Social Protection in the Face of Climate Change: Targeting Principles and Financing Mechanisms

Social Protection in the Face of Climate Change:Targeting Principles and Financing Mechanisms

Michael R Carter1 & Sarah Janzen2

1University of California, Davis, I4 Index Insurance Innovation Initiative & NBER2Montana State University

December 2015

Carter & Janzen Social Protection & Climate Change

Summary

Climate shocks are a recognized driver of povertyClimate change, which increases the frequency & intensity ofclimate shocks, threatens to make shocks an ever moreimportant part of the poverty dynamicsWorld Bank’s new Shock Waves study estimates that withoutpolicy adaptation, climate change will increase extremepoverty by 100 millionAgainst this backdrop, we ask two questions:

1 How should social protection in the face of climate change betargeted or prioritized between the already destitute and thosewho are vulnerable to becoming destitute?

2 Can public budget constraints be relaxed–and impacts onpoverty increased–by having social protection targeted at thevulnerable financed in part by the private social protectioninsurance ’premium’ contributions by its beneficiaries?


Summary

To gain purchase on these questions, we develop a theoreticalmodel of risk, accumulation and insurance inspired by pastoralregions of East Africa where climate shocks drive povertyFindings from the theoretical analysis are:

Using social protection dollars to issue contingent payments tothe vulnerable reduces the extent and depth of poverty relativeto a conventional cash transfers that targets only the destitute;But, given a budget constraint, targeting the vulnerableinduces a tradeoff between the short-term and the long-termwell-being of the poor;Can mitigate this tradeoff if the public budget is stretched byhaving the vulnerable fund a portion of the premium load foran insurance that functions as contingent social protection;However, the ability of the vulnerable to self-finance their ownsocial protection is limited and their demand for insurance ishighly price elasticClimate change-induced increases in risk can be managed–upto a point–with insurance mechanisms.


Outline

1 A Dynamic Model of Risk, Vulnerability & Chronic Poverty

Core insights from a model with fixed humancapital/capabilitiesEndogenous human capital formation & the inter-generationaltransmission of poverty

2 Social Protection Tradeoffs: Targeting the Destitute or theVulnerable?

Standard social protection via means-tested in-kind transferstargeted at the destituteInter-temporal poverty tradeoffs if prioritize contingenttransfers to the vulnerable over in-kind transfers

3 Reducing Tradeoffs with Partially Self-financed Insurance

Implementing vulnerability-targeted social protection via indexinsuranceBudget-stretching through beneficiary co-finance of VSPLimitations of co-finance


Dynamic Model of Consumption & Accumulation in theFace of Risk

Consider an infinitely lived household dynasty d , which iscomprised of a sequence of generations g = 1,2, ... & eachgeneration lasts for 25 years (t = 1...25).Enjoys initial endowments of physical assets (Ad0) and humancapital (Hd0)

Assets and human capital combine to produce income usingeither a low or high (fixed cost) technologyAssets are subject to random depreciation (mortality) shocksConsumption cannot be more than cash on hand (value ofincome plus assets) as no borrowing is assumed possibleInitially assume human capital fixed across generations at Hdo

Will then allow human capital to be updated for each newgeneration, where updating sensitive to ’childhood’ nutrition inthe prior generation

Mathematically write fixed human capital model as:


Dynamic Model of Consumption & Accumulation in theFace of Risk

maxc−→dgt

Eθ

[∞

∑g=1

25

∑t=1

u(cdgt)

]subject to :

cdgt ≤ Adgt + f (Adgt ,Hdgt)

f (Adgt ,Hdgt) = Hdgtmax[Aγh

dgt −F ,Aγ l

dgt ]

Adgt+1 =[f (Adgt ,Hdgt) + (1−θdgt+1)Adgt

]− cdgt

Hdgt+1 = Hd0

Adgt ≥ 0


Dynamic Model (fixed human capital)

Model admits 2 possible long-run equilibria:For each initial endowment pair (Hd0,Ad0), there is someprobability that the dynasty will end up in ’chronic poverty’ atthe low equilibriumFixing Hdo at an intermediate level, H̄d0, simulation of thedynamic model reveals the following:

“Micawber threshold,” AM(H̄d0) = 14Carter & Janzen Social Protection & Climate Change

Chronic Poverty Map (fixed human capital)

