iona l capacity n eeded to implement

and sustain policy reforms, which surface only at the implementation stage. Considering the totality

of institutional and political economy factors, PBL can be more complex than project lending,

and in part could explain its more variable performance.

a . I nst i tu t ional Capacit y Constra in ts and Requir ements

Clearly policy reform a nd P B L are funda menta lly a bout institutional ca pacity and chan ge

(involving considera ble time and r esources) th a t mu st be reflected in P B L design. Ca pacity issues

tha t n eed t o be explicitly considered include the a bility to a bsorb and disburse progra m inputs,

meet conditionality schedules, and realize the expected outputs of reform measur es. In pa rt this

ma y a rise due to the a ddi t iona l dimensions t ha t program lending may ha ve to address. Sector

Development Programs (SDPs), for example, may require policy measures that require legislativea ct ion a s w el l as project-type implementa t ion of the a ccompa nying investment components.

Excessive design complexity a nd conditionality w ill only compound th is risk a s w ill unrealistic

time-bound conditionality. Further problems can arise if conditionalities are inflexibly applied

especial ly where pol i t ical changes occur. A key requirement in PBL design is therefore an

assessment of the inst i tut iona l capaci ty constra ints a nd requirements for P B L implementat ion.

Such a ssessment can lea d to more effective P B L by bringing design in line wit h implementa tion

capa city, a nd by leading t o capa city building initiat ives tha t st rengthen implementing institut ions.

b. Capaci ty an d Pover ty Reducti on

When povert y r eduction a nd loca l level conditions a re a lso factored in, it might be thought

tha t t his will further complica te the P B L design an d implementa tion process. The World Ba nk

(2000c, 99-115), how ever, point s out th a t ma king st a te inst itut ions w ork bett er for t he poor, from

a capa city a nd governan ce point of view, promises broad-ba sed poverty impact, a nd provides t he

ba sis for improving t he effectiveness of public spending. These ar e area s th a t MD B s ha ve avoided

due to t heir being politically s ensitive, but a re becoming increa singly explicit it ems on th e policy

dialogue a genda.

c. I ncenti ves and M oti vati on

Ha ving th e right incentive and motivat ion smoothes t he delivery of public services t o thepoor. Key incentives include merit-based recruitment/promotion, clear specification of tasks,

rew a rds for good performa nce, and ins ula tion from political pressur e. Together w ith skilled

technocra ts a nd close collabora tion with the business community, these make up wh a t ha s been

termed developmenta l sta te. Pr omoting a n evalua tion culture for sta ff and a gencies is importa nt,



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together w ith clea rly specified a nd t ra ctable ta sks a nd competitive sala ries. While this is ideal,

implementation may be met with considerable inertia given the changes required in behavior

and related incentives. Using mass media to disseminate information on budget allocation and

spending ena bles people to hold civil serva nt s a ccounta ble, reducing inefficiency a nd corrupt ion.

d. Rul e of L aw

How state institutions comply with the rule of law greatly affects the daily l ives of poor

people who a re very vulnerable t o abuses of th eir rights. Also the ru le of la w promotes poverty

reduction t hrough better overall growt h performa nce. Ma king the rules a nd procedures simpler

a nd clea rer is importa nt in the a reas of great est concern t o the poor, such as labor disputes, la nd

tit ling, tena nt right s, a nd protection of their civil right s (including equa l access to police services

a nd protection). Sma ll claims courts a nd other informa l proceedings can r educe the ba cklog and

w iden a ccess. Alterna tive dispute resolution mecha nisms h old considera ble potent ial for r educing

dela ys a nd corruption. S pecific interventions for a id a gencies a nd NG Os in this a rea include

esta blishment of lega l service centers for th e poor. The most effective legal service orga niza tions

work outside the judicial system, protecting rights without resorting to lawsuits. The work oflegal service orga niza tions helps crea te a cultur e of rights t ha t cha nges the w a y poor people think

about themselves relative to those who have power over their l ives.10

10 See a lso ADB RE TA 5856: Lega l Lit eracy for S upportin g G overnan ce (for $500,000, approved on 24 August

1999) reports on Lega l Em powerm ent: Adva ncing G ood G overnance a nd P overty Alleviat ion (da ted November

2000).

