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Chapter 2 The 2010 <strong>European</strong> <strong>Report</strong> on Development Social <strong>protection</strong> policies can help poor rural people expand and efficiently use their assets, and adopt higher return activities. They can offer employment and income during slack periods in the agricultural calendar, allowing farmers to earn cash <strong>for</strong> working capital or build up their asset stock. They can build infrastructure, such as rehabilitate roads, improve irrigation or contribute to soil conservation. They can offer <strong>social</strong> insurance against catastrophic events, allowing farmers to maintain their assets or protect investments in human capital and in the health and nutrition of adults and children. Improving access to <strong>social</strong> <strong>protection</strong> can also support and promote better (market or community-based) insurance systems, such as micro-insurance <strong>for</strong> health, or insurance against drought events, such as index-based insurance. But caution is required to ensure that incentives and distortions from <strong>social</strong> <strong>protection</strong> programmes do not affect the potential growth of agriculture. Relief programmes and long-term public works programmes could reduce the incentives to engage in productive agriculture. In<strong>for</strong>mal support systems may also be undermined and just replaced by a dependence on public resources. While disincentives are worth keeping in mind - and programme designers should ensure that <strong>social</strong> <strong>protection</strong> schemes do not inadvertently create disincentives - the available evidence shows that they are not pervasive or severe <strong>for</strong> most of the recent rural-based <strong>social</strong> <strong>protection</strong> programmes. Source: Alderman and Hoddinott 2010; Doward et al. 2006. 2.3.2 SOCIAL INSURANCE AND MICRO-FINANCE From an economic point of view, <strong>social</strong> insurance steps in when both private insurance markets and in<strong>for</strong>mal insurance systems appear to fail. Social assistance provides grants where credit markets would usually provide the required liquidity, not least if profitable opportunities could be pursued if credit were available. While standard markets <strong>for</strong> credit and insurance appear to be failing the poor throughout the world, micro-finance institutions have spread widely, and especially <strong>for</strong> credit are offering services to the poor. So why promote <strong>social</strong> insurance and not expand micro-finance? Each has its strengths and weaknesses, and there is a clear and complementary space <strong>for</strong> <strong>social</strong> insurance alongside a more focused approach of micro-finance to reduce poverty and vulnerability. Insurance through micro-finance institutions has gained considerable attention in recent years. These institutions now offer a variety of products, including life, health and insurance against climatic shocks. While still far behind the scale of micro-credit, they attempt market-based solutions to what seem to be similar problems. Is micro-finance a better alternative to <strong>social</strong> insurance? The current evidence suggests that it holds promise, but that it is unlikely to substitute entirely, <strong>for</strong> at least six reasons. • First, insurance is a very difficult product to sell, as it is not easily understood, even in rich and well-educated settings. Consumer education will take time. • Second, as a new product, it requires considerable trust be<strong>for</strong>e households will start buying it. 156 Note the difference with micro-credit. In micro-credit, the provider first gives money as a loan and then has to try to find a means of recouping it later. In micro-insurance, the provider first has to convince the consumer to give them money, who then has to trust the provider to give them a payout in particular circumstances. For poor households, this parting with money will be seen as very risky, adding to their vulnerability, rather than reducing it. • Third, building trust and providing consumer education are costly, so it is unlikely to be possible to provide insurance products without first subsidising them, or at least providing them not profitably. • Fourth, pricing insurance requires detailed actuarial data, currently limited in poor settings in Sub-Saharan Africa. Without these data, setting up insurance schemes will be risky business activities, and regulators are unlikely to favour such financial institutions. • Fifth, private insurance is ill-suited to deal with catastrophic risks and large and covariate disasters, because it would have to be priced high and require costly reinsurance. • Sixth, different <strong>for</strong>ms of insurance are affected by in<strong>for</strong>mation asymmetries. For example, health insurance is difficult to implement due to adverse selection: when only those likely to be ill buy health insurance. Property or fire insurance suffers from moral hazard: as people buying it can become less careful. This leads to pricing and supply problems in the insurance market, leaving some not insured. 156 See, <strong>for</strong> example, Cai et al.2009. 37
