An Investigation into Optimal Safety Net Programs

Abstract

Safety net programs are increasingly used all over the world as a means to provide assistance to poor households, including in very poor countries. However, policy makers are left with little guidance to select among alternative safety net programs and designs. The objective of this paper is to derive the features of the optimum safety net program in an economy with heterogeneous agents with non-observable characteristics. It analyzes a model where the government seeks to maximize a social welfare function through the introduction of a safety net program (cash transfer or public works) financed from a linear tax on income while individuals choose whether to participate in the public works program. After calibrating the model to developing economies, the paper shows that the global optimum safety net program is a cash transfer program while a public works program may be locally optimum depending on the distribution of population skills. The paper analyzes the limitations of the model and suggests extensions with a view towards policy implications.