Working Paper
Worker retraining and transfer payments

We conduct an incentive-theoretical analysis of political economy considerations in the design of social protection programmes in developing countries to accompany economic reforms. We focus on two aspects of social protection—the provision of redistribution and retraining—that arguably characterize many reform packages.

We analyse the interaction of compensatory redistribution and retraining programmes, and demonstrate that the provision of redistributive programmes might distort incentives for individuals to undertake worker retraining. This disincentive effect can be large enough to politically derail the passage of even those reform policies that are expected to increase output and to benefit a majority of the population. Conversely, it may be possible for an economic reform to win political support in the absence of compensatory redistribution.

Thus we suggest that a ‘political failure’ may occur due to the complex interaction between the political and economic incentives created by these programmes.