Labor disincentives

Chapter 5 Benefit Levels and Delivery Mechanisms. This chapter brings together a dispersed body of knowledge on the conceptual and practical details of program benefits and payments. It covers how to determine what benefit levels might be and how to structure them, reviews issues of labor disincentives and how they can be handled via the benefit structure, describes program elements designed to move households toward inde-... 

One of the most common stumbling blocks for political support of safety nets is concern over the labor disincentives of welfare dependency (box 2.6). The fear is that potential beneficiaries will either work less after receiving the benefits or, if eligibility is tied to earned incomes or unemployment, will reduce their work efforts in order to qualify for the transfer. Both arguments and the evidence differ substantially across groups of countries, classes of programs, and types of beneficiaries. 

Policy makers and administrators have a variety of tools at their disposal to manage labor disincentives, including the following ... 

Work effort. Okun (1975, p. 99) notes that the literature shows virtually no effects on the amount of work effort of the affluent, a limited effect of transfers on the work effort of secondary earners in low-income households, and virtually no effect on low-income households primary earners. A much greater effect can be feund in tax avoidance behavior by corporations shifting remuneration and benefit packages in ways that reduce their tax liabilities. As the synopsis of labor disinoentive effects in chapter 5, section 2, indicates, recent experience with safety nets shows that well-designed programs have modest and manageable labor disincentives. 

The theoretical arguments behind labor disincentives are intuitive (Ellwood 1988). First, any transfer provides unearned income, and thus inherently will reduce the pressure to work. The typical model assumes that beneficiaries will trade some of the extra income for more leisure. Beneficiaries will feel less urgency about taking a job or having all able-bodied household members working. As a result, people will not be as likely to work as they would be in the absence of the transfer program. This is sometimes referred to as the income effect. 

BOX 5.3 Lack of Applicability of High Labor Disincentives in the AFDC to Safety Nets In Middle- and Low-Income Conntries... 

Relatively less empirical research on potential labor-market disincentives associated with transfer programs is available for developing countries. However, as shown in the following list, the few studies that have investigated the effect of safety net programs on adult work effort suggest limited labor disincentive impacts ... 

BOX 5.4 Labor Disincentives in Very Low-Income Countries The Kalomo District Pilot Social Cash Transfer Scheme, Zambia... 

In Sri Lanka, Sahn and Alderman (1996) study a rice subsidy program that induces labor disincentives through income effects. They find labor reductions of approximately 10 percent. 

Policy makers and administrators have a variety of tools at their disposal to minimize labor disincentives as discussed in chapter 2, section 3. We summarize five of them here, focusing on how to minimize labor disincentives generated by the transfer formula (the fourth and fifth options). However, reduced work effort is not unambiguously a good or bad outcome (box 5.5). 

A second option is to choose a targeting mechanism that is not tied directly to earnings, which leaves the rewards to working intact. Indeed, few developing countries use a means tests or minimum income guarantee, although many transition countries do. Infrequent recertification will also minimize the labor disincentives. Most programs outside Europe recertify beneficiaries only once every two or three years or less often (see chapter 4, section 4). 

Labor disincentives. So far studies have shown no decrease in adult labor effort, even in the case of Mexico, whose program has higher benefits, covert e, and longevity than most other programs. The link between benefits and service use seems to be sufficient to avoid major labor disincentives (World Bank forthcoming). 

Self-targeting can be effective if the wage rate is low enough Additional risk management benefits can accrue if the program is set up with an employment guarantee Politically popular because labor disincentives can be avoided and beneficiaries can maintain the dignity of work ... 

The groups members may not be expected to work thus in serving them, labor disincentives are not an issue. 

When times are good and policy makers are optimistic that the numbers that need to be served should be decreasing or that they may be able to serve those covered better, the environment may be propitious for reforms that lead to more sophisticated targeting methods or respond to concerns about labor disincentives. At such times simple programs may be transformed into sophisticated programs. 

Labor disincentives. Features of program design that discourage labor effort by potential beneficiaries (who may reduce work effort in order to qualify for a benefit) or actual beneficiaries (who may choose a different combination of labor and leisure once they have income from the program benefit). 

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