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In-Kind and Cash Transfers

Suppose that an eccentric millionaire decides to help a poor neighbor by giving him $1000 worth of nontransferable hat certificates—certificates that could be used to buy hats but nothing else. Is this gift of the same value to the poor neighbor as a gift of $1000 in cash? Economists answer that generally a gift in kind has less value than a cash gift because it has restrictions. A cash gift gives more options, and economists usually assume that more options never harm a person, but may help one.

The argument that cash gifts are superior to in-kind gifts can be shown with budget lines. In the graph below, the poor neighbor originally faces budget line A-B. A gift of $1000 worth of hat certificates means the person could buy more hats than he could previously have bought, or if all income were spent on hats, he could buy O-E rather than the O-B that he could have had before. There is no increase in Other Goods that he can buy if he spends all his income on them. As a result, the new budget line is A-C-E. A gift of $1000 in cash, on the other hand, would increase not only the number of hats that is possible, but also the amount of Other Goods. The new budget line with a cash gift is D-C-E. The dotted portion D-C represents the options that cash gives but which the in-kind transfer does not allow. Because few people spend much on hats, most people prefer to be on the segment D-C rather than C-E. In this case, the gift in kind is less valuable to the recipient than a gift in cash.

Budget constraint for cash and in-kind gifts

This analysis has underlying assumptions, as all economic analyses do, and if these assumptions do not hold, the above conclusion may not either. First, it assumes that there is no cost in making decisions. Making decisions often involves gathering information, weighing it, and worrying about whether the decision is correct or not. Anyone who has had to choose between two good job offers knows the agony that making a decision can entail. Further, some people recognize that they do not make good decisions and hire others to do so for them. This shortcoming explains the career of financial advisor, in which people draw up budgets for others and in some cases make the actual purchases. Thus, if the giver knows of items that the recipient would like but does not know about, if the cost of making decisions is high, or if the individual is not capable of making decisions that get him to his goal, the recipient may be better off with the in-kind transfer than with a cash transfer.

Most gifts between friends are not for cash but are in-kind gifts. Most girls would be upset if their boyfriends gave them money for birthdays or Christmas. Gifts between friends are a way of cementing ties and give rise to obligations. They play an important role in helping small-group associations run smoothly. The time and effort that the giver spends not only to obtain the gift but also to learn what the recipient likes and dislikes indicates that the giver is truly interested in the recipient. The economic analysis in the graph above says nothing about this signaling of affection. Although anthropologists have studied gift-giving more than economists, some economists have considered it important. For example, Kenneth Boulding's The Economy of Love and Fear argues that there are three mechanisms that help hold groups together: the integrative mechanism of gift-giving and love, voluntary and mutually advantageous exchange, and coercion and threat.1

Third, the economic analysis of the picture above refers only to the recipients' preferences, not to those of the donors. A donor may disapprove of the goals that the recipient pursues and therefore may be unwilling to let him make choices. Economists are a bit unusual because they generally assume that people know what is best for themselves. As a result, most are reluctant to approve of desires of donors to deny choices to recipients.

A final reservation with the above analysis is that people often pursue goals that involve status. Pursuit of status is zero-sum; when one person rises in status, others must fall relative to him. If I am forced to help others, I will be less resentful if my help does not change their status, especially if those being helped are close to me in status. One way to make sure that my help does not change their status is to give them specific goods that have no status: things such as free health care, public housing, and free food. In contrast, giving others money allows them to purchase items that convey status, such as fancy cars and faddish brands of shoes and clothing. People who receive government aid and who have new cars are often intensely resented by those who almost qualify for the aid. Perhaps an important reason for the persistence of many forms of in-kind grants in the face of the opposition of so many economists is that the economists are ignoring the quest for status.

The question of whether in-kind transfers are better than cash transfers is important when governments devote trillions of dollars to transfers. At one time the government gave food to the poor; now it gives food stamps. The in-kind versus cash argument was involved in the switch (though it may not have been the decisive factor). The government attempts to help poor people by building and providing public housing; would the poor be better off if the government provided money instead of the housing? The government provides education by providing free schools, but students can rarely choose which free school they attend. Would they be better off if the government stopped producing education and instead provided them with a "tuition voucher," a sum of money that they could use at the school of their choice? The present system of transfers is a mixture of cash and in-kind transfers that is only partially explainable in terms of the recipients' welfare.

The topic of present value follows naturally from the discussion above.

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1Belmont, Calif., Wadsworth Pub. Co. 1973.

Copyright Robert Schenk