Why cash transfers, not social programs, make for better charity

Both This American Life and Tina Rosenberg recently covered GiveDirectly, a charity started by a few grad students who understood that social programs that provide specific kinds of goods or services can’t be as efficient as simple cash transfers.

What’s efficiency? Laypeople incorrectly assume that efficiency, for any given process, has to do with maximizing output while minimizing input. When economists discuss efficiency, it’s actually shorthand for Pareto efficiency. An allocation of resources is Pareto efficient if no individual can be made better off without making another individual worse off.

Assume that X represents a specific good or service, and Y represents all other possible goods or services. Without any help, an individual with budget constraint BC would consume at E. A social program that distributes only X would shift the recipient’s budget constraint from BC to BD, and the recipient would then consume at F. However, if the recipient were to receive cash, the budget constraint would shift to AD, and the recipient would be on an even higher indifference curve, and would consume at G.

BC is parallel to AD. It’s important to realize that, in either case, the donor would be spending the exact same amount of money. The donor has no way of knowing the recipient’s precise consumption preferences, so donating cash gives the recipient the freedom to more precisely choose how much to purchase of X and Y.

Tina Rosenberg discusses how politically unpalatable cash transfers are,

Those on the left tend to believe that the differences come from giant structural problems: bad or no education, health, transport, housing, few jobs. Giving cash to the poor, while helpful, solves one of these problems: credit constraints. It’s a big problem. But once it’s solved, another problem is likely to get in the way.

The right-wing argument is that the poor are poor because of the culture of poverty: people make bad choices, lack discipline, look for short-term gratification. This argument holds that giving cash to the poor doesn’t help much — and many people will misspend it in ways that make things worse.

Standard consumer choice theory dissolves these kinds of left-wing and right-wing superstitions. Unfortunately, such flawed political narratives tend to be based more on availability heuristics than sound systematic analyses.

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