University of Pennsylvania Economics Department November 1999 Consumption Smoothing in Island Economies: Can Public Insurance Reduce Welfare? Orazio Attanasio University College, London Jos´e-V´ıctorR´ıos-Rull University of Pennsylvania, CEPR and NBER ABSTRACT In this paper we study the effects of certain types of public compulsory insurance arrangements for aggregate shocks on private allocations in environments with limited commitment. We show that this type of insurance can improve the wellbeing of private situations, but it can also deteriorate it. We also describe how different characteristics of the environment affect the role of public insurance. Using data on the Mexican PROGRESA program, we document the impact that some government programs have in crowding out private transfers. Keywords: Consumption Smoothing, Public Insurance, Incomplete Contracts. JEL E60, H30, D83. ¤ R´ıos-Rullthanks the National Science Foundation for Grant SBR-9309514 and the University of Pennsylvania Research Foundation for their support. Thanks to Fabrizio Perri for his comments and for his help with the code and to Tim Besley, Ethan Ligon and Robert Holzmann. Finally, we would like to thank Jos´eG´omezde Le´onand Patricia Muniz of PROGRESA for permission to use the data and Ana Santiago and Graciela Teruel for answering several questions about the data. Correspondence to Jos´e-V´ıctorR´ıos-Rull,Department of Economics, 3718 Locust Walk, University of Pennsylvania, Philadelphia, PA, 19104, USA. Phone 1-215-898-7767, Fax 1-215-573-4217, email
[email protected]. 1 Introduction In a recent meeting between a World Bank official and a finance minister from a developing country in which the provision of an income support scheme or safety net was being dis- cussed the minister opposed strongly such scheme.