Box 4:

Decentralization and Political Economy

Decentralization is in part being driven by political mandates to provide greater local-level political and

adminis tra t ive autonomy. I t is a lso seen as a means of ta king adva nta ge of local-level understan ding of

an areas specific needs. Local knowledge and information can help identify more cost-effective ways of

building infrastructure, providing public services, and organizing their operation and maintenance. Knowing

what local needs are most pressing can help the disadvantaged. Local monitoring and supervision for many

types of projects and programs can also be more cost-effective. Local authorities and agencies would need

considerable autonomy in th is regard including f iscal m at ters a s w ell as considerable support an d sa fe-

guards from the center. Mechanisms for redistribution from the central budget can mitigate inequalities

across localit ies.

However, ma ny local governments la ck the adm inis tra t ive capa city for la rge-scale decentra liza t ion and

need tra ining in a ccount ing, public adminis tra t ion, f inan cia l m ana gement , public communicat ions , and

community relations. Safeguard s a re a lso needed to monitor fina ncial probity a nd discourage t heir capture

by local eli tes . Widespread popular part icipat ion is vita l to successful decentra liza t ion. Having local

communities participate effectively in the planning and use of municipal resources greatly influences the

potent ia l for successful decentra liza t ion. Experience is showing t hat building this capa city ta kes t ime,and unt il i t occurs there are s ituat ions where ineffect ive and hurried decentra liza t ion will not lead to

improved poverty reduction efforts.

Sour ce: (Moore an d P ut zel 1999).


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issues th a t un derlie ana lysis of policy in relat ion t o policy loan design, an d th e assumpt ions t ha t

underpin the expected outcome of PBL and their impact on poverty reduction.

1. Assessment of Policy

In considering policy options it is highly desira ble to have a n a ssessment of the possible

outcome including a simula tion of wh a t w ould ha ppen if each alt erna tive were followed compa red

to the without change situation. The counterfactual problem in PBL arises from the fact that

reforms are taking place in a constantly changing domestic and international environment with

ma ny in f luences tha t can a f fect the outcome of a re form. Frequent ly , reform programs a re

implemented wit hin a n envelope of reforms supported by va rious donors a nd government bra nches

and levels (Nelson 1998). The environment cannot be held constant to isolate the impact of the

policy changes associated with a single loan. Response times may vary depending on policies:

moneta ry va riables respond fa ster th a n real va riables. Furthermore, the progra m cycle is unlike

the project cycle as there ma y be no defined beginning, middle, or end. Cy cles overla p a nd d a tacollection ma y be indistinguisha ble for monitoring. P olicy reforms ma y a lso require frequent mid-

course changes as the external environment changes. Bearing these complexities in mind, this

section outlines possible wa ys t o assess t he economic, socia l, a nd poverty impa ct of progra m loans.

Notwit hsta nding the inherent problems of ex ant e ana lysis of policy impact, a tt empts have

nevertheless been made to assess impact. For example, a conceptual framework for assessing

program loans s uggested by Eva ns (1999) is based on a w ith a nd w ithout program perspective.

This is famil iar and convenient in terms of ADB operat ions given i ts establ ished use of the

perspective in project a ssessments. B ut in view of the problems of esta blishing the count erfa ctua l

under a situation of change, it may be more appropriate to place emphasis on a broadly described

expected outcome t ha t explicitly recognizes t he possible influences on t he outcome. Fu rt hermore,

for P B L t ha t involves severa l, sometimes loosely connected policy m easur es, it is more appropria te

to indicate t he expected outcome for their combined effect ra ther th a n individua l policy mea sures.

Ta ble 1 la ys out a modified version of E va ns fra mework.

The t a bles content s ha ve much in common w ith project a na lysis, but the a ctual completion

of ea ch of th ese steps is intrinsically difficult for several rea sons. First, t here a re th e problems

of separ a ting t he impact of the progra m on the sector from nonprogra m effects, wh ich can ma ke

even static analysis difficult . Second, this implies that estimating counterfactual performance

can be more difficult w hen t he influence of reinforcing a nd count ervailing forces a re not know n.

Third, even where key indicators and their determinants can be identified, data shortages may

limit analysis. This often results in a diminishing level of rigor in the analysis that underlies

policy a na lysis and progra m design. In considering these cha llenges, Eva ns provides a summa ryof the kinds of ana lysis tha t a re possible, and t he fal lbacks tha t might be taken wh en data an d

resources are not available.

