The Direct and Indirect Effect of Cash Transfers: The Case of Indonesia

Economists have long argued that to increase households’ welfare, cash transfers are more efficient than commodities subsidies. However, not many studies address the indirect or economy-wide effect of such transfers especially in the context of poverty reduction programs in developing countries. In this paper, a 50 trillion rupiahs worth of cash transfers, roughly doubling the current level of government spending on poverty reduction program is simulated using a Computable General Equilibrium model of the Indonesian economy. The result suggests that such transfers reduce Indonesian GDP especially if domestically financed through increasing value added tax. However, the GDP reduction can be reduced to around half of that when financed by reducing distortionary fuel subsidy. Moreover, a cash transfers financed by reducing fuel subsidy also give the largest reduction in inequality. Various extents of the distribution of the transfers are compared, from giving it to the poorest 10% to distribute it equally to all households. It is found that the benefit of the transfers in terms of reduced poverty and inequality is smaller when we extend the beneficiaries toward the non-poor but its economy-wide cost in terms of the reduced GDP will be smaller. Policy implications are discussed.