Speech

Wealth Creation and Social Justice: an IMF Perspective, Peter S. Heller, Deputy Director, Fiscal Affairs Department, IMF

February 13, 2003

Over the last decade, the IMF has moved forcefully to integrate issues of poverty reduction into the mainstream of its policy objectives in fostering growth and employment creation. This presentation examines the Fund's perspective on the promotion of poverty reduction and improved distributional outcomes. It examines the relative balance that must be sought as between strictly growth-enhancing policies and those policies that are specifically targeted at poverty reduction and equity. It also explores how issues of social justice and environmental sustainability are taken into account by the Fund in working with its member countries.

Introduction

1. This session is intended to assess the extent to which wealth creation may coexist with the occurrence of absolute and relative poverty, or, in the words of the conference organizers, to "lay bare the conceptual understanding of growth and poverty eradication and social justice." Before providing an IMF perspective on the key questions that have been posed by the Conference organizers for this session, it is useful to describe how issues of poverty and income distribution relate to the Fund's central mandate.

2. It is useful to start by emphasizing the objectives of the IMF as derived from its Articles of Agreement—"to contribute to the promotion of high levels of employment and real income and to the development of the productive resources of all members as primary objectives of economic policy." The Fund's understanding of this statement of purposes has evolved considerably over time, taking account of the views of its shareholders. Specifically, there is now recognition of the importance of poverty reduction as an equally critical objective in its own right, side by side with economic growth.

3. Growth is seen as necessary for poverty reduction, but poverty reduction is recognized as a factor contributing to the achievement of high quality growth. The new approach of the Fund and the Bank "recognizes the increasing evidence that entrenched poverty and severe inequality in economic opportunities and asset endowments can themselves be impediments to growth."¹ Most important, the Fund has recognized that extreme poverty among the poorest nations of the world cannot be tolerated, but must be forcefully addressed. In his speech to the Monterrey Conference, the Managing Director, Mr. Horst Köhler, emphasized the importance of efforts to overcome world poverty.²

4. Equity issues are also pertinent. The Fund has come to recognize that growth in the context of high income inequality is not likely to have a large impact on poverty reduction. And furthermore, improvements in income distribution are likely to be an important instrument for the achievement of economic growth. At the time of the IMF's 50^th anniversary, the then-Managing Director, Michel Camdessus, explicitly emphasized the importance of policies to improve the income distribution and the implications for IMF operations of such a concern. He suggested that public support for a sustained course of adjustment and reform is most likely when "the distribution of income and opportunities to attain economic advancement are seen as relatively fair or at least not outrageously biased toward privileged groups." Moreover, he described the various channels—economic, political, and social—through which improvements in income distribution may positively affect the growth process and a distributional content. As such, while noting that income distributional issues are not the central mandate of the IMF, he emphasized that "the IMF cannot but call the attention of the country and the IMF membership to income inequality and its potential adverse consequences for the social fabric and sustainable growth." Thus, redistributive policies, particularly expenditure policies, are widely recognized and supported as a way to improve the income distribution in member countries.

5. In judging the policies necessary to achieve poverty reduction and real economic growth, it is vital to come to grips with the sources of growth, the causes of persistent poverty, and the factors associated with successful poverty reduction efforts. While much is known, the economics profession still has much to learn about these issues. The Fund seeks to be up to date with the academic literature as well as with lessons drawn from experience. It relies heavily on the World Bank, given its long-standing work on these issues.

6. Finally, a critical element of the Fund's approach to these issues is that policies should be country-driven. Lending to low-income countries should be conditional on poverty-reduction strategies drafted by the countries themselves, which are grounded in a country's own assessment of the causes and dynamics of poverty.

Responding to specific issues raised by the Conference Organizers

1. What does the IMF see as the possibilities and limits of the process of so-called wealth-creation in solving the poverty-problem?

· "Wealth creation" can be narrowly defined in terms of income generation or more broadly as the creation of assets, both in terms of physical and human capital. "Poverty" of course is a multi-dimensional concept, relating not only to a low absolute income level but also to various indicators that define an unsatisfactory level of welfare (poor sanitation or access to clean water, high exposure to disease and premature mortality, illiteracy, etc.). In terms of its poverty reduction efforts, the Fund's principal focus is related to issues of absolute poverty, recognizing that relative poverty may exist even in the most developed of nations.

