Malawi - Growth through poverty reduction

Report No. 8140-MAI Malawi Growth Through Poverty Reduction March 22, 1990 Southern Africa Department Africa Regional Office FOR OFFICIAL USE ONLY Docunent of the World Bank This documnent has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  Annual Average Exchange Rates (Kwacha per US Dollar) Year Kwacha Per US Dollar 1980 0.812 1981 0.895 1982 1.056 1983 1.175 1984 1.413 1985 1.719 1986 1.861 1987 2.209 1988 2.561 Conversion Factors for Weights and Measures 1 cubic foot (cu ft) X 0.0283 cubic meters 1 cubic meter (m3) - 35.3 cubic feet = 254 US gal 1 kilometer (km) - 1,000 meters - 0.621 miles 1 hectare (ha) = 10,000 square meters - 2.47 acres Government of Malawi Fiscal Year April 1 to March 31  FOR OMCIL USE ONLY GLOSSARY OF ABBREVIATIONS ADD - Agricultural Development Division ADMARC - Agricultural Development and Marketing Corporation ASA - Annual Survey of Agriculture ASAC - Agricultural 'ector Adjustment Credit CDA - Community Development Assistant CSR - Center for Social Research DEMATT - Development of Malawian Traders Trust DSB - Department of Statutory Bodies DevPol - Statement of Development Policies 1987-1996 EPD - Economic Planning and Development FHH - Female-headed Household HCW - Homecraft Worker HH - Head of Household ITPAC - Industrial and Trade Policy Adjustment Credit MEDI - Halawi Enterp.ise Development Institute MHH - Male-headed Household MOA - Ministry of Agriculture MOCS - Ministry of Community Services MOEC - Ministry of Education and Culture MOF - Ministry of Finance MOH - Minis.ry of Health NCWID - National Commission on Women in Development NRDP - National Rural Development Program NSO - National Statistical Office NSSA - National Sample Survey of Agriculture NTC - Northern Transport Corridor PAYE - Pay as You Earn PEM - Protein-Energy Malnutrition PER - Public Expenditure Review PFP - Policy Framework Paper PHAM - Private Hospital Association of Malawi PHC - Primary Health Care PSIP - Public Sector Investment Program RBM - Reserve Bank of Malawi RTS - Rural Trade School SACA - Smallholder Agricultural Credit Administration SAL - Structural Adjustment Loan SEDOM - Small-scale Enterprise Development of Malawi SFFRP - Small Farmer Fertilizer Revolving Fund WFP - World Food Program This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  MALAWI - GROWTH THROUGH POVERTY REDUCTION Table of Contents Page No. Executive Summary . . . . . . . . . . . . ... . . . . . . . i I. Introduction . . . . . . . . . . . . . . . . . . . . . . . . . 1 PART I. MACROECONOMIC DEVELOPMENTS II. Recent Economic Events in Malawi . . . . . . . . . . . . . . . 5 A. National Accounts ............... ... 5 B. Balance of Payments . . . . . . . . . . . . . . . . . . . 9 C. Public Finances ....... .. .. .. .. .. .. . 12 D. Money, Prices and Incentive Framework . . . . . . . . . 14 E. Macroeconomic Setting for Poverty Reduction . . . . . . 16 PART II. GROWTH AND POVERTY REDUCTION III. Poverty Profile of Malawi . . . . . . . . . . . . . . . . . . 19 A. Who Are The Poor? . . . . . . . . . . . . . . . . . . . 19 B. Why Are They Poor? ....... .. . .. .. .. .. . 25 IV. Proposals for a Poverty Strategy Consistent with Growth . . . 30 A. Employment Opportunities ............... . 30 B. Smallholder Agricultural Productivity . . . . . . . . . 35 C. Social Sector Expenditures . . . . . . . . . . . . . . . 39 D. Income Transfers . . . . . . . . . . . . . . . . . . . . 46 V. Choices Within A Macroeconomic Framework . . . . . . . . . . . 51 A. Implications of Four Approaches To Poverty Reduction . . 51 B. Macroeconomic Policy Mixes . . . . . . . . . . . . . . . 57 C. Profile of Macroeconomy Over Medium- and Long-Term . . . 66 Statistical Appendix ....... .. .. . .. .. .. .. .. . 76 List of Tables ....... .. .. . .. .. .. .. .. . 76 This report is based on the findings of a mission which visited Malawi in April and May, 1989. Mission members were Kathie Kruzmm (AF6CO, Mission Leader), Peter Fallon, Lant Pritchett, Brigida Tuason (AF6CO), Joy de Beyer (AF6PHR), Althea Hill (AFTPN), Ayse Kudat (EDI), Alan Roe (Consultant), Svein Longva (Consultant), and Candace Nelson (Consultant) and were joined by Roger Grawe (Lead Economist). The mission worked closely with a team from the Government and the Reserve Bank of Malawi. Richard Scobey (AF6CO) also contributed to the report.  LIST OF TABLES Paae No. Table II.ls Constant GDP Per Capita by Expenditure Item, 1978-1988 . . . . . . . . . . . . . . . . . . . . . . 6 Table 11.2s Flow of Funds: Savings and Investment - Private, Government and Foreign Sectors (1980-1988) . . . . . 7 Table 11.3: Constant Price GDP by Productive Sector, Growth Rate and Shares, 1978-1988. . . . . . . . . . . . . . . . . . . . .8 Table II.4: Balance of Payments Summary, 1984-1988 . . . . . . . . . 9 Table II.5: Trends in Principal Exports, 1978-1988. . . . . . . . . .'0 Table II.6: Changes in Money, Net Foreign Assets, and Net Domestic Credit, 1980-1988. . . . . . . . . . . . . . . . . . . . 14 Table 11.7: Selective Incentive Indicators, 1980-1988. . . . . . . . 15 Table III.A.l: Malawi Poverty: Incidence, 1989 Estimate. . . . . . . 20 Table III.A.2s Poverty Lines and Income Gap, 1989 Estimate. . . . . .25 Table III.B.ls Poor and Core Poor: Asset Distribution and Income Earning Indicators. . . . . . . . . .. . . . . . . . .27 Table IV.A.l: Rates of Growth in Formal Sector Employment and Real Wages, 1968-77, 1978-87 . . . . . . . . . . . . . . . 31 Table IV.B.l: Projected Targeted Agricultural Expenditure Programs. .38 Table IV.C.l: Projected Expenditures, General Programs in the Social Sectors. . . .. . . . . . . . . . . . . . . . . . . . .42 Table IV.C.2: Impact of Alternative Population Growth Scenarios, Constant Fertility vs. Moderate Fertility Decline By 2010. . . . . . . . . . . . . . . . . . . . . . . . . .44 Table V.B.1: Malawi: Flow of Funds. 