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Macroeconomic policy, external shocks and social protection

Comparative analysis

Based on the individual country case studies, this comparative study tried to answer two questions:

  • Which external shocks have the greatest impact on growth, employment, social programs, and poverty?
  • Which set of policies can be promoted in the target countries that are effective in reducing poverty and are economically and fiscally viable to reduce poverty in light of external shocks?

A study of economic conditions (including labor markets) and social protection mechanisms in countries during the 1990-2007 period shows a continued sensibility to external shocks. The study also shows that countries are not prepared to react to negative shocks with the appropriate social and economic policies in the time and scope needed to mitigate the shock. Some findings include:

  • None of the countries studied are immune to external shocks, and falling export prices have the largest effect on domestic economies.
  • Increases in global food prices also have significant effect, even in countries that are net exporters of food products due to the effect of higher international prices in domestic prices and resource allocation. 
  • Lower capital inflows impacts domestic investment, though the final effect on growth is small.

The vulnerability of countries to external shocks justifies a robust set of social policy responses to defend a vulnerable population. General equilibrium simulations show that a proper mix of policies can be effective at targeting vulnerable populations given the conditions of a particular country.

  • A policy that lowers the burden of social security contributions by employers lowers the cost of hiring workers, promotes formal employment, and boosts production. Simulations of this policy show that there is a considerable production response and a commensurate boost in employment and wage incomes. Poverty rates also fall as households increase their incomes.
  • A transfer conditional on unemployment status is effective in some cases. However, the cost of this option led to large crowding out effects on the private sector which undermined its objective. 

In many simulated policy examples there is a crowding out of private investment as the government starts to demand more from domestic capital markets to finance the measures. The availability of domestic financing is thus a very important consideration in the design of social policies, especially since the effect of lower private investment due to higher interest rates may result in even larger reductions in employment and wage incomes.

In the simulated examples, direct transfer policies were effective in reducing poverty, despite the additional fiscal cost and impact on private sector investment and growth. Countries with better developed social protection mechanisms in place have lower financing needs for additional policies. Other countries should work to strengthen their safety net programs to prepare for eventual external shocks.

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The book "Financing Human Development in Africa, Asia and the Middle East" is forthcoming in the fourthquarter of 2012.

The book's quantitative assessments, conclusions drawn, and policy recommendation are prepared based on the country studies of the project "Realizing the Millennium Development Goals through socially inclusive macroeconomic policies".