A deeper look into the cash for poor program

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.