1990-2005, Base Case Projections; Constrained Case Projections. . . . . . . . . . . . . .62 Table V.C.l: Key Macroeconomic Indicators, 1990-2005 (Base Case Projections). . . . . . . . . . . . . . . . . . . . . .68 Table V.C.2: Key Macroeconomic Indicators, 1990-2005 (Constrained Case Projections) . . . . . . . . . . . . . . . . . . 71 Table V.C.3: External Financing Requirements, 1990-1994 (Base Case Projections - In Millions of USD) . . . . . . . . . . 73  LIST OF GRAPHS Page go. Graph II.' Export (fob), Value, Unit Value and Volume Indices (1985=100), 1984-1988 . . . . . . . . . . . . . . . . . . 11 Graph 11.2s Import (cif), Value, Unit Value and Volume Indices (1985=l00) 1984-1988 . . . . . . . . . . . . . . . . . . 11 Graph 11.3: Terms of Trade, (1985-100) 1984-1988 . . . . . . . . . . . 11 Graph II.4: Fiscal Performancet Revenue and Financing as Z of GDP 1980/81-1988/89 . . . . . . . . . . . . . . . . . 13 Graph III.A.l.: Composition of Income, Smallholder - Core Poor, Other Poor, and Non-Poor . . . . . . . . . . . . . . . 21 Graph V.A.ls Impact of Poverty/Growth Strategy On Core Poor, Other Poor and Non-Poor - Cumulative Percent Change in Income . . . . . . . . . . . . . . . . . . . . . . . 53 Graph V.A.2: Contributions to Improved Poverty/Growth Index . . . . . 56 LIST OF MAPS Map III.A.1: Nutritional Problem by District, PEM Rate Weight for Age . . . . . . . . . . . . . . . . . . . . . . . . 24 Map III.A.2: Nutritional Problem by Districts PEM Rate Length for Age. . . . . . . . . . . . . . . . . . . . . . . . . 24 Map III.A.3: Educational Attainment by District . . . . . . . . . . . 24 Map III.A.4: Smallholder Household Poverty Distribution, By ADD . . . 24  STATISTICAL APPENDIX 1.00 SOCIAL AhD DEMOGRAPHIC DATA 1.01; Selected Demographic Estimates 1977 and 1987 1.02: Population 1966. 1977 and 1987 1.03: Urban Population by District, 1966. 1977 and 1987 1.04: Population Characteristics 1966, 1977 and 1987 1.05: African Population 5 Years and Over by Educational Level Literacy Rates and Region. 1977 and 1987 1.06: Enrollment Statistics 1966. 1977 and 1987 1.07: Selected Health Statistics, 1977 and 1987 2.00 NATIONAL ACCOUNTS 2.01: Gross Domestic Product by Industrial Origin in 1978 Constant Prices (1973-1989) 2.02: Gross Domestic Product by Industrial Origin in Current Prices (1973-1989) 2.03: Savings and Investment in Constant 1978 Prices (1973-1989) 2.04: Savings and Investment in Current Prices (1973-1989) 2.05: Gross Domestic Expenditure in 1978 Prices (1978-1989) 2.06: Gross Domestic Expenditure in Current Prices (1978-1989) 3.00 AGRICULTURAL AND INDUSTRIAL OUTPUT INDICATORS 3.01: Index of Industrial Production (1980-1988) 3.02: Availability of Land in Malawi by Region 3.03: Value of ADMARC Domestic Purchases by Commodity (1972-1989) 3.04: Quantity of ADMARC Purchases by Conmmodity (1972-1989) 3.05: ADMARC Producer Prices (1973174-1988/89) 3.06: Crop Production from the Estate Sector (1973-1988) 3.07: Tobacco Auction Sales (1973-1989) 3.08: Smallholder Production (1980-1989) 4.00 PRICES 4.01: Blantyre Retail Price Index, High Income (1970-1989) 4.02: Blantyre Retail Price Index, Low Income (1970-1989) 4.03: Lilongwe Retail Price Index, High Income (1974-1989) 4.04: Lilongwe Retail Price Index, Low Income (1974-1989) 4.05: Composite Retail Price Index (1980-1989) 5.00 EMPLOYMENT AND EARNINGS 5.01: Number of Paid Employees by Year, by Industry and by Private/Government (1968-1987) 5.02: Monthly Average Earnings by Industry and by Private/Government (1968-1987) 5.03s Statutory Minimum Daily Wage (1973-1989) 6.00 EXTERNAL DEBT 6.01: External Capital and Debt (1980-1988)  7.00 PUBLIC FINANCE 7.01s Central Government Budgetary Operations (1976/77-1981/89) 7.02: Central Government Revenue (1976/77-1989/90) 7.03: Econom$c Classification of Development Budget (1976/77-1988/89) 7.04: Functional Classification of Central Government Revenue Budget (1976/77-1988/89) 7.05: Functional Classification of Development Budget (1976177-1988/89) 8.00 MONEY AND CREDIT 8.01: Monetary Survey - Year ending December (1973-1989) 8.02: Official Foreign Exchange Reserves and Net Foreign Assets of Commercial Banks (1973-1988) 8.03: Commercial Banks: Advances by Main Sectors (1973-1987) 8.04t Interest Rates (1973-1988) 8.05 Commercial Bankss Composition of Sources and Uses of Funds (1973-1988) 9.00 TRADE AND BALANCE OF PAYMENTS 9.01: Balance of Payments Summary (K Million) (1973-1988) 9.02: Balance of Payments (USS Millions) (1973-1988) 9.03: Imports by End-Use (K Million) (1973-1987) 9.04: Domestic Exports by Main Commodities (K Million) (1973-1987) 9.05: Export Volumes (1980-1988) 9.06: Exchange Rate (Kwacha per US$)(1973-1988) 9.07: Trade Indices, 1980-1988  EXECUTIVE SUMMARY Recognizing the need to adjust its economy in the face of a difficult external environment, Malawi has actively implemented an evolving structural adjustment program. At the same time, Malawi has one of the lowest per capita income levpl& in the world and pervasive poverty. This memorandum focuses on removing major remaining structural constraints to sustainable growth while addressing simultaneously the roots of the pervasive poverty in Malawi. A development strategy focusing on growth through poverty reduction is desirable. MACROECONOMIC DEVELOPMENTS Malawi is now recovering from a difficult period of adjustment to the external shocks that buffeted the economy in the mid 1980s, foremost amongst these the cut off of rail transport through neighboring war-torn Mozambique and the resulting debilitating increase in international transport costs. These shocks led to two successive years of crisis management in 1986 and 1987 characterized by falling per capita real GDP, deteriorating current account, rapid international reserve losses, and fiscal imbalances. An economic turnaround begun in 1988 was aided by a resumption of imports of intermediate and capital goods, financed by higher export earnings combined with higher external inflows, and by 1989 real GDP per capita increased. The inflationary pressures that had built up were reduced; inflation fell from 31 percent in 1988 to under 8 percent as of October 1989. Nonetheless, increases in transport costs, periodic terms of trade shocks, and the slowing of ag.