Saturday, April 21, 2012

Welfare programs change behaviour

Many people like to envision worlds where the State will tax the rich and help "the needy" - this ranges from free health care to unemployment insurance to disability insurance, etc.

There are many problems with these schemes. One of them is the fact that people respond to incentives. We are not bricks, we are not stones, but men, and being men, we will optimise. When unemployment insurance is offered, people will try less hard to find a job, to acquire skills that will get them a job, to migrate to a place where jobs are more easily found, etc. When health care is free, people are more inclined to be fat or smoke or otherwise take less care of themselves. And so on.

Among economists, it's considered obvious that people drive in a more rash manner when wearing a seat belt, but in the wider discourse, this raises hackles. When researchers found that drivers pass closer when overtaking cyclists wearing helmets as compared with overtaking bare-headed cyclists, economists were among the few who were not surprised. Laypersons generally recoil from the idea that the presence of a government giving out free open heart surgery increases obesity.

The first element of the behavioural change is lying and misrepresentation by citizens. When a government says it will give out disability insurance, people have an incentive to go to a civil servant and claim that they are disabled. I remember hearing a story from Holland, when a certain set of rules were constructed to give an early pension to the disabled, and policy makers had estimated that 1% of workers would be eligible for those benefits. In a few years, 10% of workers tried to claim these benefits, and front-line civil servants were placed in the difficult situation of having to identify the few genuinely disabled within the large pool that was claiming to be disabled.

The second layer is genuine changes in behaviour. Ljungqvist/Sargent have emphasised the damage caused by European-style welfare programs, which encourage or support withdrawal from the labour market. Some of these problems are now coming about with NREG. Migration out of villages is central to India's future, but NREG is reducing the incentives of people to engage with the urban labour market and ultimately to leave.

I just came across an example of behaviour distorted by incentives that veers on the fantastical: An unemployed Austrian man sawed his foot off, to avoid being found fit enough to go back to work. We find it incredible that Aron Lee Ralson cut off his right arm (to avoid certain death). But sawing your foot off to avoid going back to work?

This is a colourful story and only an anecdote. The man is most likely a nutcase. It is nobody's case that such extreme responses will come about on a large scale. The claim of the microeconomics literature is more limited: that on average, fairly significant behavioural changes come about in response to changes in the rules of the game. Through this, welfare programs have unintentional consequences that go far beyond those visible at the surface.

Politicians and bureaucrats in India like to roll out out more welfare progarms. It would be useful to bring alternative perspectives on these questions, which are mainstream worldwide but are considered cutting edge in India: about the limited governance capacity of the State, about the fiscal crisis that the State faces, and about the behavioural changes induced by welfare programs. In this field, you may like to see a paper by Vijay Kelkar and me.

1. I completely agree that welfare programs change behavior. But the instances you have mentioned seem to point at only one kind of behavioral change. I think you could consider several other possibilities too. i.e. Several positive behavioral changes that can be triggered. Firstly there are the direct effects such as the Mid day meal scheme increasing school attendance and decreasing dropout rates. Second is the indirect effect which can further be categorized into two kinds. First is the behavioral changes in third parties. Eg. Some studies have noted changes in relations between agricultural laborers and farmers who employ them, because the farmers treat the agricultural laborers with a little more respect now that the agricultural laborers have choice. It has also pushed up the agricultural labor wages. Next, in the case of free healthcare, in a country like India, I think it will serve to increase awareness regarding health if more people are getting treatment even if for free. You will find that very few people will be willing to fall sick even if it means no extra cost for them. However if people are getting treatment and access to medical treatment is made available even to those classes who otherwise would never see a doctor in life, it is very likely that they would start taking better care of their health.

2. Can you give us some data supporting these conclusions ? Not that I don't agree, but It'd be nice to see the DEGREE of social changes brought about by such programs.

3. An interesting point that you've made sir,
more relevant in our country now as our fiscal deficit continues to increase with a lot of its cause being blamed on our spending on welfare schemes. More so as we are perhaps at a significant crossroads in our history, as debates questioning our socialist welfare state schemes take up more space in our nations consciousness.

One request sir, can you please give a brief simplified summary of paper that you've published with Dr.Vijay Kelkar on Resource Perspective for the sake of the uninitiated people like me, who are interested in the subject?

Thank you Sir.

4. On your seat belt example, my favorite hedge fund manager, Hugh Hendry, once spoke about what he would do if he had been in charge of coming up with a driver safety solution. He said he would save the R&D money and put a really sharp object sticking out of the steering wheel where the airbag goes. Boy, would people drive safely! :)

Ofcourse its impractical, but I wish policy were designed with some of that intention. To stop people from doing stupid things instead of trying to protect themselves from their own stupidity.

I'm also reminded of the economist Jagdish Bhagwati's take on the European system vs the American system (or, what used to be the American system). He said that the US has tried to craft policy with the spirit of fairness of opportunity whereas Europe has designed policy for fairness of outcome. What you want is to provide a fair opportunity to someone who wants to put in the effort, but not guarantee fair outcomes irrespective of effort on the part of the entity.

To translate it in the Indian context, the govt needs to craft policy to provide fair employment opportunities to those willing to put in the work, but it should not guarantee employment irrespective of effort/merit.

LaTeX mathematics works. This means that if you want to say $10 you have to say \$10.