· As indicated above, the IMF—and the economics profession more generally—has come to believe that the evidence forcefully argues that wealth creation-manifested by real economic growth in incomes and employment—is the principal and most forceful engine by which poverty is reduced. Substantial evidence has accumulated over the last two decades to demonstrate this (see recent papers by Bhalla; Ravallion; and Fischer (2003)). Growth in income is generally associated with an increase in a country's stock of physical and human capital though, as discussed below, in situations of high inequality, the assets of the poor may not grow commensurately.

· Other important factors influence the extent to which growth has an impact on poverty reduction. Growth can occur nationally, but poor regions may experience less growth or may benefit less in terms of poverty reduction as a result of a given national rate of growth. Specific government programs may be necessary to ensure that the poor do benefit in terms of new jobs or in the receipt of key social services critical to the accumulation of human capital.

· Moreover, as noted above, multiple aspects of poverty must be recognized. Even if real income growth contributes to reduced poverty (in terms of the number of households below some income cutoff point), it may not have as significant an impact on other indicators of poverty.

· Macroeconomic stability is critical, both for fostering rapid growth as well as sustained poverty reduction. Periods of macroeconomic instability can result in greater inequality (as the rich are more capable of protecting their assets in such situations), prove more harmful to the poor, and may result in the creation of more poor, as nonpoor fall below the poverty line in periods of crisis. Moreover, in periods of macroeconomic instability, the pressures for budgetary retrenchment often affect the poor most. Even with the best intentions with respect to social safety net programs and policies to shield expenditures on vital social services, it may be difficult to avoid cutbacks in some areas that affect the poor.

· The evidence also suggests that wealth creation results in "churning" in the poverty status of households. Inevitably, in the process of real growth, some groups and sectors benefit, while others lose out. In net terms, poverty rates may decline but some households may become poor at the same time that others escape poverty.

· Finally, real economic growth in terms of incomes may also occur at the expense of a depletion of a country's natural resource base, so that net wealth creation may be lower than would be implied by the growth in gross capital assets. Sustainability should thus be an important criterion for assessing the quality of a country's economic growth process.

2. Is it growth alone, or rather growth plus distribution that can eliminate poverty?

· The key issue is how to improve the poverty reduction elasticity of growth. Specifically, how to ensure that growth has a significant impact on poverty reduction? While there is much empirical evidence that demonstrates that economic growth reduces poverty rates—the Asian experience of the last several decades illustrates this—it is also clear that growth alone does not eliminate absolute poverty in some contexts. In situations of high inequality (say, in Latin America), one can observe significant growth in real incomes while many still remain in absolute poverty. And of course, in terms of relative poverty, even the wealthiest countries of the world continue to demonstrate significant rates of poverty.

· Devising and implementing strategies for growth that are particularly poverty reducing i not easy or always obvious by any means. In his last speech as Managing Director, Michel Camdessus emphasized the importance of pursuing high quality growth—growth that can be sustained over time without engendering macroeconomic imbalances; growth that fosters human capital development; growth that is based on a continuous effort at promoting greater equity, poverty alleviation, and empowerment of the poor; and growth that promotes protection of the environment and respect for national cultural values.³

· Redistributional policies are thus of critical importance in "reducing" poverty or at least alleviating some of its most adverse effects, particularly when income inequality is severe. The challenge is to pursue a course that both sustains high growth and provides for redistribution. This requires efforts to minimize the adverse efficiency effects that can arise when there is too forceful a concentration on redistribution (e.g., from excessively high marginal tax rates, untargeted subsidies, or price controls).

· Redistributional efforts can take several forms. The public sector, in its expenditure policies, can subsidize the provision of basic social services—in education and health—which contribute not only to the current welfare of the poor but also to the accumulation of human capital in younger generations of the poor so that they have the potential to escape poverty.

· Equally, the government, through specific targeted subsidy and transfer policies, can seek to augment, directly or indirectly, consumption of the poorest groups. Public works schemes may also be provided to supplement incomes, particularly for the unemployed. Policies are needed to enable the poor, particularly in rural areas, to reduce their vulnerability to risk.