Across full endowment space see the following:

For fixed human capital, partitions space into: Always poor(Hd0 < 1.05); Never poor (Hd0 > 1.35); and, Multipleequilibrium potentially poor in betweenAt any point in time, define the Vulnerable as those in themulti-color band & AM(H) as the ’Micawber Frontier’


Dynamic Model (fixed human capital)

Model has three key implications:

Shocks Can Have Irreversible Consequences for the VulnerableA shock that pushes a household below its critical asset level,AM(Hdgt), has irreversible consequences as the householdbecomes mired in chronic poverty.Shocks Can Induce Asset Smoothing by the VulnerableWhile households near either steady state will smoothconsumption, highly vulnerable households in theneighborhood of AM(Hdgt) will asset smooth when hit with ashock (cut consumption to preserve capital and avoid collapseinto chronic poverty).

While asset smoothing is understandable, it potentially hasdeleterious long-term consequences as consumption doubles asinvestment into future human capital.


Nutritionally Sensitive Inter-generational Transmission ofHuman Capital

Know that the ’First 1000 Days’ matter for human potentialEvidence that the poor households asset smooth by cuttingnutritional and educational investments (e.g., Hoddinott &Kinsey, 2003, Hoddinott, 2006 & Jacoby et al. 1997)Assume that household decisionmaker myopically ignore thelong-term consequences on children of these cuts:

discountinginformationmiddle age biaspresent bias


Nutritionally Sensitive Inter-generational Transmission ofHuman Capital

Consider following equation of motion for human capital:

The first term is curly brackets is the next generation’s geneticpotential expressed as a weighted average of the parentgeneration’s human capital endowment and a random draw,H̃, from the overall population capabilities distribution(E[H̃]

= 1.35 in simulations)The second term in curly brackets is a penalty that pushes anindividual below their genetic potential if they sufferedconsumption shortfalls (cdgt < z) in the first critical five yearsof life.


Chronic Poverty Map (endogenous human capital)

Again simulate the dynamic model (assuming myopia), butthis time allowing human capital to evolve

Micawber Frontier has moved to the northeast. Initialendowment positions in the lower right of the diagram, whichused to have some probability of escape from long-termpoverty have seen those prospects drop to zero.


Chronic Poverty Map (endogenous human capital)

Moreover, vulnerability has increased for a broad range ofdynasties that used to be able to rely on rapid accumulationand asset smoothing to insure a near certain escape frompoverty.Get further insight into process by looking how human capitalevolves across 4 generations:


Poverty Dynamics under a Conventional In-kind SocialProtection Policy

The inability of poor households to sustain investment in thehuman capital of their children has motivated the outpouringof ’save the children’ CCTs we now see across the worldWe begin by considering a stylized social protection programthat offers in-kind transfers τdgt that are:

Means Tested: Eligible households are those for whomcdgt < z , where z is the consumption poverty line.Contingent Transfers: Subject to budget constraints, eachhousehold receives the transfer needed to completely close thepoverty gap–i.e., τdgt = z− cdgt .Government Budget Constraint: Government has a fixed socialprotection budget, B, that is initially just large enough to closethe poverty gap for all destitute households. If budget becomesinsufficient, then transfers are adjusted so that all destitutedynasties receive transfers that close an equal fraction of theirpoverty gap.



Mathematically, define the total social protection need at eachpoint in time as:

B̃gt =D

∑d=1

(z− cdgt)1(z > cdgt)

and define the available budget adequacy as:

λgt =B

B̃gt

.

Individual transfers are thus given by:

τdgt=

z− cdgt if λgt ≥ 1λgt(z− cdgt), otherwise

.



To explore the effectiveness of these in-kind transfers, we useour dynamic model to simulate an economy comprised of Ddynasties that are initially spread uniformly across thephysical/human capital endowment spaceAssume transfers are ’unanticipated’ in sense ofBarret-Carter-Ikegami (2013)We can then see how the transfers influence the chronicpoverty map and also gauge its effectiveness via headcountand poverty gap measures defined as follows:

Hgt =D

∑d=1

1(z > cdgt)

D

Ggt =1

DHgt

D

∑d=1

(z− cdgt)1(z > ccgt)


Chronic Poverty Map under a Conventional In-kind SocialProtection Policy

Cash transfers have some impact on poverty dynamics as thearea of certain chronic poverty in the southeast corner of themap shrinks modestly.Vulnerability, however, remains high in certain portions of theendowment space.


