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Economics of the welfare state


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Economics of the welfare state


Economics of the welfare state

Sponsored by a Grant TÁMOP-4.1.2-08/2/A/KMR-2009-0041 Course Material Developed by Department of Economics,

Faculty of Social Sciences, Eötvös Loránd University Budapest (ELTE) Department of Economics, Eötvös Loránd University Budapest

Institute of Economics, Hungarian Academy of Sciences Balassi Kiadó, Budapest


Economics of the welfare state

Authors: Róbert Gál, Márton Medgyesi Supervised by: Róbert Gál

June 2011

ELTE Faculty of Social Sciences, Department of Economics


Economics of the welfare state

Week 9

Supporting human capital investments by transfers

Róbert Gál, Márton Medgyesi


Education: human capital investment

Human capital theory: people gain knowledge and competences from education which enhances their productivity.

Human capital is a special type of capital:

• inseparable from its owner,

• cannot be sold, only rented,

• time is needed for building up.


Benefits and costs of education:

Individual benefits:

• Consumption benefit: attending school might provide utility

• Investment benefits:

– higher income

– non-financial benefits: satisfaction with work, greater utility of leisure

Individual cost:

• Direct expenditure: tuition, school equipment, cloths, traveling cost, accommodation related to school.

• Indirect expenditure: foregone income.


Families and educational decisions

(Becker and Murphy 1986) every children gets the optimal level of education adequate to their

talents, abilities, (assuming parents taking schooling decision) if

• parents are altruists,

• perfectly rational and

• credit market is perfect: families can finance

education by borrowing money at the deposit

interest rate.


Lower then individually optimal level of education

Credit-market imperfectness:

• If education cannot be financed by credit, the low income of poor families creates an effective limit.

Rationality-assumption is not met:

• parents underestimate the benefits of human capital investment,

• high discount rate or self-control problems can also result in the low level of human capital investment.

Altruism-assumption is not met:

• conflict of interests between parents and children. E.g.

parents have a higher discount rate then their children.


Low level of human capital investment among the poor

• Income constraint: less money for education, extra lessons, health care and other inputs.

• Poor parents might be less informed

• Lower aspirations:


Reference-group theory

• Poor parents might have higher discount rate

• Benefits of education might be lower

Poverty makes it difficult to be a good parent.

Children of rich families attend better schools.

The rich benefit from better social network in the labour market.


Family-factors influencing the development of children

Mental status of parents: poverty increases stress, anxiety, personality disorders, chronic poverty might result in depression.

• Poverty negatively effects personal

relationships: the unemployment of the father undermines the parents’ feeling of competence.

• Parent-child relation: stressful parents can pay less attention to their children.

Home-environment: poor families generally

provide less stimulating environment for child



Individually optimal but socially low level of education

Positive externalities of education:

More educated people

• have generally higher health consciousness,

• invest more in the health and education of their children,

• are more capable of innovation,

• have more interest in public issues, higher degree of participation in politics, which also improves the

effectiveness of political decisions,

• commit less crime, more charity, and volunteering,

therefore social cohesion is strengthening.


Public policy responses to low level of private human capital investment

Demand side:

If the underlying reason of low human capital investment

• are financial difficulties: solution: free public education, cash transfers.

• is incomplete information, consumer impatience, conflict of interests within the household: solution: ”Conditional Cash Transfers”.

• is child development problems due to poverty: solution:

early development programs.

Supply side:

Development of infrastructure of education, quantitative and qualitative improvement of labor force (teachers) in the

education sector.


Educational decisions of families in response to a CCT program

Source: Das et al., 2005


Consumption decision of families in response to an in-kind transfer

Source: Currie and Gahvari, 2008


Public policy response to low demand for schooling

The case for Conditional Cash Transfers

1. microeconomics

2. political economy


Microeconomics arguments for CCT

1. Incomplete information: poor families systematically underestimate the benefits of education. Self-fulfilling prediction: difficult to break them by simple information campaigns.

Paternalism of CCT: the regulator has a better knowledge of the benefits, than families themselves.

2. Imperfect markets

If capital market is perfect:

• UCT does not effect education: every parent chooses the optimal level of human capital investment.

• CCT lessens the direct cost of studying: the lost wage is not w, but (w–t), hence CCT increases the demand for education.

