A Methodology Note on the Employment and Welfare Impacts of the 2007-08 Financial Crisis

Abstract

The welfare impacts of economic downturns generally have to be estimated using simulation tools because of delays in conducting detailed household surveys. This note documents a methodology with which social impacts of an economic slowdown, through its impact on the sources of household income, can be simulated using a simple partial equilibrium model. The simulated impacts are direct, short-run impacts, and do not take into account general equilibrium effects. The methodology has the advantage that it can be implemented in a relatively short time and the data requirements for the analysis are household surveys, which are now generally available in most countries around the world. The methodology was implemented by The World Bank in Turkey and Latvia in early 2009. The main purpose of the work was to help policymakers estimate the scale of the welfare impact on households. This type of information can be crucial to draw attention to the “human impact” of an economic slowdown, but also to help simulate the strength of safety nets needed to avert erosion in human capital. This note will focus on the Latvia and Turkey cases to illustrate the ease with which the model can be adapted to estimating the distributional impacts of economic shocks. Simulations show that both countries will experience a sharp rise in poverty, widening poverty gap, and a rise in income inequality. With an 18 percent GDP contraction in 2009 and the above employment projections, poverty will increase from 14.4 percent to 20.2 percent of the population in Latvia. In Turkey, simulations indicate that estimated GDP contractions of 5 percent and 1 percent in 2009 and 2010 respectively, in the absence of policy changes, will increase poverty headcount from a predicted 17.4 percent (2008) to 21.7 percent.