Poverty Dynamics under Conventional PolicyMeasures based on realized post-transfer consumption

As can be seen, cash transfers initially cut into the extent anddepth of poverty.Over time, the poverty headcount measure drifts upwards asshocks slowly increase the number of destitute dynastiesGiven the fixed budget, this increase in the number of cashtransfer-eligible households in turn pushes up the averagedepth of poverty


Poverty Dynamics under Conventional PolicyMeasures based on potential earnings

These measures are based on expected income (based onassets)More stable, but draw out that in-kind transfers have limitedimpact on potential (except via human capital circuit)


Vulnerability-targeted Contingent Social Protection (VSP)

The pernicious effects of the underlying system dynamicsraises the question as to whether there can be a more effectivedeployment of the given social protection budgetConsider a VSP scheme as one which is:

Vulnerability TargetedIssues payments to the “moderately vulnerable” (non-poor20-80% chance of collapse into destitution) when they are hitby a shock that could push them into chronic poverty (notethat these are contingent payments)Follows Triage RuleSocial protection resources are triaged by replacing the assetslost by the vulnerable who have been hit by shocks, and thentransferring the residual social protection budget to the alreadydestitute. Analogous to restocking programs in pastoral regions


Vulnerability-targeted Contingent Social Protection

This asset replacement strategy reduces the upward creeppoverty based on earning capacityBut tradeoff in depth of poverty visible in poverty measuresThis tradeoff emerges because triage eats up funds for in-kindtransfersAlso note instability in budget for in-kind transfers


Using Insurance Mechanisms to Reduce Targeting Tradeoff

In principal, contingent social protection is essentially a socialinsurance contract that pays off in moments of needAs already seen, contingent social protection can break thedescent into poverty for the vulnerableGiven these large private gains from contingent socialprotection, and the tradeoff implied for the poverty gap whenbudget is redirected from in-kind transfers to a VSP, might itbe possible for the vulnerable to pay for their own socialprotection?To explore the willingness of the vulnerable to pay for thisprotection, we explore the pattern of demand for an indexinsurance contract set up to mimic a VSPIn particular, will explore an implementable index insurancecontract that pays off any time a covariant shock occurs(idiosyncratic shocks do not trigger payments, exposing thevulnerable to ’basis risk’)


Vulnerability & the Demand for Insurance

Cash-on-hand spent on insurance directly competes withconsumption and investmentDespite potential gains from insurance payouts, thevulnerable’s willingness to purchase insurance at market pricesis modest, because their shadow price of liquidity is highHowever, price elasticity of demand is high (see Janzen, Carterand Ikegami, 2015):

x Carter & Janzen Social Protection & Climate Change

Evaluation of Cash Transfer & Subsidized Insurance SocialProtection Scheme

Taking the same budget constraint, government first spendsmoney offering a 50% insurance subsidy to anyone with lessthan 35 units of assetsResidual budget spent on cash transfers as before


Further Insights into Efficacy of Alternative Schemes

Insurance subsidy leads to a smaller & more stable on budgetthan does the full cost asset replacement programCheaper despite ’sloppier’ targetingFinally, see growth impacts of insurance (note have assumedthat asset transfers are unanticipated & rule out the kind ofmoral hazard equilibrium found in Barret-Carter-Ikegami 2013)


Shocks and Climate Change


Conclusion

Weather & other shocks may be an important driver of povertyCoping strategies of the vulnerable are partially effective in theshort-term, but may fail in the longer-term as theconsequences of reduced nutrition are transmitted through tothe next generationLogic of contingent social protection for the vulnerable is clear:

Prevent the growth of the number of destitute (which crowdsthe social protection budget & increases the poverty gap)Reduce the inter-generational transmission of poverty causedby asset smoothing

Insurance can in principal serve at least a partially self-financedform of social protection for the vulnerableHowever, if climate change & risk become too severe, theneven vulnerability-targeted program lose their efficacy.There are also challenges to making insurance work, but thatis a topic that merits its own discussion


Social Protection in the Face of Climate Change: Targeting Principles and Financing Mechanisms

Government & Nonprofit

Transcript of Social Protection in the Face of Climate Change: Targeting Principles and Financing Mechanisms