-icultural'output have reduced real GDP per capita to about 20 percent below its level a decade earlier. Adjustment of domestic absorption fell heavily on investment, but private per capita consumption also declined steadily before rebounding in 1988-89. The incentive framework that had been strengthened during the structural adjustment process remained largely intact during this period of stabilization. The real exchange rate depreciated over the period. Domestic agricultural prices remained by and large in line with border equivalents. Interest rates became increasingly market determined during the period, reaching positive levels by 1989. Real wages continued to fall, with labor in fact bearing a significant part of the adjustment burden. Nonetheless, improvements in macroeconomic balance were due primarily to contraction of domestic demend, with limited structural responsiveness. Export responsiveness was limited by non-price factors in the agricultural sector; private investment has responded slowly to increased profitability and declining real wages, with undeveloped financial channels to non-traditional clients. Daunting development problems continue to face the country in the 1990s. STRATEGY FOR GROWTH THROUGH POVERTY REDUCTION Elements of the Strategy The strategy for Malawi has two obiectives: growth and poverty reduction. It is a combination of four major elements that reflect the  - ii - poverty profile of Malawis expansion of employment opportunitie*, programs and policies enhancing smaller smallholder agricultural productivity, social sector expenditures for human resource development and population, complemented with income transfers. The poor are predominantly rural and conservatively encompass about half of the population, including disproportionate numbers of women and children. Given that the major causes cf poverty are limited employment opportunities, complicated by labor constraints for female-headed households, low agricultural yields, limited human resources, rapid population growth, and minimal income transfers, the four elements of the strategy address the underlying causes of poverty. The approaches to poverty reduction are simultaneously the critical components of a growth strategy for Malawi. They are not alternatives. Rather they complement one another. Malawi's growth largely will come from expanding the base of the economy through expanded employment and greater realization of the country's agricultural potential. Improved education and health will ensure that the population, including the poor, can take advantage of these employment and agricultural opportunities. Expanded child spacing se.-vices for population control will reduce pressure on agricultural land, social services, and labor markets needed to support the strategy. The macroeconomic considerations underlying the strategy are central, albeit complex. Macroeconomic policy affects the poor while at the same time the strategy for poverty reduction has implications for macroeconomic balance, including increasing the responsiveness of the economy to adjustment measures. The strategy takes into account the main features of the macroeconomy and the channels to the poor through which macroeconomic policy operates in the short term, namely, employment levels, wages, relative food prices, access to inputs, and availability of government services, and identifieE policy mixes with a favorable impact on poverty. These include trade liberalization with its encouragement of labor-intensive activities, inflation stabilization designed to avoid unduly contractionary fiscal policy, and financial deepening to facilitate generation of domestic resources and redirection to labor-intensive - tivities. The strategy has important implications for macroeconomic balance. In the medium-term the strategy implies significant levels of investment, encompassing extensive human capital formation, financed primarily by domestic savings. Resulting fiscal pressures are modest, with at most an increase in expenditures of 1 percent of GDP. Import requirements and delayed export response result in continuing pressure on the current account for several more years. Although the direction for policies and programs remains the same whether or not foreign savings are available to support the strategy, the scenario in which foreign savings complement domestic savings in financing this investment ensures more rapid progress toward meeting development objectives. The strategy also increases responsiveness to enable structural adjustment. Employment opportunities in labor-intensive sectors will enhance production of competitive exports and import substitutes; increased agricultural productivity will improve  - iii - food security while at the same time releasing resources for export production; labor productivity in both agriculture and other sectors will stem from the more highly educated and healthier population. The strong export performance and broad income base for strong domestic resource mobilization will achieve the