MACROECONOMIC ADJUSTMENT AND THE POOR IN MADAGASCAR: A CGE ANALYSIS Paul Dorosh* * I am grateful to Nancy Benjamin, Shanta Devarajan, and Erik Thorbecke for their many useful suggestions on CGE model ing; to David Sahn for his comments on this paper; and to Ren6 Bernier, for his work as a research assistant. The Cornell Food and Nutrition Policy Program (CFNPP) was created in 1988 within the Division of Nutritional Sciences, College of Human Ecology, Cornell University, to undertake research, training, and technical assistance in food and nutrition policy with emphasis on developing countries. CFNPP is served by an advisory committee of faculty from the Division of Nutritional Sciences, College of Human Ecology; the Departments of Agricultural Economics, Nutrition, City and Regional Planning, Rural Sociology; and from the Cornel 1 Institute for International Food, Agriculture and Development. Graduate students and faculty from these units sometimes collaborate with CFNPP on specific projects. The CFNPP professional staff includes nutritionists, economists, and anthropologists. CFNPP is funded by several donors including the Agency for International Development , the World Bank, UNICEF, the United States Department of Agriculture, the New York State Department of Health, The Thrasher Research Fund, and individual country governments. Preparation of this document was financed by the U.S. Agency for International Development Mission to Mozambique under Cooperative Agreement 656-0218-A-00- 1005-00, the Republic of Mozambique, and the World Bank. 1994 Cornell Food and Nutrition Policy Program ISBN 1-56401-161-5 This Working Paper series provides a vehicle for rapid and informal reporting of results from CFNPP research. Some of the findings may be prel iminary and subject to further analysis. This document was word processed by Mary Getsey. The text was formatted and the cover produced by Gaudencio Di zon. For information about ordering this manuscript and other working papers in the series contact: CFNPP Publications Department 308 Savage Hall Cornel 1 Uni versi ty Ithaca, NY 14853 607-255-8093 CONTENTS LIST OF TABLES 1. INTRODUCTION 2. THE MALAGASY ECONOMY AND ECONOMIC POLICY IN THE EIGHTIES Economic Policies in the Eighties 3. MODEL DESCRIPTION 4. SIMULATION RESULTS Investment Boom and Stabilization: Simulation 1 Increased Rice Imports: Simul ation 2 Trade Liberal ization: Simulations 3 and 4 5. CONCLUSIONS REFERENCES APPENDIX TABLES LIST OF TABLES Macroeconomic Summary, 1973-1989 Subsectors in Madagascar SAM Household Groups in Madagascar Estimated Household Income Shares, Madagascar 1984 Foreign Capital Inflows for Simul ation of Investment Boom and Stabilization Investment Boom and Stabil ization: Simulation Result 1 Breakdown of Household Income Changes: Simulation 1 (Investment Boom) Increased Rice Imports: Simulation Result 2 Breakdown of Household Income Changes: Simulation 2 (Increased Rice Imports) Trade Liberal ization: Simulation Results 3 and 4 Breakdown of Household Income Changes: Simulation 3 (Trade Liberalization, no change FSAV) Breakdown of Household Income Changes: Simulation 4 (Trade Liberal ization) APPENDIX TABLES Trade Levels and Parameters, Madagascar 1984 Household Budget Shares, Madagascar 1984 Household Demand Parameters 1. INTRODUCTION Stabi 1i zation and structural adjustment dominated economic pol icy in sub- Saharan Africa during the decade of the eighties. In Madagascar, as in a number of countries, IMF stand-by agreements in the early eighties were followed by a succession of World Bank and bi1 ateral structural adjustment and sectoral loans designed to restore macroeconomic balances and liberalize markets. Early in the reform process, a contentious debate developed as to whether the policy changes harmed the poor (see UNICEF 1984; Cornia, Jolly, and Stewart 1987). No repre- sentative household survey data exists with which to trace the actual evolution of household incomes and expenditures in Madagascar during the eighties. Using avai 1able information on prices, household income and expenditure patterns, Dorosh, Bernier, and Sarris (1990) provided evidence suggesting that in Madagascar, the adverse effects of adjustment policies, per se, were more limited. This study, based on computable general equilibrium (CGE) model simulations of external shocks and policy changes, attempts to shed more light on the important 1i nkages between macroeconomic adjustment and we1 fare of 1ower income households in Madagascar. The case of Madagascar is important for several reasons. The immediate cause of the balance of payments crisis of the early eighties is simi 1ar to that in a number of other countries of sub-Saharan Africa: a sharp decl ine in foreign exchange avail abil ity. And as in other