· During periods of macroeconomic instability, social safety net programs may provide assistance to nonpoor that have fallen into poverty (see below). They serve both as a mechanism to generate income transfers to the poor but also as a mechanism for investment in human capital that can prevent the adverse long term effects that macroeconomic shocks can have on poor households. Social safety "rope" policies—such as unemployment insurance— can prevent poverty from being experienced by nonpoor individuals facing shocks which might come from macroeconomic instability or from wealth creation itself.

· Moreover, even if the focus is only on growth without redistributional efforts, there is increasingly a recognition that the kinds of policies used to promote growth must take account of the objective of poverty reduction. This may affect the kinds of investment policies pursued or the focus of public expenditure. It may also influence the posture taken by macroeconomic policy makers in relation to the relative weight to be placed on real growth and inflation. Accepting a higher inflow of foreign assistance may create some macroeconomic risks which may be deemed acceptable in view of the objective of poverty reduction. In other words, macro policies need to mutually support the realization of both growth and poverty reduction goals.

3. Does the Fund acknowledge that poverty is also induced by, or grows, during such a process? What place do we give to income generation by the poor themselves?

· As noted above, there is no question that some individuals or households may fall into poverty in the context of the normal growth process. But the evidence suggests that the net number in poverty will fall with growth. The key issue is to put in place public policies that help those employed in declining sectors to move on to growing sectors, while cushioning the adverse effects experienced by those left short in the process.

· A very high emphasis should be placed on income generation by people in poverty themselves, as well as on the need to create opportunities for future high value employment by the children of today's poor. That is why so much effort has gone into studying the factors underlying poverty among poor households and of efforts to understand the kinds of policy instruments that can reach and target income generation by the poor. Policies that specifically target income creation opportunities for the poor have included micro credit schemes, public works for the unemployed, and the provision of training and agricultural extension. And of course, education and health programs seek to build up the human capital of poor children in order to enhance their capacity for productive employment in the future. Creating jobs for the nonpoor is also important and relevant for poverty reduction policies, enhancing overall growth and stimulating demand in ways that can generate incomes for the poor.

· However, it is also important to recognize that some groups of the poor may not be able to rise above poverty through their own efforts and that targeted forms of income or consumption assistance may be vital as a result to alleviate the consequences of poverty.

· Finally, the Bank and the Fund have emphasized the importance of the participation by the poor in terms of the formulation of strategies for poverty reduction in a country. Such an approach is integral to achieving meaningful country ownership of such strategies.

4. How does the Fund seek to ensure that economic growth is guided by the values of social justice?

· "Social justice" is obviously a very normative term. Even defining it may provoke controversy, for example as to whether it should include issues of race, gender, or income. Each country, by its culture, religion(s), or history, may define social justice quite differently. President Bush's concept of "compassionate conservatism" is certainly different from the concept of social justice espoused by many European governments. Even across segments of the Christian church, the concept of social justice and the tools to achieve it may differ. Thus, what constitutes a "fair" or "just" income distribution may not be readily accepted by all countries.

· Yet, there may be some commonality in defining core elements of social and ethical justice. Some would argue that there are inalienable human rights that are transcendent across cultures and religions. For example, note the Declaration Toward a Global Ethic, which was approved by the Parliament of the World's Religions in Chicago in 1993. In some ways, the definition of the Millennium Development Goals can also be construed as asserting such rights, in effect recognizing the elements of what makes for a fair and just society. Indeed, Mr. Köhler, has argued forcefully that "cultural and religious diversity... enriches this planet."⁴ He has emphasized the importance of building "bridges through dialogue, cooperation, and inclusion, to create a sense of global ethics... and a respect for human rights."

· The emphasis by the IMF and the World Bank on country-led strategies for poverty reduction reflects the recognition that the people of countries themselves must define and own how to go about reducing poverty and where the key priorities for poverty reduction strategies should be, thus allowing for cultural and religious diversity. Social justice is far better achieved when those directly concerned reveal and put their own values in place.

5. How can this situation be rectified beyond safety nets?

· An important element of the new approach of the Bank and the IMF in their poverty reduction efforts is the effort to conduct poverty and social impact analyses (PSIAs). In low income countries, the IMF is promoting the use of such analyses to facilitate, ex ante, the assessment of the distributional impact of policies and thus the improvement of policies at the design stage, including the minimization, ex ante, of adverse effects. In this respect, the IMF, along with other development partners, is working toward an understanding of the social impact, of key policy interventions before, during and after they implemented, so that the tradeoffs of policy choices can be fully understood and planned for.

