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Economy Apr 23, 2012

Welfare programmes change people’s behaviours

By Ajay Shah

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.

The first element of the behavioural change is lying and misrepresentation by citizens. Reuters

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 percent of workers would be eligible for those benefits. In a few years, 10 percent 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 programmes, which encourage or support withdrawal from the labour market. Some of these problems are now coming about with NREGA (National Rural Employment Guarantee Act). Migration out of villages is central to India's future, but NREGA 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 programmes have unintentional consequences that go far beyond those visible at the surface.

Politicians and bureaucrats in India like to roll out more welfare programs. 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 programmes. In this field, you may like to see a paper by Vijay Kelkar and me.

Ajay Shah's Blog

by Ajay Shah

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