Developing countries are more vulnerable to aggregate shocks, including those that led to the food, fuel, and financial crises that erupted in 2008. Indeed the “3Fs” are a portent of things to come. Global economic integration, climate change, the increasing frequency of weather-related shocks, evolving energy, food, and water demand (and supply) conditions, fundamental economic and political changes in many parts of the developing world (including large countries like Brazil, Russia, India, and China), and continuous advancements in financial innovations (coupled with lagging and often limited cross-border regulatory oversight) are only some of the factors that could contribute to higher economic volatility in years to come. Two policy areas – social budgeting and social protection – need serious re-thinking, not just in light of the present food, fuel, and financial crises but, more importantly, in order to prepare for future aggregate shocks which are sure to come.
Social budgeting as part of the countercyclical response
During a crisis, social budgeting is especially relevant for at least two reasons. First, some types of shocks, such as those resulting in a financial crisis or an economic slowdown, severely diminish the fiscal space of the public sector, which in turn puts pressure to shrink social budgets and spending. This reduction could not only derail countries from achieving the Millennium Development Goals but also impose a large opportunity cost in terms of forgone advancement in human capital and possible improvements in countries’ growth trajectories.
Baldacci et al. (2008), for example, examined the links between social spending, human capital, and growth using data on 118 developing countries during the period 1971-2000 and found evidence that increased social spending could help achieve the Millennium Development Goals, boost countries’ long-run growth, and reduce poverty. These authors found that increasing education spending by 1% of GDP could increase a country’s net enrolment rate from 90% to 99%, reduce child mortality rate from 76 to 65 per thousand from 2000 to 2015, increase per capita growth by about 0.5 percentage points per year on average during this period, and decrease the initial poverty headcount by about 17% over the 15-year period.
Furthermore, channelling resources to poor households could help prevent harmful coping strategies like pulling children out of school or eating less (or less nutritious) food. Children are extremely vulnerable to the adverse effects of aggregate shocks, notably in terms of poorer health and nutrition, which could generate long-term harm. Malnourished children score poorly in tests of cognitive function, and they acquire skills at a much slower pace. Foetal and infant undernutrition also contribute to permanent changes in body structure and metabolism, which increase the risk of chronic infections and diseases later in life and contribute to stunting. The World Bank (2006) reports that interventions to improve child nutrition outcomes could result in productivity gains reaching up to 10% of lifetime earnings re-gained for the individual, and for some countries, up to 2-3% of long-run GDP growth re-claimed.
Thus, a potentially critical policy innovation in this regard is that of preserving – perhaps even increasing – social budgets as part of countries’ “pro-poor” countercyclical responses to shocks. This is not without precedent – in the OECD, for example, there is recent evidence that age- and health-related social expenditures already react to the business cycle in a stabilising manner (Darby and Melitz, 2008).
Enhancing social protection systems
Poorer countries (and poorer people) live with more uncertainty and volatility. For instance, weather-related natural disasters hit rich and poor countries alike, but developing countries tend to face a relatively larger adverse shock to their macroeconomy as a result. One study has shown that a natural disaster of a standardised magnitude, on average, results in a 9% decline in output growth in a developing country and a less than 1% decline in output growth in an industrialised country (Noy, 2009).
Emerging market economies are also vulnerable to sudden stops in capital inflows, and these economies are, on average, twice as volatile as that of industrial countries (Aguiar and Gopinath, 2007). The poor, who tend to benefit least during the “boom period”, are also the least-equipped to weather the inevitable “bust” and in many cases face the brunt of its harmful impact. One result is that inequality increases with economic volatility – a doubling in aggregate income volatility (measured as the standard deviation of per capita GDP) leads to a 2.7% increase in the Gini coefficient, a 2.4% reduction in the income share of the poorest quintile, and a 1.1% increase in the income share of the richest quintile (Calderón and Yeyati, 2007).
Short-term shocks could also generate adverse long-lived and potentially inter-generational effects, pushing the household and the next generation into a path of destitution. To help prevent this in the context of the food and fuel price shocks of 2008, a large number of countries responded by building on their existing social protection systems, reflecting a growing consensus on their importance. Nevertheless, many countries have yet to build more robust systems. Figure 1 illustrates the number of social protection programmes by type and country group based on an unofficial survey of 144 developing countries by Nora Lustig (2008). Nineteen of 49 low-income countries and 49 of 95 middle-income countries do not have established social safety net programmes. Only about one-third of low-income and middle-income countries have some form of cash transfer programme.
Figure 1. Developing countries with social protection programmes, out of 144
Source: Lustig (2008:52).
Programme coverage of the poor is also weak in many countries. In Latin America, for example, cash transfer programmes cover more than 25% of the poor population in only 8 of the 26 countries in the region for which data is available (Lustig 2008). In other regions, programme coverage is better – in Asia, the proportion of the poor receiving some social protection benefits is about 57%. However, benefits there are also much more limited. An analysis of 31 Asian and Pacific countries found that about half of the countries had social protection expenditures approximating a mere 20% of the poverty line income or expenditure (Wood, 2009).
In addition, most social protection programmes across the world do not have a clear mechanism to deal with the “new poor” (i.e. those pushed into poverty by the aggregate shock). Policy adjustments in this regard are often made in an ad hoc fashion and after the fact, suggesting that the “vulnerable near-poor” do not receive adequate social protection. During a crisis, large numbers of the “new poor” join the ranks of the poor, with many left trapped even years after the crisis has passed.
There is now growing recognition of the need for a broader view on macroeconomic policy reforms and strategies, including efforts to boost “fiscal empowerment” by increasing investments in education and health. In handling the present food, fuel, and financial crises and future crises, stabilisation policies need to be made more “pro-poor.” In this regard, reaching the most vulnerable children will be critical, not just in breaking the cycle of poverty but also in safeguarding countries’ future economic growth and human development.
Editors' note: This article is based on the author's paper "Aggregate Shocks, Poor Households and Children: Transmission Channels and Policy Responses" (Working Paper, UNICEF Policy and Practice, New York). The views expressed here are the author's and do not necessarily reflect those of UNICEF.
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