Distributional effects of adjustment policies : simulations for two archetypes economies

The 1980s was a period of external shocks for developing countries, and domestic macroeconomic imbalance and structural inefficiencies compounded the effects. But the performance of developing countries was not uniform. The authors devised a model for simulating the effects of terms of trade and interest rate shocks on two archetype economies, one representing an average Latin American economy, and the other an average African economy. The study examined the effects of the shocks and of different adjustment policies. Identical shocks and adjustment packages yield different outcomes for growth, poverty, and income distribution in the two economies. The simulations suggest three important conclusions : i) with the standard adjustment package, inequality increased significantly for the Latin American archetype but decreased significantly for the African archetype; ii) adjustment can lead to a sharp redistribution of income from groups with low marginal propensities to save towards groups with a high marginal propensity to save; and iii) trade and tax reforms that improve allocative efficiency by equalizing incentives across sectors can reduce inequality significantly, provided that governments are able to implement these revenue-neutral measures.