Pennies from the Sky, or a Piece of the Pie?

By Stephanie Parker

In the last ten years, Latin America has experienced significant growth due to the adoption of neo-liberal policies around the exploitation of its natural resources. However, whilst socioeconomic conditions are improving, economic growth has not managed to solve structural poverty, as evidenced by continuing disparities and poverty in rural areas. Governments have thus tasked their ministries with carrying out decentralised welfare initiatives to address structural poverty through the utilisation of state infrastructure and resources.

Conditional cash transfers vs Universal basic income

In this context, conditional cash transfers (CCTs) have been increasingly utilised across Latin America economies. CCTs are an institutional mechanism endeavour designed to redistribute wealth and accumulate human capital in low-income families. To do this, they grant monetary transfers to beneficiaries on a regular basis to incentivise them to participate in government-led initiatives, with the final goal of reducing dependence and long-term structural poverty via social investment.

The introduction of CCTs has successfully reached low-income groups previously excluded from social assistance throughout Latin America, having a positive short-term effect on headcount poverty reduction, which now range from 18.1% in Peru and 7% in Nicaragua to 3% in Colombia, 2% in Brazil and 1% in Mexico. Moreover, the targeting and monitoring efforts behind CCTs have shown to be successful in improving targeted socioeconomic indicators over the long term, including school attendance, health clinic visits, and nutrition as well as extending job opportunities for men and the employment of women in the formal sector. This thereby has a desirable effect in assisting low-income families and reducing poverty by providing a stimulus for human capital development, with no negative effects on labour supply.

However, recent debates centre around replacing the current welfare system with the adoption of a universal basic income (UBI), with the argument that a UBI could give low-income individuals, through the relaxation of income constraints, the opportunity to thrive, or self-develop, and therefore combat harsh labour conditions. Nevertheless, potential positive impacts on market outcomes as well as the potential self-development nexus remain a theoretical supposition, and one should be mindful of potential damage to the labour market.

Is it feasible for Latin American countries to switch to a UBI?

The provision of a universal basic income (UBI) at a level above the poverty threshold is likely to be extremely costly, and unmet by only using current public assistance budgets. For instance, implementing a UBI in Peru will substantially increase the funding needed for welfare assistance. It is estimated that with the population-weighted national poverty line being US$58.34, handing out a UBI of US$60 per month would consume more than 25% of total tax revenues, compared to the current allocation of 0.6%. Moreover, UBIs, unlike targeted social assistance, would also be allocated to people who are not in need, namely middle and upper-class, childless, and non-elderly individuals. This would require a much larger public assistance budget compromising the funding of other publicly provided services which are not readily replaced in the private sector, such as existing public expenditures that underpin education and health service. This may not be the most cost-effective way to use the scarce resources at the disposition of the state, as UBI programs would, in this case, be ineffective in reducing inequality or advancing opportunity and social mobility.

In the Latin American context, the only viable alternative to bring about a successful UBI would be an increase in marginal income tax rates. The literature provides an estimate ranging between 40% to 50% for a flat tax rate on additional income as the most likely alternative for funding the scheme. However, in Latin American countries such as Peru, where 65.7% of workers work in the informal sector, and 79% of formal sector workers receive income below the tax exclusion thresholds, an increase in marginal income tax rates not only restricts the amount of funds available but also skews taxation towards top earners, who contribute to more than 42% of tax revenues. This in turn risks labour market distortions by inducing top earners to change to lesser-paying jobs, minimising taxes and provoking a further reduction in the revenue used to fund the scheme. The cost of a UBI appears to render the scheme as not feasible, especially considering the undesirable and counterproductive impacts of higher taxation and labour supply distortions.

Although UBI supporters stand by the potential positive impacts on market outcomes as well as the potential self-development nexus, neoclassical theory indicates that a substantial increase in taxes would be accompanied by large distortions in the labour market in the form of a significant decrease in the labour supply. This would consequently undermine work incentives while incrementally offsetting poverty reduction efforts, thereby undesirable and counterproductive to the ultimate goal of the welfare initiative.

Superseding the CCT system in place poses a risk to labour markets due to manifesting, disincentivising, and distorting traits, and neoclassical analysis confirms these risks and characterises UBI as engendering idleness. Meanwhile, CCTs pose less of these risks and present empirically sound outcomes, despite their administrative burden and potential for the misallocation of benefits. Some advocate that UBI offers positive outcomes due to enabling self-development, increased bargaining power, and innovation, but this remains in the realm of theory. In contrast, Latin American CCTs have been successful in delivering on government objectives, and switching to a UBI opens a Pandora’s Box of negative consequences centred around funding, not least of which is the potential damage to existing state-funded health and education programs, with little private capacity to fill the gap.

The views expressed in this article are the author’s own and may not reflect the opinions of The St Andrews Economist.

Bibliography

Clark, C. and Kavanagh, C., ‘Basic Income, Inequality, and Unemployment: Rethinking the Linkage between Work and Welfare’, Journal of Economic Issues, vol. 30 no. 2 (1996), pp.399-406
Cruz-Saco, M., ‘A Basic Income Policy for Peru: Can it work?, Revisa de Ciencias Sociales (2002), pp.5-26
Bastagli, F., ‘Conditional Transfers as a tool of social policy’, Economic and Political Weekly, vol. 26 no. 21 (2011), pp.61-66.
Hanna, R. and Olken, B., ‘Universal Basic Incomes versus Targeted Transfers: Anti-Poverty Programs in Developing Countries’, The Journal of Economic Perspectives, vol. 32 no. 4, (2018), pp.201-226
Kearney, M. and Mogstad, M., ‘Universal Basic Income (UBI) as a Policy Response to Current Challenges’ (2019), pp.1-19.
Skoufias, E. and Di Maro, V., ‘Conditional Cash Transfers, Adult Work Incentives, and Poverty’, The Journal of Development Studies, vol. 44 no. 7 (2006), pp.1-38

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