If capital market is imperfect:

• UCT: increases human capital investment.

• CCT: stronger positive effect since there are income as well as substitution effects.


Political economy arguments for CCT

• Low voter-support of redistribution programs

targeting the poor: median voter is not poor and does not benefit from it.

• BUT: voters’ decision is not based exclusively on financial benefits: fairness considerations.

• Stronger support can be expected for poverty- relief programs, which target those who

themselves do something in order to be in a

better situation.


Administration and effects of CCT programs


• CCT programs try to target poor families: income-test or proxy in most cases. Sometimes on the ground of geography or some other easy-to-check feature

(gender, ethnicities).

• Programs differ in the coverage of the poor: 1%

Cambodia, 60% Brazil, Ecuador, Mexico.

Reason of low coverage:

• budget of program

• program limited to specific age-groups

• accessibility of schools and healthcare facilities

• imperfect income-test

• weak information

• decision of the family


Amount of subsidies:

• Usually but not always depends on the number of children.

• Sometimes depends on level of education or gender.

• Further differentiation based on the level of poverty or price level is rare.

• Subsidies paid to the parent (mostly the mother).

• The amount differs across countries, most generous programs are in Nicaragua and Mexico.

Administration and effects of CCT programs



• school attendance on 80-85% of schooldays

• in some cases school-performance is also a condition:

not to fail

• regular visit of healthcare facilities, vaccination Monitoring, sanctioning

• Monthly (Turkey); yearly (Chile).

• Data necessary for monitoring is provided by the service providers (schools, healthcare facilities).

• The most frequent sanction is suspension of subsidy, in repeated cases outright withdrawal.

• Many programs work with „soft” sanctions: in case of violation of terms social-workers help to solve the


Administration and effects of CCT programs


Effect of CCT programs on enrollment


Age/Gender/ enrollment Transfer Evaluation

Country Program Grade (%) Impacta (% of PCE)b method Reference

Latin American and Caribbean countries

Ecuador Bono de Desarrollo Ages 6–17 75.2 10.3** 10 IV, Schady and

Humano (4.8) randomized Araujo (2008)

Honduras Programa de Ages 6–13 66.4 3.3*** 9 Randomized Glewwe and

Asignación (0.3) Olinto (2004)


Mexico Oportunidades Grades 0–5 94.0 1.9 20 Randomized Schultz

(25.0) (2004)

Grade 6 45.0 8.7***

(0.4) Grades 7–9 42.5 0.6


Nicaragua Atención a Crisis Ages 7–15 90.5 6.6*** 18 Randomized Macours and

(0.9) Vakis (2008)

Nicaragua Red de Protección Ages 7–13 72.0 12.8*** 27 Randomized Maluccio and

Social (4.3) Flores (2005)

Source: Fiszbein and Schady, 2009


Effect of CCT programs on enrollment


Age/Gender/ enrollment Transfer Evaluation

Country Program Grade (%) Impacta (% of PCE)b method Reference

Non–Latin American and Caribbean countries

Bangladesh Female Secondary Ages 11–18 44.1 12.0** 0.6 FE Khandker,

School Assistance (girls) (5.1) Pitt, and

Program Fuwa (2003)

Cambodia Japan Fund for Grades 7–9 65.0 31.3*** 2–3 DD Filmer and

Poverty Reduction (girls) (2.3) Schady (2008)

Cambodia Cambodia Grades 7–9 65.0 21.4*** 2–3 RDD Filmer and

Education Sector (4.0) Schady

Support Project (2009c)

Pakistan Punjab Education Ages 10–14 29.0 11.1*** 3 DDD Chaudhury

Sector Reform (girls) (3.8) and Parajuli

Program (2008)

Turkey Social Risk Primary 87.9 –3.0* 6 RDD Ahmed et al.

Mitigation Project school n.a. (2007)

Secondary 39.2 5.2

school n.a.

Source: Fiszbein and Schady, 2009


The effect of the Oportunidades program on enrollments

3 4 5 6 7 8 9 100%



Control group

Rate of enrolment

Source: De Janvry and Sadoulet, 2006


Examples of education-incentive CCT programs in developed countries (1)

1. UK: Education Maintenance Allowance

• Features

• Entitlement: income-tested, 16-years-old, full-time education.

• Incentives: weakly-payment + bonuses per successful exams or in case of extended education.