sustainable internal and external macroeconomic balance at the heart of the development strategy. Employment Opportunities The first element of the strategy is increasing employment opportunities and labor productivity and reducing constraints on women's time, directly benefitting the poor who do not have many assets other than their labor. Continuing trade liberalization will encourage greater use of Malawi's abundance of labor fcr both export and import substitution activities. A dynamic informal sector also provides employment opportunities, and the Government should review the constraints placed upon its growth. Increased financial deepening as well as a supportive investment climate are necessary complements to attract both domestic and foreign investment. Wage policy must support mobility and competitiveness in labor markets, requiring more frequent review of the minimum wage. Land r rents which reflect land scarcity will not only increase efficiency but also increase employment in line with increased land utilization. To increase the efficiency of home and family maintenance that make large demands on women's time, particularly for the large percentage of female- headed households among the poor, emphasis should be placed on labor- relieving programs in water, transport, and agricultural technology. The National Commission on Women in Development (NCWID) should continue to be strengthened and the fledgling ?rograms for promoting income generation for rural women should be fostered. Smallholder Agricultural Productivity The second element of the strategy is increasing the low levels of agricultural productivity of the smaller smallholders. The promotion of widespread fertilizer use will require a significant increase in fertilizer imports and enlargement of agricultural credit programs. Despite the resulting production increases, the poor will continue to rely on off-farm activities and transfers for a large portion of their income. Other innovative programs for raising productivity which contain an income transfer element for these farmers should be considered. For the longer-term, a reorientation of the research and extension agenda towards the development and dissemination of flinty hybrid m_ize varieties that will win more rapid adoption by small-scale farmers is essential. The proposed extension of licenses to grow certain high value crops to smallholders, in particular, burley tobacco, is expected to provide additional income for some poor households without a significant reduction in efficiency compared to estate production. Public Expenditures and Social Sector Policies The third element is to irvest heavily in human resources thzough an expansion in social sector expenditures. The Government will need to  - iv - pay explicit attention to the factors that inhibit enrollment of children from poor families and limit access to health, child spacing, and water services. The quality of primary education, and of rural schools in particular, must be given higher priority. In health, the focus on primary health care is critical for cost-effective use of constrained resources, and there is an urgent need to extend access to child spacing services beyond the current third of health centers. Given the links between water services and other critical productivity factors such as health and use of labor, it is critical to increase access to clean water particularly for the majority of the rural population without it. Income Transfers The fourth element of income transfers complements the other three growth-oriented approaches by providing additional support to the poor in the interim until their incomes have increased. These ensure that the poor will not be too incapacitated to participate in other productive activities. Continuing efforts in tax reform and greater encouragement of NGO participation in development activities will be critical to finance these transfers. One targeting mechanism that should be expanded is nutrition intervention through feeding programs. Impact on Growth and Poverty The combination of these four elements will result in steadily growing incomes for the poor and non-poor over the next five years and well into the future. They will provide economic opportunities as well as enable the poor to participate. The initial impact will come from smallholder agricultural productivity and increased employment with the impact of social sector expenditures complementing these sources of growth at a latet stage; the transfer programs partly meet any gaps. The social sector and income transfer elements will be particularly effective in increasing the incomes of the lowest income poor while the labor and agricultural approaches will ensure significant increases for the both the poor and non-poor. This effective and comprehensive strategy for growth and pove-ty reduction in a resource-poor but well-managed country deserves the full support of the international donor community.  