Combating fraud in Poverty-Alleviation Programs - should we use monitoring, workfare or both?

This paper presents a static model of adverse selection where the government (principal) aims to minimize the cost of a Poverty Alleviation Program (PAP) ensuring that all agents have access to a minimum level of income. In a two-type-agent model (Rich and Poor) in which agents differ either on their income generating ability or in their disutility of labour, we study the effectiveness of workfare and monitoring as tools to prevent fraud in PAP. When only income generating ability is unknown, we show that the optimal PAP depends on the fraction of Rich agents, the costs of monitoring and the productivity gap between the two types. Thus, the optimal solution might use (a) only workfare; (b) only monitoring; (c) a combination of both; or (d) none of the instruments. When agents differ only in disutility of labour, the optimal PAP does not include workfare. It is shown that the greater the fraction of Rich Type agents and the higher the income differential, the more likely is that the optimal solution includes monitoring.