· Alleviating the worst manifestations, in welfare terms, of poverty, is thus critical, before safety nets are considered. The principal emphasis should be on pursuing policies that foster economic growth and opportunities for income generation and that provide critical health and education services to promote human capital development As indicated above, policies that foster macroeconomic stability as well as the dynamics of poverty generation in the future are integral to any long-term success.

· This is not to deny the importance of safety nets, but they are not sufficient for a comprehensive poverty reduction strategy. While important, their emphasis is to limit the extent to which policy reforms or macroeconomic adjustment measures have an adverse impact on the welfare of those who are poor and provide a welfare cushion for nonpoor households who fall into poverty. Safety nets, when used, need to be tailored to the specific country setting.

· Moreover, as clearly argued by Mr. Köhler at the time of the Monterrey Conference, the burden of poverty reduction efforts is not solely a problem of the poorest countries. The broader international community has an important responsibility as well, in terms of fostering a global macroeconomic environment supportive of economic growth; in opening up the markets of industrial and emerging market countries to the exports of developing countries; in promoting the provision of global public goods; in providing increased financial assistance to the poorest countries; in resolving financial crises in countries that can threaten the global economy; and in attacking the sources of climate change, which affects the poorest countries far more than the rich.

6. Growth and sustainability of the environment are at least partially contradictory objectives. How can the concept of and the striving for economic growth (especially in the rich countries) takes place in a way that also facilitates global sustainability?

· This poses an important but difficult issues. The international community has recognized, in the context of the Kyoto Accord and in the various reports of the Third Intergovernmental Panel on Climate Change, that as a starting point, rich countries must introduce mitigation strategies to reduce the rate of emission of global greenhouse gases, with the objective of stabilizing their concentration. The difficulties in securing the effective implementation of this Accord are well known. But the challenge of limiting the extent of future global climate change is even greater. Implementation of the Kyoto Accord, in itself, is not likely to make a significant difference in the global climate situation, at least for a century. Economic growth among the emerging market and poorest countries will need to be fostered in an environmentally sustainable way if greenhouse gas stabilization is to effectively occur. Moreover, industrial and developing countries face the difficult challenge of adapting to the climate change which is inevitably going to occur in coming decades.

· In both developed and developing countries, fiscal policy will play an important role in facilitating a sustainable use of natural resources and in safeguarding the environment. For example, harmful subsidies and inappropriate tax policies that lead to the excessive exploitation of natural resources will need to be phased out. The prices of energy products will have to reflect their social costs. Subsidies for pesticides and fertilizer use—which contribute to over farming of land—will need to be eliminated and replaced with government expenditure programs that more directly benefit small farmers. At the same time, industrial countries must implement similar policies to ensure that the world's environmental resources are not overexploited.⁵

· The IMF has emphasized the importance of considering whether or not the policies in Fund-supported programs may have adverse environmental effects or whether there are environmental issues that are sufficiently important that they might influence the design of Fund programs. Issues of environmental sustainability are also increasingly recognized, including with respect to taking account of environmental effects in more accurately measuring real growth rates.

· Finally, in coming decades, other issues will confront the rich countries that will further complicate the global challenges faced by rich and poor countries alike. In particular, aging populations will add further fiscal pressures that will make it more difficult for the industrial countries to shoulder environmental sustainability programs and additional foreign assistance to poor countries.

¹ The Poverty Reduction and Growth Facility (PRGF)— Operational Issues (Washington: International Monetary Fund, December 13, 1999).

² Horst Köhler, The Monterey Consensus and Beyond: Moving from Vision to Action, Introductory Remarks at the International Conference on Financing for Development (Monterrey, March 21, 2002)

³ Michel Camdessus, A speech on Development and Poverty Reduction: a Multilateral Approach (Bangkok: International Monetary Fund, 2000).

⁴ Horst Kohler, World Religions—Universal Peace—Global Ethics (Washington DC: International Monetary Fund, September 19, 2002).

⁵ International Monetary Fund, Contribution to World Summit on Sustainable Development (August/September 2002).