The effects of a program loan should be based on as thorough a statistical analysis as

possible including, for exa mple, econometric estima tion using t ime series da ta for estima ting sector



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trends and parameters. A voluminous amount of time series and cross-sectional data has been

produced to examine the impact of, for example, adjustment loans. However, while statistical

analysis can be useful in sorting out the relationships between policies, growth and variables,

other results have proved less definitive. Cross-country studies, for example, provide broadly

identifiable trends in economic development, but only country-specific analyses yield operationally

useful pol icy opt ions for a gencies such a s ADB . Accura te conf i rmat ion o f hypotheses a nd

representa tion of development principles being used in reforms point s t o the n eed for fur ther

rigor in the use of statistics and avoidance of misuse.

a . Economi c M odel in g

Economic policy m odeling can help qua ntify a spects of progra m projections t hrough t he

select ion of an a ppropriat e ana lyt ica l fram ework combined w ith benchma rk a ccounting da ta .

Partial equilibrium analysis has been applied in some ADB projects to assist in understanding

how a sector works, to assess distortions an d to roughly estima te orders of ma gnitude chan ges.

Evans (1999) lists areas where partial equilibrium analysis can be usefully applied including:

(i) fiscal impact of interventions; (ii) consequences of price policy changes; (iii) impact of changesin educat ion policies on costs, tea chers, an d gra dua te nu mbers; (iv) impact of health policies in

numbers of heal th workers required to tr eat pat ients; a nd (v) r isk ana lysis . However, part ial

equilibrium analysis cannot handle changes in macro-level variables that affect several sectors

a nd a re likely t o progressively change t hemselves as a result of certa in reform mea sures. In t his

Table 1: Without Program and Expected Outcome Framework

Without program situa t ion, Benchma rking of the economy/sector in terms of key economic and socia l

t h e r a n ge of p os si bl e i nd ica t or s, d es cr ipt i on a n d a s ses sm en t of cu rr en t p ol icy en vi ron m en t ,fut ure scena rios possible t ra ject or ies of t he t a rget sect or

Ra t iona le S um ma ry of w hy t he sect or or inst it ut ions a re under-per form ing a nd t he

causes and effects, scope for improvement through reforms, and the costs

that are likely to be incurred during the process of adjustment

Object ives The a spect s of t he ra tiona le for economy/sect or reform tha t ca n be

addressed in a part icular program loan

P o li cies a n d ju s t if ica t ion C h oice of pol icy in st r u m en t s , t h e w a y in w h ich t h ey a r e l ik ely t o a c h ieve

the objectives, an d t he items t o be covered in the policy/program ma trix

Expected policy outcomes The expected impact on economy/sector development and speci fic

indicators identified in the without situation. Description of keyassumptions, identified exogenous influences and risks and their

possible effects


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case general equi l ibrium analysis is needed, but requires a great deal more data, t ime, and

resources for useful and a ccura te modeling. Social a ccounting ma trices are a lso a u seful w a y to

test policy outcomes on the economy as a whole (for a fuller discussion see Weiss et al. 2001).

b. H istor i ca l and Qu al i ta t i ve Anal yses

Full quantitative analysis (such as applied general equilibrium) can be constrained by

data l imitat ion and research resource avai labi l i ty, and use of qual i tat ive methods including

historical a nd institut iona l a na lyses a re helpful in understa nding t he nua nces of policy a pplicability

in individua l DMC s. ADB produced comprehensive survey volumes on poverty in Asia w ith seven

count ry stu dies: Quibria (1994) on rura l poverty a nd P ernia (1994) on urba n poverty. While several

new count ries ha ve joined ADB since these studies w ere prepa red, th ey nevertheless provide a

useful guide upon w hich to build furt her det a iled country-specific poverty a na lyses.

c. Countr y Compari sons and Est im ates

When data are shor t and model ing i s not poss ible , Evans (1999) suggests country

compa risons an d direct count ry est ima tes to be the next level or fa llback. For exam ple, an ear lier

experience in the country or in other sectors may provide some clues on sector workings and

compar a ble productivity a nd performa nce, a s could compa rison with simila r situa tions in oth er

countr ies. However, such compar a tive studies must be used with grea t caut ion a nd benchma rking

does not necessar ily say a nyt hing a bout how t o improve performa nce or expected outcomes given

the difference in contexts.

d. Checkabl e Stor i es

A rela ted fa llback described by E va ns (1999), is th e telling of checkable st ories. Economic

historian s often look at past events a s th e basis for hypothesizing a nd principle inference when

forma l evidence is not a va ilable. Progra m loa n formulat ion in th e tra nsition economies ha s very

much relied on th is wh en considering the a pproa ch a nd outcome of moving from centr a lly planned

to ma rket economies. The key t o appropria te use of th e a pproa ch in th e a bsence of rea sonable

sta t ist ics a nd st at ist ical a na lysis is t heir pert inence and checkabi l ity .

