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Let recipients speak with their money

Cash transfers as an allocation mechanism for international aid

By Jeremy Shapiro

Photo by Eric Muhr on Unsplash

What’s wrong with giving poor people — individuals who live on less than $2 a day — cash? Once upon a time, a major concern was misuse; recipients would squander it in the bar, buy frivolous items and so on. A decade of research, however, shows this is not the case. Poor people use cash in a variety of positive ways including feeding their families, investing in businesses and putting their children through school.

Does this mean the aid industry should pack it up and give people money? Not necessarily. Alleviating the acute ills of poverty with cash transfers does not solve the whole problem. People still need access to public goods like effective schools, quality healthcare and decent infrastructure, as these are important to poverty reduction and economic development. This sets up a dichotomy: with limited resources, is it better to invest in public goods that reduce long-term poverty, or direct aid to address the immediate hardships faced by people living in poverty?

What this dichotomy misses is that cash transfers are not only a direct approach to poverty reduction but also a distinct allocation mechanism for aid money.

The unique nature of cash transfers is that they let the poor allocate aid money to address problems they find most pressing, as well as solve the problem that aid organizations do not always know what type of assistance is best.

Though less often discussed, the same problem applies to the provision of public goods. If everyone benefited equally from all public goods, the job of aid agencies and governments delivering those goods would be simple. This is not the case: the farmer may prefer road construction to get crops to market, a mother may wish for a primary school built near her home, and an elderly person may seek improved healthcare services. When people have differing views on what public goods are most valuable, a single entity — government or aid agency — may not maximize the consumer surplus (the difference between how much someone values a specific good and the cost to obtain it) of those they seek to help when allocating funds to public good investment. Building the road does little for mothers and the elderly, and vice-versa for schools and clinics.

How much this matters depends on how variable the preferences of poor people are — if everyone wanted the same thing, there would be no loss from providing those goods to everyone.

We recently conducted a study (led by Dr. Jeremy Shapiro and published in the World Bank Economic Review) to evaluate this question. We found that poor people have hugely variable valuations for different aid interventions
– including public and private goods. For example, some aid recipients value clean water systems at 14 times the cost of providing them, while others value them at only 4 times the cost. Similarly, particular aid recipients believe supplying computers in public schools is worth 18 times the cost, while others think it is barely worth doing. The point is illustrated in the graph below which shows the distributions in the value-to-cost ratio recipients express for common aid interventions. The bars represent the 25th to 75th percentile of the value-to-cost ratios, and the white line is the median value-to-cost ratio for that intervention.

What does this variance in valuations mean? It means that under some circumstances, poor people would be better off with cash transfers than public goods provided by aid groups and governments. The intuition is if some people value a public good — say water systems — a lot, while others value it little, then providing water systems only benefits a few. In this case, the whole community might be better off if the cost of the water system was distributed as cash transfers and each person could buy the private good they most value. Alternatively, the group would be even better off if the people valuing the water system could pool resources to get it, and people valuing another public goods, such as teacher training, could join together to fund that.

The strength of cash transfers is that they allow people to obtain what they need most. A limitation is that cash transfers do not easily lead to investment in public goods. People can try to pool resources to invest in local roads, schools and clinics, but this creates the classic free riding problem, some people will seek to benefit from the good without contributing to it. Our study suggests, however, that maximal surplus for poor people can be achieved by using cash transfers as an allocation mechanism. Finding ways to enable recipients to effectively use transfers to fund the public goods that matter to them may be superior to having the decisions made by aid organizations.

This is a challenge for the development community to overcome.

Jeremy Shapiro holds a PhD in economics from The Massachusetts Institute of Technology. He has spent a decade in academia and international development: at Yale, Princeton, The World Bank and The Gates Foundation. He is a co-founder of GiveDirectly, and a board director of The Busara Center for Behavioral Economics.

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