Think Global, Act Local:Think Global, Act Local:

Social Credit based on MDGsSocial Credit based on MDGs

Think Global, Act Local:Think Global, Act Local:

Social Credit based on MDGsSocial Credit based on MDGs

International Poverty Center, August 2005International Poverty Center, August 2005International Poverty Center, August 2005International Poverty Center, August 2005

Marcelo NeriMarcelo NeriSocial Policies Social Policies CenterCenter – CPS/FGV and EPGE/FGV– CPS/FGV and EPGE/FGV

Marcelo XerezMarcelo XerezEPGE/FGV and Brazilian Central BankEPGE/FGV and Brazilian Central Bank

• Principal-Agent ModelPrincipal-Agent Model

TheoryTheory

Poor

Municipality

Federal Government

Government Budget = YF

Municipality Budget = YM

YP = Poor´s Welfare Level

T = Government Transfer

UF = GF + NP. v(YP)

UM = GM + NP..v(YP)

PrincipalPrincipal

AgentAgent

References: Besley (1997), Gelbach and Pritchett (1997), and Azam and Laffont (2001)

Autarchy (A)Autarchy (A)

1 21 2 P PY Y

The larger the coefficient of the local government´s aversion to poverty, the larger will be the poor´s welfare level.

Max GMax GMM + N + NP P .. . v(Y . v(YPP))

YYPP

s.a: Gs.a: GMM + N + NP P . . YYPP Y YMM

Unconditional Transfer (I)Unconditional Transfer (I)

FOC:FOC:

Proposition 1: If the federal government perfoms unconditional transfers to the local governments, the poor´s situation does not change. Crowding-out Effect

M P P

PI

M P P M

Max G N . .v(Y )Ys.a : G N .Y Y T

I I AP P P

1v (́Y ) Y Y

The government does not establish any social target, it transfers unconditionally a fixed amount, TI.

Poverty Incentives (IP)Poverty Incentives (IP)

The smaller the poor´s income, the greater is the The smaller the poor´s income, the greater is the income per capita transfer carried out by the income per capita transfer carried out by the government to the municipality government to the municipality =>=>poverty incentives

PP NYKT ).( Transfer:

Max GM + NP . . v(YP)

YP

s.a: GM + NP . YP YM + (K – YP).NP

IP AP PY Y

The government always helps more the municipalities where the The government always helps more the municipalities where the poor are poorerpoor are poorer.

Transfer Conditional on the Fulfillment of Social Targets (MS)Transfer Conditional on the Fulfillment of Social Targets (MS)

FOC:FOC:

Proposition 2: the establishment of a social credit mechanism increases poor´s income.

MSF P P P

MSP

MSM P P P P P

Max Y T (Y ) N .v(Y ){Y ,T }s.a : (Y T (Y ) N .Y ) N . .v(Y ) U( ) (RP)

MS MS AP P P

1v (́Y ) Y Y

1

Social CreditSocial Credit

Linear Contract:Linear Contract:

P PT(Y ) a b.Y

Proposition 3: The coefficients belonging to a linear contract The coefficients belonging to a linear contract of social targets are:of social targets are:

MS MSP Pa T(Y ) b.Y 1

b1

MS MS A MS AP P P P P PT(Y ) N .[(Y Y ) .(v(Y ) v(Y ))]

where

Social CreditSocial Credit

Transfer Conditional on the Fulfillment of Transfer Conditional on the Fulfillment of Social Targets (MS)Social Targets (MS)

Furthermore, a social credit contract leverages Furthermore, a social credit contract leverages locally funded social investments.locally funded social investments.

MS AM MG G

Social CreditSocial Credit

1.1. Poverty Incentives (IP)Poverty Incentives (IP)

2.2. Autarchy (A)Autarchy (A)

3.3. Unconditional Transfer (I)Unconditional Transfer (I)

4.4. Social Credit (MS)Social Credit (MS)

1.1. Political Favoritism without Transfer Political Favoritism without Transfer

2.2. (FA)(FA)Favoritism with Social Credit (FSC)Favoritism with Social Credit (FSC)

Static Models Static Models

1.1. Complete ContractsComplete Contracts• Full CommitmentFull Commitment

• Long term commitmentLong term commitment

• No commitment or spot commitmentNo commitment or spot commitment

2.2. Incomplete ContractsIncomplete Contracts

Dynamic Models Dynamic Models

Full CommitmentFull Commitment

T t t t tP t P t t 1t t

t t t

t t t

T Tt 1 t 1

F t P P F t P P(Y ,T ,Y ,T ) t 1 t 1

Tt 1

M t P P P Pt 1

Tt 1

M t P P P Pt 1

Max . (Y T ) N .v(Y ) (1 ). (Y T ) N .v(Y )

s.a : (RP ) .[(Y T N .Y ) N . .v(Y )] U( )

(RP ) .[(Y T N .Y ) N . .v(Y )] U( )

(

t t t t t t

t t t t t t

T Tt 1 t 1

M t P P P P M t P P P Pt 1 t 1

T Tt 1 t 1

M t P P P P M t P P P Pt 1 t 1

RCI ) .[(Y T N .Y ) N . .v(Y )] .[(Y T N .Y ) N . .v(Y )]

(RCI ) .[(Y T N .Y ) N . .v(Y )] .[(Y T N .Y ) N . .v(Y )]

Government´s Problem:

Dynamic Model Dynamic Model

1.1. Idiosyncratic Shocks Idiosyncratic Shocks Insurance Insurance Provision.Provision.

2.2. Aggregate Shocks Aggregate Shocks Performance Performance Comparison.Comparison.

Non Deterministic ModelsNon Deterministic Models

Conclusion: TheoryConclusion: Theory

• Unconditional Transfer does not change poor´s situation;• The smaller the poor´s income, the greater is the income per capita transfer carried out by the government to the municipality =>poverty incentives;• Social Targets increase the efficiency in the use of public money and help to reduce the social difference among the different groups;•The existence of a commitment mechanism, when there is not the possibility of any type of renegotiation among the parties, makes possible greater efficiency in the dynamic problem (with complete contracts);

Main Lesson: It is not Main Lesson: It is not enough to know the enough to know the social budget employed; social budget employed; it is necessary to it is necessary to measure social resultsmeasure social results..

But how we do it?But how we do it?

How? through Social Credit How? through Social Credit mechanisms that transform mechanisms that transform poverty emancipation into poverty emancipation into financial resourcesfinancial resources..

Why? to reduce Moral Why? to reduce Moral Hazard problems in social Hazard problems in social transfers to local transfers to local governments.governments.

• Exogenous for a Given Country (credibility)Exogenous for a Given Country (credibility)– Coordinate actions across different government Coordinate actions across different government

levels from different political parties (spatial levels from different political parties (spatial consistency)consistency)

• Long-Lasting (time consistency)Long-Lasting (time consistency)– Smooth transitions between different political Smooth transitions between different political

mandates.mandates.

Why use MDGs as numeraire in performanceWhy use MDGs as numeraire in performancebased contracts?based contracts?

Advantage: Time and Spatial ConsistencyAdvantage: Time and Spatial Consistency

Pratical Issues:Pratical Issues:

• NNot use the value of the indicator at a given date ot use the value of the indicator at a given date but its discounted present value along its path.but its discounted present value along its path.

• 11stst MDG should be based on P MDG should be based on P22 (squared poverty gap) (squared poverty gap)

and not on the proportion of poor (Pand not on the proportion of poor (P00).).

Care with MDGs ContractsCare with MDGs Contracts