I. INTRODUCTION 1.01 Halawi has one of the lowest per capita income levels in the world. Not surprisingly, poverty is pervasive and not merely the situation of the lowest economic groups. Removing major remaining structural constraints to sustainable growth will address simultaneously the roots of the poverty in Malawi. The memorandum outlines four approaches and the policies and programs for each that are most promising in terms of both growth and poverty reduction: expansion of employment opportunities, enhanced smaller smallholder agricultural productivity, social sector expenditures for human resource development and population, and income transfers. A development strategy which combines these four elements will realize Malawi's potential for growth while reducing poverty. Strategy for Growth Through Poverty Reduction EswnshnrM i Scia lESndestor EnhancingSmaller| Employment_ Human Resource || o Income Transbx OpportunMes DevlopmeJnt and Agr ctural _Popubfion fiXProdur,fXs Background 1.02 Malawi is characterized by pragmatic management of its economy. However, that economy has a fragile and narrow resource base. Malawi is landlocked; land density already is among the highest in Africa; its population continues to grow at relatively high rates; human resources are largely undeveloped; the economic base is dependent on a small range of export and domestic markets. In addition, the economy has been subjected to a number of external shocks in the 1980s that have adversely affected prospects for growth and development. Foremost amongst these has been the  - 2 - war and civil strife in neighboring Mozambique which not only led to a severely debilitating increase in international transportation costs but also to increased security-related expenditures and a large influx of refugees. 1.03 The strategy in the first decades following Independence in 1964 by and large emphasized agriculture and infrastructure. In agriculture, the strategy emphasized increased production. Direct public expenditures in agriculture were relatively large, concentrated on the smallholder subsector. Prices paid to smallholders by the monopsonistic marketing board (most recently Agricultural Development and Marketing Corporation (ADMARC)) were considerably less than world levels, but a considerable share of the profits were reinvested in agriculture, albeit the estate or agro-industry subsectors. The estu,e subsector was deemed critical to export performance; growth in estate output was primarily extensive. In infrastructure, public expenditures in transport and communications took the largest share of total expenditures, benefitting primarily the estate sector. Explicitly recognizing its constrained resources, the Government limited expenditures on social services, resulting in lower allocations than in other Sub-Saharan African countries to primary education among others. Domestic manufacturing and urban development were not emphasized; the Government perceived little contribution to economic growth and the elimination of poverty from the development of capital-intensive industries or increased wage costs for an urban elite. Low wages also were regarded as consistent with strong estate export performance. 1.04 Adjustment strategy in the 1980s was formulated to strengthen performance of key markets. The policies, embraced and implemented by the Malawians with the guidance and support of the World Bank and other international institutions, created a sound base from which to grow. The major policies were liberalizing smallholder marketing, restructuring major private and public enterprises, strengthening fiscal institutions and performance, and restoring a relatively open trade and exchange regime. In light of continuing external shocks and the country's low social indicators, the policy measures undertaken during the decade of the 1980s, despite their breadth and successful implementation, were necessary but not sufficient to lead to sustained growth. Adjustment was the result largely of contraction in domestic demand, with limited movement into new activities. 1.05 In the 1990s the country will continue to face daunting development problems which limit responsiveness of the economy to adjustment measures. The Government has outlined a number of new directions in its Statement of Development Policies 1987.1996 (Devpol) to face this challenge. It recognizes the progress that has been made, for example, by giving the private sector a central role in the economy, and will maintain approaches that have proved successful. At the same time, it recognizes that land and human resource constraints call for shifts in emphasis toward the smaller smallholder and human capital development.  Framework for Analysis of Growth in the Context of Poverty Reduction 1.06 This memorandum explores the constraints to growth and adjustment, in particular, the potential for growth from attacking poverty and integrates the strategy for reducing poverty into a macroeconomic framework. It continues the search for sources of sustainable growth in Malawi. In the post-Independence period. Malawi relied on its initial abundance of land for growth. With the growth in population, the country now is increasingly labor abundant, similar to certain South and East Asian countries. The growth through efficiency-promoting policies in the 1980s will continue, but the greatest growth potential is in utilizing that labor abundance and making it more productive. Malawi is in a position to join other successful countries that have chosen this path. 1.07 This growth strategy also represents a medium-term poverty reduction strategy by using resources to enhance the productive income of the poor. 1/ This productive income depends on the assets that the poor control. They have command over few resources other than their own labor and human capital. Increasing the income of the poor from employment opportunities, investment in human resources and child-spacing services, and improvements in agricultural productivity would be a central element of a poverty reduction strategy. Certain options for transfers of income complement the strategy, in particular, those that work effectively in the short-term without jeopardizing the medium-term growth framework. 