HELPING THE POOR IN DEVELOPING COUNTRIES: HOW ‘SOCIAL SAFETY NETS’ ARE FINANCED IS AS IMPORTANT AS HOW THEY’RE SPENT

How social safety net programmes are financed is as important as how effectively they target the poorest households, according to new research by David Coady and Rebecca Harris. For example, the need for domestic financing can have important consequences not only for the distribution of the net gains from the programme – how much the poor really benefit – but also for the overall level of national income – the size of the ‘cake’ available for redistribution.

In recent years, development organisations like the International Monetary Fund, the World Bank and bilateral donors have come to recognise the importance of effective social safety nets (SSNs) for the development process. SSNs provide a way of alleviating the undesirable effects of policy reforms aimed at promoting efficiency and growth, especially the adverse effects on already poor households, and can thus help to promote support for these reforms.

But most of the evaluations of SSN programmes in developing countries have focused primarily on the expenditure side of these programmes and the need for more effective ‘targeting’ of the poorest households. Such a focus ignores the equally important issue of how these programmes are to be financed.

This study, published in the October 2004 Economic Journal, develops an approach that facilitates the integration of both the expenditure and financing sides of SSN reforms. Coady and Harris’s approach makes it possible to combine the rich detail of the household survey data now available for most developing countries with the more aggregate results typically available from economic models used to simulate policy reforms.

The result is a more comprehensive and policy-relevant evaluation of SSN reforms, which identifies both the net distributional and aggregate efficiency implications of these reforms and shows how they can be integrated for a complete evaluation of the programme. More specifically, the researchers’ illustration highlights the importance of explicitly incorporating the need for domestic financing when evaluating reforms of an existing SSN.

The illustration the researchers use is motivated by the shift in Mexico in the late 1990s away from transfer programmes based on universally accessible food subsidies, which were deemed to be very badly targeted at poor households, towards a more effectively targeted SSN programme called PROGRESA.

Recent evaluations of how well this programme’s expenditures were targeted have shown that it ranks in the top 25% of programmes for which such information is available. But focusing simply on expenditure targeting ignores potentially important welfare consequences arising from the need for domestic financing.

The illustrations presented by the authors show that financing the transfer programme through the elimination of highly inefficient food subsidies, which distort both domestic production and consumption patterns, results in substantial efficiency gains of the order of 38 pesos for every 100 pesos of programme expenditures.

In other words, when these efficiency gains are taken into account, the total cost of introducing the programme is only 62% of programme outlays. In addition, they find that this cost is disproportionately borne by the poorest households, although this is more than offset by the high targeting effectiveness of the programme.

In order to broaden the relevance of their results to countries with different financing options, the authors also simulate the welfare effects of financing the programme through reforms in the structure of value-added taxes. When the reforms involve the introduction of a more efficient tax system, similar, although less substantial, efficiency gains result.

These results thus highlight the dual benefits that can arise from the introduction of more efficient transfer instruments, namely, the welfare gains from improving expenditure targeting efficiency together with the gains associated with accompanying the programme with reforms that improve the efficiency of the overall tax system.

ENDS

Note for Editors: ‘Evaluating Transfer Programmes within a General Equilibrium Framework’ by David Coady and Rebecca Harris is published in the October 2004 issue of the Economic Journal.

Coady was a Research Fellow at the International Food Policy Research Institute; Harris is at the University of Southern Florida.

For Further Information: contact David Coady on +1-202-623-7849 (email: pcoady@imf.org); or RES Media Consultant Romesh Vaitilingam on 0117-983-9770 or 07768-661095 (email: romesh@compuserve.com).