There is no such thing as a free lunch: evidence from the effect of in-kind transfers

Abstract

Economists have frequently argued that cash transfers are to be preferred to in-kind transfers. However, the argument is strictly true only where there are no market failures, and there are several arguments in favour of in-kind transfers that are valid in these circumstances In-kind transfers are often used where policy may be specifically concerned with the welfare of the recipient but a cash transfer cannot be made directly to the intended recipient. This might be the case with basic health care and education services for children where cash transfers would have to be made via the parents who might choose to spend such cash in a different fashion. This is called the agency problem. A second argument relates to the desire to exploit the stigma associated with visibly being in receipt of some transfer, in order to improve the targeting of such transfers to the most needy. This may be most relevant where recorded income may not be a good indicator of well-being such as may be the case in an economy with a large underground. The essence of this argument is that only the genuinely poor find it worthwhile to participate in the programme if it is stigmatised. In order to encourage only the poorest to select themselves into the programme the quality of the in-kind provision may have to be low: if the quality is a normal characteristic of a good then few of the richest will participate if the quality is low since they prefer a higher quality at the market price. Both of these arguments suggest that an in-kind transfer is not valued as highly as cash by the recipients: in the first case because the agent cannot trade the transfer for cash from which rent could be extracted; and in the second case because the value of the transfer is net of the costs of the stigma. The fact that in-kind transfers are worth less than cash but worth more to the poor than to the rich, offers the attractive prospect of being able to both relieve poverty and improve work incentives. In fact, in-kind transfers seem to be most prevalent in welfare schemes for those out-of-work while cash transfers are most commonly used for those in-work. At the same time as improving work incentives and improving the targeting of expenditure to alleviate poverty, in-kind transfers may be able to protect the welfare of children in poor households from adverse shocks associated with variations in parental income. Indeed, this is precisely why many such schemes were introduced. However, if family members are altruistic towards each other then there is the prospect that an in-kind transfer directly to one household member may be offset by some countervailing action by other household members. This so-called rotten-kid phenomenon severely undermines the case for in-kind transfers to children - if such transfers can be neutralised by some corresponding intra-household reallocation then not only is the affect on child welfare undermined but so too is the potential beneficial work incentive effect since the benefit of the transfer to the child could be appropriated by the parent. This paper is concerned with the effect of three UK nutrition programmes (free school lunches, school milk and welfare milk) on the household expenditure on milk and (non-milk) food. The aim of the paper is to estimate the extent to which households offset these in-kind transfers by reducing corresponding expenditures. Thus, the paper addresses the issue of the extent to which dependent children and parents are altruistically linked as well as the more conventional issue of the extent to which in-kind transfers are equivalent to cash. Our analysis is based on detailed modelling of the determinants of household expenditures and shows that households do offset these in-kind transfers - the effect is small for free school lunches suggesting that the agency problem may be small, but is large for the two milk schemes suggesting altruism is quite strong. The policy lesson is that in-kind transfers may not be desirable because agency is not a big problem and will typically not be effective unless what is being transferred would not typically be bought (a low quality school lunch for example).