Monday, November 07, 2005

Cash Transfer

Here's my take on the current cash transfer program. Unfortunately, The Jakarta Post has edited it in a manner I wouldn't have suggested. To avoid misleading, here is the original, uncut:

A Perspective on the Cash Transfer Program

My main skepticism toward the current cash transfer program (CTP) lies on the failure of the government in identifying who are and who are not eligible. As with most other social safety programs, CTP suffers from adverse selection and moral hazard problems. Evidence for all this are widespread. Pick any local newspaper today, you will find stories about people run amok because they are deemed ineligible. Some old, thin person is pictured with his extremely poor house in the background, looking at the camera with empty eyes. The caption says it all: “Pak Fulan of Desa Bojong earns fifty thousands rupiah ($5) a month from scavenging around. With that, he has to feed his family of five. Yet, he is not on the list”. Or, there are news about how local government officials can manipulate the system by directing the CTP to their relatives and friends who are not eligible.

If the government’s objective is to improve income distribution, however, it deserves some credit. The government knows nothing what a given citizen really needs. It has no information whatsoever whether Family A is in desperate need for rice, or for motorcycle, or for health services at one particular moment. So, giving away cash is preferable than providing in-kind assistance: it gives freedom to the recipient to spend it anywhere he or she wants.

But where does the cash come from? It is from oil subsidy cut. The government claims that the subsidy has been benefiting the rich rather than the poor. It is now time to “give justice to the poor”: transfer the money from the rich to the poor. Some might ask, however: Why should a hardworking person be punished because he earns a lot higher than others? Who is the government to decide that Family B should give his money away to Family A? These questions are valid; but might be missing the point. The CTP now undertaken is financed through reduction in distortionary oil subsidy. People, regardless of income groups, have been enjoying oil subsidy for years. And that is not sustainable; unless everybody agrees to give up other development targets such as good infrastructure, education, and health facility. (Or, if everybody accepts tax increase). The demand for development increases over time. With limited financial resources, the subsidy should be removed gradually and let the “saved” resources be used for other development targets. Surely this is painful. The government is required to provide a pain reliever. Hence the CTP. To put simply, CTP is a means to take back some amount of subsidy from everybody and give it back in cash to the poor, not to the rich (for lack of better dichotomy). This is a form of redistribution. In its ideal, the CTP aims to leave the poor at least as well off as before the change. This is what welfare economists used to call “compensating variation”, measured by the “willingness-to-accept” the change. What about the rich? What is the compensation for them? The government uses statistics: even though everybody enjoyed the subsidy, it is the rich who enjoyed it more. The rich deserves no cash back. Fair enough.

As a side note, however, the compensating variations argument above may be shaky on theoretical ground. John Hicks, who first proposed the compensating variations as a measure of welfare change in 1943 defined it as the minimum amount a person would require as a compensation for welfare loss. We have yet to hear clearly how the government comes up with the Rp 100,000 per month per family. Is it really the minimum amount required? Or is it simply a back-of-the-envelope calculation subject to budget concern, regardless of people’s willingness-to-accept? If the latter is true, we should not claim it as a “compensating variation”. The fact that people stand in long queue to receive cash suggests that they are willing to accept it. However, “willingness-to-accept” – as the name suggests – should be based on voluntary exchange between both parties. In the absence of negotiation the long queue does not reflect the true minimum willingness-to-accept. It is a reflection of involuntary submission – “better than nothing”. In fact, it might be perceived as a pure “bribe”. At least, public bribe can be explained using political economics framework: the government has to cut on subsidy. People will suffer. Bribe them, so they will not react harsly. If “bribe” is too much a bad word, replace it with “compensation” (note the sarcasm).

Speaking of bribe leads us squarely to the issue of corruption. And this is where again my skepticism builds upon. Implicit in the first paragraph above, a smooth transmission mechanism is a necessary condition to ensure the effectiveness of any wealth transfer. But the coast is far from clear for a smooth landing. We have read evidence where aid does not work well in countries with severe corruption. Jeffrey Sach’s humanitarian effort for Africa will not work if all the aid he mobilized end up in the pocket of corrupt government officials. Nick Kristof writes in the New York Times (Oct 18, 2005) how Nigerians are starved by red tapes, not just by malaria and measles. In a more academic-oriented paper using cross country comparisons, Easterly (2005) finds support for democratic institutions and economic freedom as determinant of growth – while aid is less effective, especially in a corrupt environment. Cash transfer program works in similar mechanism as foreign aid. It is supposed to transfer some wealth from rich to poor. It is fair to say, therefore, that failure factors in aid programs might as well be existent in cash transfer programs.