A key to the checkable story a pproa ch ha s been the development a nd increasing r elian ce

on the use or ra pid appra isal (RA) techniques over the pa st 20 years . RA techniques ha ve become

widely used not only because of their increasingly part icipatory approach that involves key

stakeholders and knowledgeable informants, but also because of their potential for relativelylow cost in time and funds. However, the more participatory and intensive the technique, the

higher th e cost in terms of time and often funds t o hire skilled opera tors. Furt hermore, despite

their effect iveness as a consul tat ive and part icipatory tool , i f not used in conjunction with

quantitative data collection, they will not provide the necessary data that allows modeling for



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hypothesis testing a nd predictive purposes. This furth er confounds the q ua ntit a tive estimat ion

of expected program effects.

e. H ousehold Sur veys

Living sta nda rd mea surement studies (LS MS) and similar household surveys a re becoming

a n importa nt source of poverty impact benchmar ks a nd indicat ors. The World B a nk is increasingly

collecting poverty da ta by employing pa rticipa tory m ethods. Its sta ff recommends a tw o-pronged

strategy: a more structured approach to data collection; and improved, unstructured attempts

to mea sure t he impa ct of specific intervent ions (ma inly project loa ns a s it is impossible to design

a control group for program impact). The World Banks model five-year work program has five

components: (i) na tiona l household survey every five y ear s, (ii) collection of consum er a nd producer

prices to monitor spat ial a nd t empora l price cha nges, (iii) regular par ticipatory poverty a ssessments

to ga th er commun ities own perceptions of needs, (iv) a nnua l Core Welfare I ndicat ors Questionna ire

(CWIQ) to monitor key s ocioeconomic indicat ors a nd pr ovide quick feedba ck on cha nging a ccessto a nd u til izat ion/sa tisfa ction of services by different groups, an d (v) a household pa nel survey

to monitor th e dyna mics of povert y a nd int ra household issues. These components a re supplemented

by timely an nua l nat iona l accounts a nd disa ggregat ed public expenditure reviews. H owever, these

measures are intended to serve country strategies, not individual loans. The World Bank has

concluded that i t is impossible to measure or even at tr ibute addi t ional i ty at the level of the

individual program11 (Nelson 1998, 9).

f. L im it at ions in M easur in g Povert y

Other limitations in poverty impact assessment of PBL pertain to measuring povertys

mult idimensiona lity. Apa rt from income/expendit ure poverty defined in food and n onfood commodity

baskets, ma ny a tt empts to ca pture the multidimensiona lity of poverty ha ve not been very useful

in MD B opera tion. For exa mple, World B a nk (2000c, 19) notes: th ere is now a growing consensus

tha t i t is neither feasible nor desirable to ca pture vulnera bility in a single indica tor. Mea suring

other dimensions in a mean ingful and consistent w a y to facilita te compa risons across countries

a nd over time w ill require considera ble a dditional efforts on both th e methodologica l an d da ta -

gat hering fronts.

Even the n a rrow definition of poverty a s comma nd over commodity consumption poses

serious mea surement problems. However, i t is not contr oversial th a t inadequa te comma nd over

commodities is t he most importa nt dimension of poverty, a nd a key determinan t of other a spects

of welfar e such a s hea lth, longevity, a nd self-esteem. And it ha s been a pow erful motive of policy(Lipton and Raval l ion 1995, 2553). From a consistency and operat ional point of view, i t is

11 The World Bank has, however, produced a handbook for ex post poverty impact evaluation in the context of

project loans (Baker 1999).


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l ikely and intertemporal trade-offs are important, a refinement is the distinction between the

indirect short-run a nd m edium-run effects on th e poor wh ich could be macro or otherw ise. Direct

effects can all be considered short-run.

In line with practiced modifications, any mitigation measures that are needed to offset

the nega tive consequences of the poor can be explicitly a dded in the ma trix a s a n extra column.

To help overcome th e problems of trea ting t he poor a s a homogeneous group, and a dd t o the

specificity of the impacts a nd mitiga tion measur es needed, i t is suggested tha t a nother column

be added describing the groups affected.

G iven t he limita tions of ex ante poverty impact a na lysis of P B L, completion of P IAM may

to a la rge extent r emain a qua litat ive exercise or selectively qua ntit a tive for pra ctica l purposes.

In such cases understanding can sti l l be raised for all parties by la

Documents

Policy-based Lending and Poverty Reduction: An Overview of Processes, Assessment, and Options