countries, stabil ization efforts included cutbacks in imports of food and a reduction in food subsidies. Unlike in many other developing countries, however, there is evidence that a large share of these subsidies actually reached lower-income urban groups. Finally, Malagasy agriculture is sufficiently diverse to enable an analysis of effects on both smallholder export crop producers and food crop producers. This paper first presents a brief overview of the economy of Madagascar and a summary of key economic policies in Madagascar in the eighties. A brief description of the CGE model and of the data base follows. In section 3, results of model simulations of major elements of the investment boom, stabilization and structural adjustment pol ici es adopted by Madagascar are presented. Conclusions are found in the final section. 2. THE MALAGASY ECONOMY AND ECONOMIC POLICY IN THE EIGHTIES1 Madagascar is typical of many low income countries of sub-saharan Africa with large agricultural and service sectors and a small industrial sector. Less than twenty percent of the population 1ives in urban areas. A1 though some 1arge farms managed by parastatals exist, the bulk of agricultural production is carried. out by traditional small holders whose average farm size is only 1 .I5 hectares .' Madagascar's agriculture differs from that of most of sub-saharan Africa because of the dominance of irrigated land, especially on the densely populated high plateau which ranges from the north to the south in the center of the island. Irrigated area, planted primarily with rice or cotton, accounts for 44 percent of traditional cultivated area nationwide (MPARA 1988). Rice consumption, a1 one, represents 54 percent of total calorie consumption (FA0 1984). The re1 ative importance of agricultural exports (mainly coffee, cloves, and vanill a) decl ined during the 1980s because of decl ines in world prices of coffee and cloves, yet agricultural exports still accounted for 51.5 percent of Madagascar's total exports in the 1987-89 period3 (down from a share of 65.7 percent in 1980) (World Bank 1986, 1991). Production of the formal industrial sector is concentrated in import- substitution sectors such as food processing, textiles and beverages, and in nontraded sectors such as water and electricity. Imports of raw materials, energy, and capital goods, make up about 70 percent of the import bill (World Bank 1991). High transport and marketing costs contribute to the large size of the service sector; marketing alone accounted for 21 percent of value added in 1984. Based on poverty 1ines for rural and urban households calculated using food requirements and typical expenditure patterns, approximately 37 percent of rural households, 26 percent of households in small urban areas, and 18 percent of households in the seven large urban areas can be classified as poor (Dorosh, Bernier, and Sarris 1990). Nationally, 34 percent of all households are poor, 90 percent of which are in rural areas. This discussion draws heavily from Dorosh, Bernier, and Sarris (1990) and Dorosh and Berni er (forthcoming) . Traditional farmers defined in the 1984 Agricultural Census as farmers owning ten or fewer hectares, hiring fewer than 5 full-time, paid workers, and not using any specialized modern equipment or machinery. 3 Including agroindustrial exports such as cloth, preserved meats, and essences of cloves and yl ang yl ang, the share rises to 62 percent (IMF 1991). ECONOMIC POLICIES IN THE EIGHTIES At the start of the eighties, severe macroeconomic imbalances plagued the Ma1 agasy economy. The "investment to the 1 imi t" development strategy of the late seventies had led to a huge surge of imports, unsustainable balance of payments deficits, 1 arge government budget deficits and accelerating growth in the money supply (Table 1). The current account deficit reached 16.9 percent of GDP in 1981, and inflation jumped from 9.1 percent per year in 1977 to 23.8 percent per year in 1981. Between 1981 and 1984, macroeconomic adjustment in Madagascar focused largely on stabilization efforts endorsed by the IMF. Aggregate demand was quickly reduced through cuts in public investment and other government expenditures. Initial efforts at 1 i beral ization of rice marketing were begun, including a large reduction in the subsidy on rice for consumers. These stabil ization efforts proved successful in terms of their major goals: by 1984 inflation had dropped to 10.3 percent per year and the trade deficit was cut to only 5.0 percent of GDP. However, real GDP also fell sharply, by 5.4 percent between 1979-81 and 1982-84. Structural adjustment reforms aimed at restoring growth enjoyed relatively little success until 1988, the year a major trade liberalization was completed. Thereafter,