Evaluating Targeted Cash Transfer Programs: A General Equilibrium Framework with an Application to Mexico

It is now widely accepted that social safety nets play a crucial role in any comprehensive poverty alleviation strategy. However, many people perceive that existing social safety nets are not cost effective because they are both badly targeted to poor households and often involve inefficient financing policies. Consequently, many developing-country governments and international development institutions have come to favor direct transfer instruments such as cash transfers or subsidized food rations. But most evaluations of such programs focus solely on the partial equilibrium impacts of program targeting outcomes, and those that focus on the general equilibrium impacts tend to concentrate on their efficiency implications with very limited analysis of income distribution outcomes and little attempt to combine both the equity and efficiency dimensions. In this report, Coady and Harris study the general equilibrium effects of transfer programs, focusing on the recent switch by the government of Mexico toward targeted transfer programs and away from universal food subsidies. They show how the results from a computable general equilibrium model can be combined with the information available in standard household surveys to provide an integrated analysis of both the direct distributional impact of such programs and the indirect distributional and efficiency impacts arising from the nature of its domestic financing. The focus on the domestic financing aspect of these programs reflects the view that any credible poverty alleviation strategy must have a credible underlying financing strategy, and this need for domestic financing can have important consequences for both the level and the distribution of household incomes. It is often argued, for example, that the major constraints for developing countries in establishing a comprehensive social safety net are the undue strain put on domestic finances and the economic inefficiencies generated by the policy instruments used. The results presented in the report clearly show that the general equilibrium welfare impacts associated with domestic financing can be quite substantial. When initial redistribution mechanisms are inefficient, the welfare gains from switching to a better-targeted direct transfer scheme are reinforced by efficiency gains associated with the removal of relatively distortionary financing instruments. More generally, the indirect welfare costs associated with domestic financing can be reduced by taking the opportunity to reform the existing tax system to reduce any existing trade-off between efficiency and equity objectives. The analysis of the spatial distribution of these welfare impacts helps to highlight the importance of recognizing the shortcomings of crude geographic targeting. Not only did the urban poor not benefit from the transfer program but they were also adversely affected by its general equilibrium impacts. The analysis also found, however, that combining the transfer program with efficient tax reforms reduced this adverse impact and ultimately benefited the urban poor through the general equilibrium changes in incomes and prices.