A deeper look into the cash for poor program

Arianto A. Patunru, Jakarta

My main skepticism of the current cash transfer program (CTP) for the poor to offset the impact of the fuel price increase is due to the failure of the government in identifying who is eligible. As with most other social safety programs, the CTP suffers from adverse selection and moral hazard problems.

Evidence for all these are widespread. Pick any local newspaper today, you will find stories about people running amok because they have been deemed ineligible. Some old, thin person will inevitably be pictured with his extremely poor house in the background, looking at the camera with empty eyes.

The caption will say it all: "Pak XYZ from village ABC earns fifty thousand 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 bits about how local government officials have manipulated the system by directing the CTP to their relatives and friends; who are certainly not eligible.

If the government's objective is to improve income distribution, however, it deserves some credit. The government knows nothing about what the average citizen really needs. It has no information whatsoever whether Family A is in desperate need of rice, or a 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 the 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.

The CTP now being undertaken, is financed through a reduction in distorted oil subsidy expenses. People, regardless of the income group from which they hail, have been enjoying oil subsidies for years. And that is not sustainable; unless everybody agrees to give up other development targets such as good infrastructure, education and health facilities. (Or, if everybody accepts a tax increase). Yet, demand for development increases over time.

With limited financial resources, the subsidy should be removed gradually and let the "saved" resources be devoted to other development targets. Surely this is painful. The government is required to provide a pain reliever; hence the CTP. To put it 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 a 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 grounds. 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 was able to come up with the amount of 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 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 lines to receive cash suggests that they are willing to accept it. However, the willingness to accept -- as the name suggests -- should be based on voluntary exchange between both parties. In the absence of negotiations the long lines do not reflect on 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 the very least, a public bribe can be explained using a political economics framework: the government has to cut down on the subsidy. People will suffer, so bribe them, then they will not react harshly. If "bribe" is too harsh a word, replace it with "compensation" (note the sarcasm).

Speaking of bribes leads us squarely to the issue of corruption. And this is where again my skepticism builds. 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 ends up in the pockets of corrupt government officials. Nick Kristof writes in the New York Times (Oct. 18, 2005) how Nigerians are starved by red tape, not just by malaria and measles.

Cash transfer programs work in a 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 (the Economic and Management Research Institute of the Economics Faculty, University of Indonesia in Depok) have found evidence of severe corruption in the Indonesian economy. For example, in 2000, a typical business in Indonesia had to pay extortion "fees" as high as 10 percent of its total production costs (LPEM-FEUI, 2001). In 2003, the average size of bribes vis-a-vis annual production costs was 4 percent (LPEM-FEUI, 2003).

Finally, the logistical 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 direct the resources from subsidy cuts to combat the "high cost economy". This includes establishing a solid set of rules of law.

Such a Robin Hood policy might look good in the very short run. But in due time, it is nearly useless if economic sustainability is taken into the equation. There are ways around the budget problem other than cutting the subsidy. The artificial domestic fuel price has been the root of all economic evils: it creates "triple-distortions". Distortions between domestic prices and international prices, between industry prices and household prices; and between products (e.g. gasoline vs. kerosene).

This is not to claim that a cash transfer program cannot be successful at all.

In conclusion, the current CTP might end up to be a waste, if it is 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. But both options would require better PR skills, which have been lacking from the government.

The writer is the Research Director at LPEM-FEUI. He can be reached at patunru@gmail.com.