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Resource centre on India's rural distress
 
 

The Case for Direct Cash Transfers by Rupa Subramanya Dehejia
Would you rather buy a necessity like kerosene or food grains at a subsidy or receive an equivalent amount of cash instead? Would you prefer that the government decides your consumption pattern rather than figuring out on your own how to spend your income?

One of the “big ticket” reform items in the budget was the announcement that subsidies on kerosene, fertilizers and Liquefied Petroleum Gas and delivery through the Public Distribution System would be replaced by direct cash transfers in a phased manner for people living below poverty line.

Is replacing this system with direct cash transfers a good idea? To economists, it’s almost an article of faith that a direct transfer is better than a subsidy. The reason is that the former increases the resources available to households without distorting the market or individual choice, whereas a subsidy necessarily involves a market distortion. The most obvious distortion is that subsidies, which reduce the market price and by definition cannot be targeted allow everyone to benefit, even those who don’t need help, whereas direct cash transfers can, in principle, be targeted directly to the poor.

An important recent book, “Just Give Money to the Poor,” by Joseph Hanlon, Armando Barrientos and David Hulme, argues strongly that direct cash transfers are an essential component of a national development strategy and a vital tool for empowering the poor. As Mr. Hanlon explained to me via email: “The key point is that poor people, in general, use money wisely, and waste less than the better off. The central point about cash transfers is that they are regular (typically every month) and you can plan on them, and include them in the household budget.”

In the case of India specifically, economists Puja Dutta,  Rinku Murgai, and Stephen Howes published an article December 2010 reporting on their research which showed that India’s limited experience with direct cash transfers for the elderly and widows has worked well in reducing leakage and better targeting the intended recipients as compared to the existing system.

Critics point out the potential pitfalls of replacing the current albeit imperfect system with direct cash transfers. One of the most vocal of these is the celebrated economist Jean Drèze, a member of the National Advisory Council. I spoke to Professor Drèze, who subsequently shared his views via email in the form of an unpublished note on moving from food rations to direct cash transfers. He writes: “A wholesale transition from the Public Distribution System to cash transfers in rural India would, in my view, be misguided and at the very least premature.” Many of the objections that he and other critics raise would apply equally to the direct cash transfers proposed in the budget.

Let’s take the most important concerns and see if they hold water.

What if inflation reduces the value of direct cash transfers? This is obviously a question of institutional design. A direct cash transfer system could and indeed should be indexed to inflation.

How do you target the intended beneficiaries? It’s true that targeting beneficiaries is a challenge. In fact, there has been controversy surrounding who is excluded from the below the poverty level group—who are the recipients of government help. However, the difficulty coming up with a fair below poverty line criterion does not negate the need to directly target the poor. As Mr. Hanlon notes, it is important to target the poor, but not so narrowly that the needy are excluded. By contrast, the existing non-targeted subsidy based system has the opposite problem, which is that the middle class extracts most of the benefits.

Will it benefit the rural and urban poor equally? Evidence from one of the most successful direct cash transfer schemes, the Bolsa Família (family grant) in Brazil which pays mothers to keep their children in school and stay healthy, suggests that there was a differential impact in terms of efficacy on rural versus urban poor—with the former benefiting to a greater extent than the latter. In India, unlike Brazil, the vast majority of the poor still live in rural areas, and therefore this concern, while legitimate, should not be overblown.

Will direct cash transfers work in an environment characterized by low banking density? The plan in India is to link direct cash transfers to the new Unique Identification Authority of India, which when when fully implemented will document every Indian. Once up and running, with bank accounts linked to identity cards, this will prevent identity fraud and corruption since money will go directly into a recipient’s bank account. In its absence, there is the danger that, “in remote areas, where the need for income support is the greatest, the banking system is simply not ready for mass transfers in cash,” according to Professor Drèze.

However, as Mr. Hanlon noted, direct cash transfers in most developing countries are paid in cash, through non-bank institutions such as post offices, lottery sales offices, and even mobile cash machines, which travel through villages on a regular schedule in places like Namibia. And in the case of India, a United Nations Development Program report noted that the large and spread out network of post offices could be used to deliver financial services.

With direct rather than conditional transfer, how do you know that the money is being spent as intended? In India, fears have been expressed that unconditional direct cash transfers will lead to money being wasted. A recent survey by Self Employed Women’s Association in 2009 showed that 56.6% of the women surveyed worried that any cash that the household received would be used for needs other than food. While understandable, this is not a legitimate basis for opposing direct cash transfers. It is deeply paternalistic to suggest that the poor will squander their money while the middle class and rich use it wisely. More importantly, there’s no compelling evidence to support such a claim.

The crux is that direct cash transfers are not perfect, but we’re not living in a perfect world. The current system of subsidies and the Public Distribution System are so riddled with leakage, corruption, criminality, and waste, that the system hardly benefits the poor—and is, in fact, a huge and wasteful subsidy to the middle class.

Do you believe that moving towards direct cash transfers is a step in the right direction or are you persuaded by the critics? If the latter, what would be a better alternative to the existing system?