IMF Working Papers

Transfers, Social Safety Nets, and Economic Growth

Author/Editor:

Xavier Sala-i-Martin

Publication Date:

April 1, 1996

Summary:

This paper analyses the role of social safety nets in the form of redistributional transfers and wage subsidies. It is argued that public welfare programs can be viewed as a crime-preventing or disruption-preventing devices because they tend to increase the opportunity cost of engaging in crime or disruptive activities. It is shown that, in the presence of a leisure choice, wage subsidies may be better than pure transfers. Using a simple growth model, the optimal size of the public welfare program is found and it is argued that public welfare should be financed with income (not lump-sum) taxes, despite the fact that income taxes are distortionary. The intuition for this result is that income taxes act as a user fee on congested public goods and transfers can be thought of as productive public goods subject to congestion. Finally, using a cross-section of 75 countries, the partial correlation between transfers and growth is shown to be significantly positive.

Series:

Working Paper No. 1996/040

Subject:

Consumption Crime Employment subsidies Income inequality Labor National accounts Personal income

Notes:

Also published in Staff Papers, Vol. 44, No. 1, March 1997.