1.08 The Malawi case suggests that each of the four approaches to poverty reduction are consistent with growth. Expansion of employment opportunities through labor-intensive activities and relief of women's time constraints will result in efficiency gains; addressing the structural factors inhibiting smaller smallholder productivity will result in a broad response to the significant agricultural price and marketing reforms which already have taken place; increased social sector expenditures will raise levels of human capital and labor productivity as well as reduce population pressures; income transfers will play a complementary role by ensuring that the poor are not too incapacitated to take advantage of productive opportunities. The approaches are viewed over two time-frames, the medium-term 1990-95 and the long-term 1995-2005. These approaches are not alternatives because of the complementarities among them. Hence, should resources be tightly constrained, the analysis of trade-offs and poa.icy choices are inevitably difficult. Nonetheless, the report outlines a framework in which to make these choices. 1.09 The macroeconomic considerations underlying the strategy are central, albeit complex. Short-term macroeconomic management affects the poor through a number of channels, with important roles for trade liberalization and financial deepening in stimulating new activities and employment. At the same time, the four approaches affect macroeconomic 1/ Jagdish Bhagwati, "Poverty and Public Policy," World Development, Vol. 16, No. 5, pp. 539-555, 1988.  - 4 - balance. They have implications for the major macroeconomic aggregates including fiscal and external resources. In addition, they are fundamental in increasing the responsiveness of the macroeconomy to enable adjustment. With adequate support from foreign savings to complement domestic resources, all four approaches can be pursued simultaneously, resulting in sustainable internal and external balance in the long-term. Outline of Memorandum 1.10 This report has two parts. Part I (Chapter II) is an analysis of recent economic events and the context for growth, focusing on macroeconomic developments. Part II (Chapters III-V) develops the growth and poverty reduction strategy for Malawi. 1.11 Chapter III draws a profile of poverty. It characterizes both the poor and a sub-set of core poor (III.A) and identifies major factors underlying their low income level (III.B). Chapter IV outlines the four approaches to poverty reduction based on the profile of poverty and the economy of Malawi. The central role of the labor market and employment is outlined in section IV.A. The report presents a set of options for expanding employment opportunities, with attention to the informal sector, trade reform, land policy, and measures to remove constraints and create opportunities for the women of Malawi. Section IV.B summarizes the key elements of a strategy for enhancing agricultural productivity of the smaller smallholders, in line with the program supported by the Agricultural Sector Adjustment Credit (ASAC). Section IV.C outlines the poverty impact of social sector expenditures and sets forth specific recommendations on delivery of service and cost recovery in the social sectors and implications for public expenditure allocation. Section IV.D analyzes income transfers, including the implications for resource mobilization, both NGO activity and tax policy, as well as delivery and targeting options. 1.12 Chapter V pulls together the strategy in a macroeconomic framework. Section V.A compares and contrasts the four main approaches, making use of a poverty/growth index. It identifies the complementarities among the approaches, the limited trade-offs with growth, and the implications of the strategy for macroeconomic balance, including the fiscal and external resource implications of each approach. In the context of the growth and poverty reduction objectives of these approaches, section V.B sets forth the implications of macroeconomic policy mixes based on the features of the macroeconomy of Malawi. It identifies how the four approaches increase the ability of the macroeconomy to adjust. For the short-term, it evaluates the major links between the macroeconomy and the poor and identifies the alternative macroeconomic policy mixes (including trade, stabilization and financial policies) consistent with both growth and poverty objectives. The final section quantifies the resulting profile of the macroeconomy over the medium- and long-term and outlines the implications for external resource requirements and the pattern of donor support to Halawi.  P A R T I - M A C R O E C O N OM I C D E V E L o P M E N T S II. RECENT ECONOMIC EVENTS IN MALAWI II.A NATIONAL ACCOUNTS 2.01 Initial Adiustment Period. Further Shocks, Crisis and Recovery. Malawi's period of strong economic growth, driven primarily by extensive growth in the estate agricultural sector, came to a halt in the early 1980s. Dramatic declines in the terms of trade, combined with a drought and the beginning of transport difficulties through Mozambique, led to sharp declines in GDF per capita in 1980 and 1981. Some early signs of success in the adjustment process began to show in the years 1982 to 1984 as economic growth returned. During this recovery period, further external shocks buffeted the economy. In 1984 the rail link through Mozambique was cut off completely; the terms of trade took another nosedive from a temporary peak in 1984, driving down the dollar value of exports by 20 percent. These shocks led to two successive years of crisis management in 1986 and 1987, years of falling per capita GDP. Malawi adjusted to these additional external pressures primarily by resorting to tight exchange controls on imports. A broad based recovery in output began in 1988 and continued through 1989, reflected in increased capacity utilization. This was aided by a restoration of fiscal discipline and relaxation of import controls, with increased imports of intermediates and capital goods financed by both higher export earnings and higher external inflows. In spite of earthquakes and flooding in certain parts of the country, per capita income increased significantly in 1989. 