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Victoria Dyas

November 30th, 2013

Cash transfers and economic growth: uncovering the myth

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Estimated reading time: 5 minutes

Victoria Dyas

November 30th, 2013

Cash transfers and economic growth: uncovering the myth

0 comments

Estimated reading time: 5 minutes

While there is a moral case for social protection, new research in Cambodia finds little evidence to prove that these schemes boost the local economy. (First published in The Guardian on 28 November 2013).

Stephanie Levy
Dr Stephanie Levy

Can cash transfers stimulate the local economy and economic growth in low-income countries? This hypothesis is often discussed, in the current debate on social protection, but it is rarely supported by evidence. Wouldn’t it be fortunate indeed if by providing the poor with safety nets and reducing their vulnerability, policymakers were inducing new investment in productive assets and boosting their local economy? The research we have conducted on Cambodia shows that this wishful thinking might need some re-considering.

In order to analyse the potential economic impact of social protection policies, Prof Sherman Robinson at the International Food Policy Research Institute and I have designed a macroeconomic model of the Cambodian economy, which we tailored specifically to simulate a large range of social policies and strategies that target households. Our model aims to trace and estimate the economic impact of redistributive and social policies and their ripple effects throughout domestic markets.

Testing assumptions

While cash transfers used to refer to pilot experiments and village level projects, they are now part of the social protection agenda of a growing number of developing countries. So while most studies on cash transfers focus on the household as the observation unit, we deliberately chose to look at the whole economy to estimate their potential impact.

When we simulated cash transfer policies alone, we found no increase in the real GDP, even when up to 4% of the gross domestic product is distributed to households and even when the policy is fully aid funded – and so does not increase the domestic tax burden that could slow down the economy. From the test it would appear that cash transfers are insufficient to promote the economic growth when implemented alone. How can this be explained?

The rapid introduction of a relatively large-scale cash transfer programme seems to distort local markets, agricultural ones in particular, where the supply – either through production or trade – does not adjust rapidly enough to the increase in household demand. Our results show a potential increase in some domestic prices, again, agricultural commodities ones in particular. This of course would be bad news not just for the poor households targeted by cash transfer programmes but also of the rest of the community. Even if a significant share of the targeted households decide to invest part of the transfer they receive into productive activities and assets (such as cattle, tools, seeds), the benefit of this investment on the domestic economy seems insufficient to overcome the distortion on domestic markets, and therefore remains unable to stimulate the domestic economy in the short term.

more-money

Social protection: the verdict

Does that mean that social protection should not be a priority for governments who aim to tackle poverty and reduce inequality between their citizens? Certainly not. The benefits of social protection for poverty reduction, for reducing vulnerability and protecting livelihoods are well demonstrated and reason enough to implement them. It does however mean that justifying social protection policies in terms of their impact on growth might not be the most convincing argument in favour of the policy.

Still there is good news. Our results show a strong link between cash transfers and productive investment in agriculture (rural infrastructure, irrigation and productivity enhancing inputs). For example, we find that it would be economically more efficient to spend 50p on productive investment and 50p on cash transfer, than £1 on any of these measures alone. Such a combination of policies creates strong synergies and would be conducive of more economy-wide impact and more poverty reduction than social or investment measure alone.

By stimulating the domestic supply and allowing it respond to the increase in demand without increasing prices, public investment appears to be an ideal complement to social protection and the combination of the two a robust engine for growth. Therefore social protection could become an engine for growth, if it is complemented with productive investment that enhances productivity in key economic sectors.

To summarise our findings, this is what I would say. First, there is enough moral ground to defend the need for social protection, not as an engine for growth but for what it really is: an immediate provision of safety nets for the most vulnerable. Second, economic synergies and multiplier effects would be fortunate but more likely to arise when these transfers are complemented adequately to allow the economy to respond fast enough to an increase in household’s demand, without distorting prices and domestic markets.

Policy makers have limited, typically scarce, funding capacity. They demand realistic and honest assessment about what social protection can achieve. Our results suggest that the efficiency of these policies could be improved by taking into account, at an early stage of policy design, the capacity and ability of the local production to respond to a sustained increase in domestic demand. Our research identifies a number of complementary measures that could improve the impact and even maximise the benefit of cash transfers.

While economic context varies, the fact that social protection needs to be complemented with public investment that increase productivity, improve the functioning of markets, allow for a faster response of the local supply and create synergies at the national level is likely to remain relevant to most of the developing world.

Dr Stephanie Levy is a visiting research fellow in the Department of International Development at the London School of Economics.

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Victoria Dyas

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