The 2010 <strong>European</strong> <strong>Report</strong> on Development Social <strong>protection</strong> to fight persistent poverty and vulnerability So a market solution <strong>for</strong> <strong>social</strong> <strong>protection</strong> will be insufficient, definitely in the short run but also beyond. Just as in rich economies, it would lead to underinsurance, in which poor understanding drives people to buy insufficient or inadequate cover. And many perils would not be covered because the market would undersupply the products. Pricing would also be affected, with products too expensive. As a result, it is likely that micro-insurance cannot just substitute <strong>for</strong> <strong>social</strong> insurance activities, at least not in the short run. But it holds a promise of providing cost-effective <strong>protection</strong> <strong>for</strong> many specific hazards, and could be part of a <strong>social</strong> insurance system, including payments of premiums <strong>for</strong> specified benefits. Much could be learned from attempts to provide private micro-insurance <strong>for</strong> the design and sustainability of <strong>social</strong> insurance schemes. Foremost is that insurance involves a contract that, with appropriate regulatory frameworks, can be en<strong>for</strong>ced: this feature leads to credibility and guarantees <strong>for</strong> the customer. A clear entitlement and right to <strong>social</strong> insurance would be required to mimic this, as a means of offering true <strong>protection</strong>. Private insurance markets find it hard to deal with catastrophic risks, and <strong>social</strong> insurance would face similar problems. Making appropriate arrangements to deal with these instances, drawing inspiration from the principles of reinsurance, would be required. And many of the problems of insurance, such as trust and moral hazard, also apply to <strong>social</strong> insurance provided by the state or other agents, undermining its effectiveness and increasing its costs. Could not more use be made of the existing mutual support and other in<strong>for</strong>mal insurance systems to improve <strong>social</strong> <strong>protection</strong>? In<strong>for</strong>mal insurance systems are embedded in local society, exploiting people’s <strong>social</strong> connections and the high degree of trust and in<strong>for</strong>mation that this delivers. Clan-based and network-based systems rely on shared knowledge and understanding, but also norms of behaviour that make the sustainability of these systems easier. Mutual support groups, such as funeral societies, tend to have strict membership rules and regular meetings to en<strong>for</strong>ce their bond. Insurance delivery, including <strong>social</strong> insurance, can benefit from these relationships to limit some of the typical problems of moral hazard and trust. In other words, in<strong>for</strong>mal insurance systems could reach the poor through either market insurance or <strong>social</strong> insurance. This would both limit the costs and increase the effectiveness. For risks that need large-scale risk pooling, such as covariate risks, <strong>social</strong> insurance could complement existing mutual support systems, without crowding them out. One caveat is that the strength of these organisations is their independence from market or state structures. For example, funeral societies in Ethiopia and Tanzania are considered among the most democratic and <strong>inclusive</strong> institutions, mostly devoid of elite or political capture. Scaling them up could undermine them. Social assistance provides liquidity to specific groups of people, in the <strong>for</strong>m of grants. Why should this not be credit, provided by micro-credit institutions? Microcredit, a key part of the general <strong>development</strong> mantra, is a key instrument to reach and empower the poor. While it is still not straight<strong>for</strong>ward to find clear and undisputed evidence that micro-credit offers the trans<strong>for</strong>mation of lives promised, 157 the evident appeal and success of the larger Asian and Latin American micro-credit institutions suggest a powerful, more market-based alternative to offering much broader <strong>social</strong> insurance to the poor. One argument <strong>for</strong> broader <strong>social</strong> assistance is that micro-credit programmes find it notoriously difficult to reach the poorest. 158 For example, one of the largest micro-finance institutions in the world, BRAC, (initially based only in Bangladesh but now also in several African countries), has started to design specific ultra-poor programmes to find ways of allowing some of the poorest group to graduate into their micro-credit programmes. Furthermore, credit is not costless to the poor: in most delivery models, little distinction is made between a failure to repay due to improper behaviour or to genuine bad luck. This led some to refer to ‘microdebt’ programmes rather than micro-credit, as obligations are created that cannot be fulfilled after shocks. Cases have been documented in which moneylenders were used to refinance micro-credit loans that needed to be paid back, creating a debt trap. 159 Despite being offered credit <strong>for</strong> inputs, fear of indebtedness and the hardship that it would bring has reduced the uptake of modern inputs in rural Ethiopia. 160 In short, micro-credit may not be suitable or offer a solution to all the poor. Nevertheless, the success of micro-credit programmes of reaching millions across the world illustrates a possible lesson <strong>for</strong> <strong>social</strong> assistance programmes. Microcredit involves a clear contract between provider and borrower, with clearly spelled out rights and obligations. In the contracts by some micro-credit institutions, repayment offers a credible promise <strong>for</strong> larger loans. Offering such guaranteed path of rights and obligations would strengthen the scope <strong>for</strong> using <strong>social</strong> assistance as an enabling <strong>for</strong>ce. The emergence of better functioning credit markets, helped by micro-credit schemes, may also be hurt by a growing role <strong>for</strong> <strong>social</strong> <strong>protection</strong> systems. Conceptually, the problem lies in offering a welfare floor. For those close to this floor, it may encourage ‘gambling <strong>for</strong> resurrection’ behaviour, as observed in firms with limited liability legislation. 161 Offering loans to people who have little to lose from not repaying, because they can get a minimum payment through <strong>social</strong> <strong>protection</strong> schemes, would encourage 157 Armandáriz de Aghion and Murdoch 2005. 158 Armandáriz de Aghion and Murdoch 2005. 159 Matin 1997; Adams and von Pischke 1992. 160 Dercon and Christiaensen 2010. 161 Stiglitz 1981. 38
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SOCIAL PROTECTION FOR INCLUSIVE DEV
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