2.02 Expenditure and Absorption. From 1984 to 1988, real GDP rose on average by only 2 percent a year while population grew by over 3 percent per annum. Despite further recovery of over 4 percent in 1989, GDP per capita was more than 20 percent below its level a decade earlier. The cumulative effect of increases in transport costs, periodic terms of trade shocks, and the slowing of agricultural output growth as acreage expansion slowed led to much slower growth in output in the 1980s compared with about 5 percent yearly growth during the 1970s. This contraction in output per person was reflected in both consumption and investment trends. As shown in Table II.1, private consumption per capita fell by 2 percent per annum from 1980 to 1984 and another 1 percent per annum by 1988 before rebounding sharply in 1989. 2.03 Savings and Investment. Much of the adjustment of domestic absorption fell on investment. Gross fixed capital formation fell from 19.5 percent of total expenditures in 1980 to 13.3 percent in 1984 and 1988 (Table II.1). Although the level of investment has recovered from its nadir in 1986, fixed capital formation per capita in 1988 was roughly a third of its peak level of 1977-80 and less than half the level of the  - 6 - Table II.l: TRENDS IN CDP BY EXPENDITURE ITEM 1980-1989 Recent Annual Change. Expenditure Share Expenditure category Est. ------------------- 1986 1986 1897 1988 1569 1980 1984 1988 Consumption* 8.23 1.86 -2.2 4.4% 11.6X 76.8X 66.9X 89.63 Private 0.71 -O.81 -2.7X 7.11 18.6X 61.4X 72.01 70.81 Government 11.6X 9.7X -0.5 -2.9% 8.8x 16.9X 16.0X 18.83X Investmnt (nci. stocks) 47.2X -47.21 21.41 26.0% 5.6X 21.71 18.1X 16.81 Gross Fxled Capital Form 9.5X -26.11 2.6X 14.9% 7.51 19.61 18.8X 18.8X Gross Domestic Expenditure 8.9X -6.7X 0.2X 7.2% 10.21 100.6X1 196.0 1W.0X GMP at market prices 4.61 -0.2X -1.11 2.91 5.0X 87.7X 102.9 91.7X Growth Rat.. by Period 197S-80 1980-84 1984-88 *Per Capits Consumption O.0X -2.21 -0..91 Private -1.4X -2.1X -1.6X Governmnt 4.8X -2.43 1.2X Source: Statistical Appendix mid-1970s. The fall was due primarily to the completion of major public investment projects. However, private investment (including parastatals) also was stagnant. Constrained aggregate demand, capacity underutilization, import controls. and the lingering effects of the restructuring of some of the economy's largest enterprises led to a fall in private investment to under 5 percent of GDP before recovering in 1988 and 1989. While some of the decrease in investment reflects a fall in available external capital flows, domestic savings have fallen more sharply than income over the last four years. As shown in Table II.2, national savings in 1989 were only 5.8 percent of GDP compared to 11.4 percent in 1982-84. Private savings continued to fall as a share of GDP in 1988 and 1989, consistent with the previously forced savings for fiscal deficit financing and the recovery in private consumption levels after several years of per capita declines. This was offset by a sharp improvement in Government savings performance, in line with fiscal contraction outlined below. Public enterprise profitability and contribution to savings has been strengthening. The balance of resources to the private sector (investment less savings) swung from large negative transfers in 1984-87 to positive levels in both 1988 and 1989. 2.04 Production: Agriculture. The Malawian economy remains predominantly based on agriculture which accounts for over 35 percent of GDP, )O percent of exports and 85 percent of total labor force utilization. Both smallholder and estate sectors experienced fluctuations  Teblo 11.2: FLOW OF RFIS: SAVINt AND INVESTWN - PRIVATE. WOVEI A1 FADRION SECTORS ---~~~---- (In pe rcnt of 0, 19199) to" 196f1 162 to" Ind 1i 0"6 1907 19o" i96 Or.. I enstent 24.7 17.6 21.4 22.6 12.6 16.l 12.2 12.6 15.4 16.6 Public 10.5 7.6 6.9 7.2 6.7 8.6 6.6 6.6 8.4 6.1 Privaet a/ 14.2 1i.6 14.6 15.6 0.2 t1.6 a 7 6.6 16.1 11.4 Fixed 11.7 6.1 7.7 6.6 6.4 6.e 8.6 6.0 6.6 6.2 Stock euilding 2.S 2.6 0.6 9.1 4.2 6.2 0.2 1.6 8.3 3.2 Savings (Notional Concept) 24.7 17.6 21.4 22.6 12.9 1S.1 12.2 12.6 16.4 16.5 Foreign Savings 21.2 12.8 1U.6 11.6 1.0 9.6 6.8 4.9 6.7 16.7 Notional Savings 8.6 6.8 1.$ 11.$ 11.1 9.8 6.9 7.7 0.7 6.6 Publ ic -4.4 4.2 -6.9 -8.1 -2.0 -1.7 -..9 -4.4 -1.9 -1.2 Privet* 7.9 18.5 16.6 14.9 18.2 11.6 9.6 12.1 6.6 7.6 Fi,i Dficit. (calendar y"er) 14.9 16.2 12.6 1.8 6.7 6.1 12.8 10.2 7.8 6.3 Private Setor BElance 6.3 -2.9 -2.2 0.7 -0.9 6.6 .4.0 -5.8 1.4 4.4 Current Account Deficit 21.2 12.8 16.6 11.0 1.6 9J. 6.8 4.9 6.7 16.7 -.___-__-___-_______ __--_ -_-_ _ _----- SOURCE: Statistical Apendia. */ Includes Statutory Bodies. during the past five years. The smallholder sector. distinguished by customary land tenure, is by far the largest, absorbing about 80 percent of the labor force and producing nearly 80 percent of agricultural value added. For the 1984-88 period the growth rate in smaliholder agriculture has been 0.7 percent a year, as shown in Table 11.3. The production of maize, which accounts for 70 percent of smallholder acreage, has been subject to wide fluctuations, largely weather induced, with large purchases by the Agricultural Development and Marketing Corporation (ADMARC) in 1985 followed by serious shortfalls by 1987 which necessitated food aid imports. Output was 20 percent higher in the 1987/88 season than the previous one due to a return to favorable weather