• Maximum transfer is 1/3 of the accessible wage.

• Status:

• Pilot from 1999, whole-country coverage since 2004.

• Evaluation: (Dearden et al., 2009): among those who are entitled to get max transfer, the ratio of full-time education participants in the first year is higher by 4-5%, and in the second year by 6-7%

compared to the control group.


Examples of education-incentive CCT programs in developed countries (2)

2. USA: Opportunity NYC-Family Rewards from 2007, 3 years

• Conditions:

• Education: school-attendance (95% of school-day), test result, parents’


• Health care: family healthcare-insurance, attending routine inspections.

• Work: full-time employment of parents, parents’ participation in training programs.

• Evaluation (MDRC, 2010):

• No effect on attendance in primary school classes (4th, 7th classes).

• Secondary school students: 5% increase in school-attendance.

• Stronger effect among better students! Reason: too much obstacles facing worse students: they do not have instruments to improve their performance.

• Status:

• Pilot program, decision on extensions after final evaluation.


CCT in Hungary

Education subsidy

• Legal background: A családok támogatásáról szóló 1998. évi LXXXIV tv (Law on the support for families, 1998).

• In effect: between 1999–2002.

• Condition: regular school-attendance.

• Sanction: withdrawal of family allowance in case of 10+

unjustified absents or 30+ absents justified by parents but not accepted by the school.

• Systematic analysis of effects: missing.

• Evaluation (REF 2010, Herczog): no significant effect on school- attendance and zero effect on the performance of children at school.

• Possible reasons: under-preparation of professional helpers, the vagueness of sanctioning, few has been screened of those who regularly missed classes, qualification of Roma students as

private-students – dropout.


CCT in Hungary

Kindergarten subsidy

Start: 2009

Entitlement: 3-4 years of age, family in multiple deprivation (”HHH”)

Amount of subsidy: at enrollment 20,000 HUF.

Condition: regular kindergarten-attendance.

Evaluation: not yet.

Monitoring: in process.

Expectations (kindergartens, local governments, and parents):

Behavioral effect:

– money can improve enrollment, but it is uncertain if it can improve the regularity of attendance.

– scarce data on information and motivation of parents entitled to the subsidy.

Supply side:

– it is uncertain whether there are enough kindergarten places in smaller villages where the number of entitled children is high.


– idosynchratic interpretations by local governments of highest completed education of parents

– unequal treatment of children frequently ill.


Scholarships in Hungary: on social or ethnic basis?

Scholarships based on ethnicity

• Macika (Magyarországi Cigányokért Közalapítvány – Public Fund for the Roma in Hungary)

Functioning: since the 1990s Target group: Roma students

Aim: to help students getting into secondary schools, taking successful maturity exams, getting skills and diploma

Non-financial benefits: no

Amounts (2009): HUF 30,000, HUF 40,000, HUF 90,000 annually Magnitude: 14,000 students, approx. half a billion forints

• Útravaló:

Functioning: since 2005

Target group: poor students

Aim: to make student stay in school as long as possible from primary school to university.

Non-financial benefits: role of the mentor-teacher (rewarded too).


Public policy response to development-problems of the child:

early development programs

• USA 3 programs, long-term assessment

• Perry Preschool Experiment:, between 1962 and 1967; 64 randomly chosen children from poor families with the average age of 3.5 at the start of the program; children took part in the research for 2 years;

from October to May 2.5 hours of classes per day + 1.5 hour visit of the teacher per week to get the parents involved (Heckman and Masterov)

Assessment: follow-up until the participants reached 40 years of age:

• better test-results in school

• higher degrees of education: (ratio of secondary school graduates)

• higher rate of employment, higher wages

• lower rate of crime

• less frequent teenage pregnancy

• higher rate of marriages


Evidence-based choice of policy

What is the source of the lower level of education among the children of poorer families?

Kertesi G. and Kézdi G.: Children of the post-communist transition: Age at the time of the parents' job loss and dropping out of secondary school B E Journal of

Economic Analysis & Policy. 2007;7(2):1-25.


The effect of the child’s age at the time parent lost job

Source: Kertesi and Kézdi, 2007


Source: Kertesi and Kézdi, 2007

The effect of the child’s age at the time

parent lost job


Source: Kertesi and Kézdi, 2007



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