Alas, we too live in a corrupt country. Many studies, including those by LPEM-FEUI, have found evidence of severe corruption in Indonesian economy. For example, in 2000, a typical business in Indonesia has to pay extortion as high as 10 percent of its total production costs (LPEM-FEUI, 2001). In 2003, the average size of bribes per annual production costs is 4 percent (LPEM-FEUI, 2003). Finally, the logistics inefficiency in export industries is almost 6 percent of total production costs (LPEM-FEUI, 2005), due mostly to poor infrastructure conditions and bad government regulations. Having listed just a few of them, it might be a better idea to use the resources from subsidy cut to combat the “high cost economy”. This includes establishing a solid set of rules of law. Robin Hood policy might look good in a very short run. But it is near useless if economic sustainability is of concern. With regards to the current problem, however, I have a slightly different position with some fellow economists. They believe that the subsidy cut should have been cancelled. There are ways around the budget problem other than cutting the subsidy. That includes, combating rent-seeking activities in oil and gas industry, mobilizing other sources of fund (e.g. tax reformation), and debt restructuring. I think we should do them all (including the subsidy cut). The domestic fuel artificial price has been the root of evils: it creates “triple-distortions”: between domestic prices and international prices, between industry price and household price, and between products (e.g. gasoline vs. kerosene). The world responds to the increasing oil price by investing on oil drilling and expanding refining capacity (supply side); and developing alternative energy resources and good public transportation (demand side). Both forces are likely to hold crude price well below $100/barrel. Unfortunately, such responses are not evident in Indonesia – the incentives are blocked by the artificial prices.

One might ask, if the saved resources are for building schools, roads, hospitals, etc., what is then the “compensation” for the poor who have to face higher prices? The better schools, the better roads, the better hospitals, the better rules of law, are it. This sounds cliché, true. But it is the government job to convince the people.

I should say, I am not claiming that cash transfer program can not be successful at all. A program called “PROCAMPO” (Program for Direct Assistance in Agriculture) in Mexico aimed to provide compensation for anticipated price effects of trade liberalization on basic crops is found to create multiplier effects when the farmer recipients put the money to work so as to generate further incomes (Sadoulet et al, 2001). It is hard to imagine that this can be done in Indonesia with the current CTP: the Rp 100,000 would simply vanish as consumption in a matter of days. The PROCAMPO transfers cash of $300 per year per family, or roughly Rp 250,000 per month. The program is relatively well-managed: eligible farmers have to show that they have planted at least one of the listed nine staple crops. In addition, the PROCAMPO card can be used as collateral in borrowing from commercial banks. The Mozambique’s Cash Transfer Program (“GAPVU”) is also successful, thanks to a well-designed program that succeeds in reaching household targets, using decentralized health and community administrative structures, and “strong political and institutional backing” (Schubert, 1995). GAPVU transfers cash of “only” $2.5 per month per capita, or roughly Rp 125,000 per month per family of five. Note, however, that GAPVU has nothing to do with compensation. It is merely a welfare program with clear targets: poor households with severely undernourished children or severely undernourished pregnant woman, elderly persons living alone, severely disabled persons living alone, and female-headed households with at least 5 family members. The eligibility is reviewed annually. Finally, the Social Safety Net Program (“RPS”) in Nicaragua uses conditional cash transfer system (Maluccio and Flores, 2004). Selected poor households should maintain their eligibility by sending their children to schools and visiting preventive health-care providers. They are eligible for a cash transfer of $357 per year per family, or roughly Rp 300,000 per month.

In conclusion, the current CTP might end up wasted, if not managed well. The government has two options: leave it and use the money for other development targets; or, make it better. As usual, either way is costly. And both needs better PR skill that has been lacking from the government.

1 comment:

Blue Cross of California said...

Great blog I hope we can work to build a better health care system as we are in a major crisis and health insurance is a major aspect to many.