conditions, improved prices relative to smallholder export crops, and increased fertilizer uptake; maize output increased a further 8 percent in the 1988/89 harvest. However, the 1988/89 output level was only 8 percent above the output five years earlier, less than the cumulative increase in population. Maize yields have stagnated at low levels. Output in the sector as a whole declined in 1989 due to floods and earthquakes in certain parts of the country. Estate agricultural production provided much of the impetus for economic growth in the 1970s. primarily due to acreage expansion. After rapid growth up to 1983, value added in estate agriculture grew more slowly, with stagnant yields and littlo growth in employment. From 1983 to 1986, output of the major crops stagnated due to falling yields in tobacco and adverse price movements in tea that limited production. The combination of favorable weather and increasing prices for burley tobacco led to strong output increases, and the estate sector grew by 7 percent in 1987 and 1988 and 10 percent ln 1989 (Table 11.3). A major shift has been the incressing share in total tobacco production of burley, more labor-intensive than flue-cured tobacco and typically grown by tenants, increasingly on smaller estates which account for lower yields. Burley tobacco now accounts for about two-thirds of the value of estate tobacco compared to only a quarter a decade earlier. 2.05 Production: Industry. The industrial sector in Malawi is small. contributing about 20 percent of GDP and employing only 3 percent of the labor force. Although the sector is highly concentrated, it has been  Table 11.3: CONrAr PRICE GOP BY PROUCTIW SEr0. 03Wht RATE AND SKf 1076-lOIS Orebth Rates per Annum Sectoral Share. by Pr;iod Annual OroAth Ratt in MP Est. 1078-2 1082-64 1984-86 1U85 NU6 1967 1986 1980 1976 1966 Agriculture -1.51 S.1S 1.43 0.5S 0.63 2.45 1.6S 1.2# s.73 813.93 Smilcale -S.2S 8.61 0.71 0.5S 1.03 1.1S 0.81 -1.43 81.23 27.81 Largeacale 6.13 8.13 S.4s 0.63 4.0.CS 7.23 7.1S 0.01 6.56 6.83 Industry -0.25 1.41 3.61 7.53 -1.86 1.81 7.38 12.. 10.811 20.13 M.nufacturing 2.03 4.6311 2.41 S.1S 2.29 0.. 8.83 12.011 11.43 lS.S3 C ertusetwion 4I.0 -0.43 6.85 25.73 -16.11 -0..t 24.4S 10.03 6.251 4.61 Electricity end Water 4.03 6.03 4.43 1.ff 5.53 6.13 2.12 6.01 1.71 2.23 Services 2.S3 4.1S 8.63 6.6S -2.63 S.1s 2.63 8.63 41.06 41.03 Governmnt services 6.93 7.61 6.83 6.43 0.13 14.01t 6.63 1.63 9.1U 15.7 Otlhcr 0.73 2.3 1.63S 0.53 -.63 -1.63 1.63 4.05 31.03 23.83 Source: statistical Appendit relatively efficient. After recovering in the 1982-84 period and into 1985, industrial value added fell in 1986, as shown in Table 11.3, as low domestic demand and constraints on imported intermediates lowered capacity utilization in the manufacturing subsector to under 50 percent. Tbo construction subsector felt the impact of the reduction in investment levels most strongly. The sector rebounded sharply in 1988 and 1989 with the relaxation of import controls and increesed demand from agricultural estate incomes, leading recovery in the economy. 2.06 Productions Services. The service sector accounts for about 40 percent of value added (Table 11.3). Within services, the most important producers are government, distribution, transport, and financial services. The apparent growth in output of government services is due primarily to productivity assumptions made in constructing the constant price series for compensation of employees; removing this upward bias would reduce the government services share of GDP to about 11 percent of GDP rather than 16 percent for 1988. This adjustment also would reduce the estimated annual GDP growth rate for 1980-88 by almost a quarter. The transport sector has been under heavy supply pressures, with the lack of imported spare reducing operating vehicles and the demands on the distribution network at times strained by the added task of supplying the refugees. The number of registered vehicles has fallen and the capacity of the sector has not expanded. 2.07 Refugees. Since 1987, there has been an influx of refugees from neighboring Hozambique totaling about 700,000 people, equivalent to 10 percent of the Halawian population, the highest recorded percentage in the world. In addition to the transport pressures from movement of food aid, the influx contributed to an initial sharp rundown in the Government's strategic grain reserve and imposed an additional budgetary burden estimated at about 1 percent of GDP beyond the services provided to the refugees by the international community.  -9- II.B BALANCE OF PAYMENTS 2.08 One aspect of the continuing economic crisis in Malawi is the continuing pressure on the external accoAmts brought about largely by terms of trade deterioration and increasing transport costs. After a strong year in 1984, in which the current account deficit fell to 1.8 percent of GDP, due largely to an export value boom, the current accaunt deficit rose to 9.0 percent of GDP in 1985 (Table II.4). This, combined with decreased inflows on the capital account, led to increasingly rapid reserve losses. Gross reserves in 1986 fell to less than a month's worth of imports. In response, the Malawian authorities imposed a strict system of foreign exchange allocation that reduced the current account deficit in 1986 and 1987 by sharply containing import growth. In 1988 and 1989, the relaxation of these controls along with increased capital inflows associated with Bank adjustment lending and some increase in export receipts allowed a large surge in imports. The current account again rose to 8.7 percent and an estimated 10.7 percent of GDP, respectively, combined with a restoration of reserves. Tabla 11.4: BALANC1 OF PAYMENTS SUWARY