Evaluating Transfer Programmes within a General Equilibrium Framework

Abstract

We develop a general equilibrium model for evaluating domestically financed transfer programmes and derive analytical expressions which provide a framework for combining results from a computable general equilibrium model with disaggregated household data. We separate the welfare impact into three components, i.e. redistribution, reallocative, and distortionary effects. We show how these are subsumed within one parameter, the cost of public funds. Using a Mexican programme for illustration, we show that substantial welfare gains result from a switch from universal food subsidies to targeted transfers, reflecting both the improved targeting efficiency of the latter and the relaxation the trade-off between equity and efficiency when designing tax systems. In an attempt to maximise the welfare impact of government transfers on lowincome households, many governments in both developed and developing countries have moved towards better targeted transfer programmes. In developed countries these transfers mostly take the form of cash transfers or tax credits, whereas in developing countries they take the form of either cash transfers (e.g. in Latin America) or infra-marginal subsidised food rations (e.g. in South Asia).l When evaluating the economic impact of such transfers, it is useful to separate these into direct and indirect income (or welfare) effects. The direct income effects reflect the design of the programme (i.e. the rules for targeting transfers) - these are often referred to as first-round effects and are captured by partial equilibrium approaches to policy evaluation. The indirect effects capture the second-round income changes brought about by the impact of cash transfers, and their financing, on the level and composition of demand and supply. Most evaluations of social safety net programmes focus on the partial equilibrium evaluation of programme targeting outcomes. Even those that focus on the indirect impacts tend to concentrate on their efficiency implications with only a very limited analysis of income distribution outcomes and with little attempt to combine both the equity and efficiency dimensions. This is all the more limiting given that the central objective of these programmes is to improve income distribution. In this paper we focus primarily on the indirect income effects. In particular, we show how the results from a computable general equilibrium model can be combined with the information available in standard household surveys to