Catalog

Economic Analysis of Policy-Based Operations: Key Dimensions

Chapter Summaries

Chapter 1 – Introduction

Chapter 2 – The Macroeconomic Context of Sector Policy

Macroeconomic context such as growth, inflation, unemployment, and the balance of payments and key macroeconomic variables such as interest rates, money supply, and foreign exchange rates can greatly influence the outcome of sector policy reforms.

Vulnerability to external change and crises can trigger system-wide policy changes and affect the outcomes of structural and sector reforms. These reforms can have feedback affects on the macroeconomy.

A macro-meso-micro framework helps to understand the forward and feedback effects of sector policy changes. Understanding the macroeconomic context and the mesoeconomic channels through which sector policy changes will be effected helps to identify key influences on sector policy.

Macroeconomic assessment is country specific, but a consistent approach to assessment is required to understand:

• economic growth performance
• macroeconomic policy and management
• key structural policies
• economic outlook
• macroeconomic framework including risks or vulnerabilities

The analyst needs to carry out a country-specific macroeconomic assessment and how markets and institutions, the mesoeconomic level of the economy, affect the decisions and incentives by the consumers and producers at the microeconomic level.

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Sector diagnosis is needed to understand policy and institutional issues that affect sector performance.

Analysis helps to identify binding constraints to improve sector performance. Alternative ways of removing constraints sequentially provide the basis for the appropriate timing and sequencing of sector reforms. Key issues of the sector diagnosis include:

• markets, prices, and the incentives structure
• institutional roles, functions, performance and capacity
• adequacy of infrastructure

Analysis of price policy issues continues to be important, given their impact on economic and financial incentives and behavior of affected stakeholders including producer and consumer groups as well as the government.

Institutions include the provision of public services, functioning of markets, and 'rules of the game'. They affect transmission of market signals, incentives to consumers and producers and their behavior.

Analysis of the institutions provides insights on the linkage between economic management and the range of institutions that affect the form and adoption of policies. This includes understanding the implementation capacity of public and private institutions to effect policy reform.

Reforms involving institutional capacity building usually involve a medium to long-term view, often beyond the administrative life of a program loan.

The political economy context affects policy formulation, timing, reform acceptance, and implementation. Understanding is needed of the political environment, a country's policy priorities, trade-offs involved, and the stance of affected stakeholders. This includes those who will gain from reforms and those who will lose and prefer to maintain the status quo.

In this way insights emerge on possible influences and implementation issues of a policy operation.

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Policy change can be analyzed beforehand in different ways with increasing levels of rigor. The extent of analysis may be limited by practical considerations such as data availability, cost of collection, and analytical capacity.

Key considerations and analytical options are as follows:

• The starting point is to understand the status quo or the "without program" situation. Sector studies can provide much of the framework and data, and can potentially employ a range of macro, meso and micro analyses, depending on the nature of the policy changes and strength of likely feedback effects.
• Advanced assessments of policy options and the effects of the "with program" situation, are often based on deductive reasoning that should be checked to the extent possible by empirical verification. Where data availability is limited and collection impractical, valid and verifiable assumptions need to be clearly presented to allow monitoring during implementation.
• Policy analyses and simulations, where they can be done, can identify short and medium term effects of policy change. General equilibrium analysis is useful if there are significant feedback effects that need to be identified and assessed. Partial equilibrium analysis is useful where feedback effects are minimal. When equilibrium analysis is not possible, descriptive statistics and provisional calculations must be relied upon to understand sector parameters and possible responses.

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ADB has routinely carried out poverty impact assessment for program loans since 1995 as a response to concerns about the social impact of policy changes.

The analytical framework identifies the main channels of effect of policy change through which the poor are affected, assesses if the impact is direct or indirect, and the distributional implications between the poor and others affected. Improvements on the current framework include:

• channels of effect focusing on access to labor and product markets as well as the effects of wages and producer and consumer price changes in markets, access to and better use of assets, access to public services, and access to transfers
• clearer assessment of specific poor groups affected in relation to other stakeholder groups affected by reforms
• assessment of the timing of the effects that are likely to be felt in the short or medium term - or the time dimensions of reform effects
• designing mitigation measures if short-term negative effects on the poor and other stakeholders are identified. Also, ways to enhance the positive effects and inclusion on the poor can be identified and built into the program design

In this way, the poverty impact assessment framework becomes a design tool that should be used early in analytical work.

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Understanding is needed on the processes of cost and benefit realization of policy change as a complement to quantitative analysis of its effects.

This will help to establish whether reforms are feasible from the point of view of how stakeholders will be affected and can adjust to change.

Assessing the policy change process involves four key dimensions of adjustment:

• Intertemporal: Policy change involves restructuring that often occurs over the medium to longer term. Policy change effects need to be considered in dynamic, not static, terms.
• Distribution: The distributional effects of reforms need systematic assessment to identify who the gainers and losers will be, as the adjustment process unfolds.
• Political economy: Given the intertemporal and distributional effects, the groups affected can be identified and their views canvassed on reform support or opposition and why. The strength of the status quo versus reformers needs assessment. The needs for possible compensation for negatively affected groups during the adjustment process can be assessed and built into the program's design and costs.
• Development implications: Often, reform measures will have direct linkages to development efforts such as institutional reforms and related capacity building needs. The linkage between reforms and complementary development efforts should be established to increase the likelihood of sustaining the overall reform effort.

The government will have to shoulder the fiscal impact of reforms to the extent that they arise. The net fiscal impact of reforms should be related to the overall fiscal situation through national or local medium-term fiscal and expenditure frameworks.

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The final, essential step involves incorporating the results of analysis into program design.

The analysis helps to inform decision makers and affected stakeholders of options and their possible outcomes. Reaching a shared understanding on the nature, costs, and dimensions of policy changes is a basic requirement to successful reform implementation.

The policy matrix can be considered as a roadmap for government commitment on specific policy actions to ensure the reform implementation is on the right track. The emphasis of the policy measures included in the matrix should be on milestones and key actions.

Clear linkages among program framework, policy matrix, and poverty impact assessment framework will help ensure consistency between the analysis and design.

Effective monitoring and evaluation during and after reform implementation should supplement practical policy analysis as part of program design. This will also help in overcoming the inherent risks and uncertainties of up-front analysis and implementing policy reforms.