How Can Digital Payments Strengthen State Capacity? Four Areas with High Potential

Rapid advances in digital technology have opened up new possibilities for governments to interact and transact with their citizens. We have followed closely the evolution of biometric technology over the last five years. It has been deployed in the run up to elections to help clean voter rolls in over 35 low- and middle income countries; it has been used to uniquely identify beneficiaries in large health insurance schemes and to track patient visits for TB and HIV treatment; and it has revolutionized the delivery of cash transfers.

These recent developments in identification, combined with rising mobile phone ownership, broadening Internet access, and innovative payment delivery mechanisms, can be harnessed to transform the way states implement poverty-reduction programs and improve the lives of their citizens. Digital payments promise faster, more transparent, and lower-cost delivery for existing cash-based government transfers, and can also transform the way governments deliver subsidies. The difference could mean billions of dollars in savings. In addition to the large monetary benefits, direct digital transfers can also strengthen citizen oversight over government spending, reinforcing democratic processes. At the same time, the number of people with actual and potential access to digital payments is rising sharply: 62 percent of adults now have a financial account, and the number of mobile money accounts is growing by over 100 million per year.

In a new background paper, Dan Radcliffe reviews the evidence on the gains from digital payments and pinpoints four ways in which they can improve development outcomes:

1. Reducing fuel subsidies while helping the poor: according to recent IMF estimates, regressive pre-tax fuel subsidies cost government and their citizens over $330 billion in 2015 alone. Governments are spending (or foregoing income where sales from national production are below the world price of fuel) the equivalent of 20% of their revenues in several countries, including Iran, Bangladesh, Pakistan, and Cameroon. Turning price-based subsidies into digital payments can help cut the diversion of subsidized products, improve the welfare of the poor, and improve financial inclusion—as Iran’s and India’s experience with moving to direct transfers shows.
    
2. Taxing dirty fuels and reimbursing citizens: eliminating fuel subsidies is of course important not only because they are wasteful and regressive, but because fuel consumption carries many negative externalities. These externalities, such as serious harm to human health, need to be taken into account for energy pricing: fuels need to be taxed appropriately to enable governments and their citizens to counter the harmful effects associated with their consumption. If corrective taxes were applied to fossil fuels globally, IMF estimates indicate it would add $2.9 trillion to government revenues. However, a fuel price hike without any compensatory mechanism would likely hurt the poor and would also be politically unsustainable. This is where direct digital payments come in: the public could receive a digital payment so that the poorest customers are protected; in addition, a share (or perhaps all) of the revenue from fuel taxes could be directly delivered back to citizens.
    
3. Improving food subsidy programs: delivering food to the poor is an enormous logistical challenge and prone to leakages. The latest figures by the Indian Government show that 54% of subsidized wheat, 48% of subsidized sugar, and 15% of subsidized rice never actually reaches its intended beneficiaries. Physical delivery of food may be necessary in some areas, such as those with severe food insecurity and where food markets are weak or nonexistent, but for the majority of countries (digital) cash transfers deliver the biggest bang for the state’s (or donors’) buck. Giving individuals the freedom to spend on what they need the most delivers better results, while it can also boost local markets and local production.
    
4. Boosting government transparency and accountability: digital payments can strengthen the fiscal contract between citizens and the governments. Cash transfers offer the opportunity to introduce ‘tax payments’ at source, whereby a small tax would be levied on government payments. Combined with the use of transparency-enabling technologies that would enable recipients to monitor both the payments received and the ‘taxes’ paid, these transactions could improve accountability and build a fiscal contract between the state and even its poorest citizens.

To what extent these and other potential benefits from digital payments will be realized depend on a number of factors. An estimated 1.5 billion people lack a recognized identity globally; without an identity, they may not be able to open a financial account that would enable digital payment delivery. Governments will also need to have the capacity to uniquely identify beneficiaries to sustain public confidence in government cash transfer systems. Political economy constraints around the introduction of payments and identity technology may delay its implementation. Infrastructure constraints which limit coverage and the speed of implementation could also be a concern in a number of countries.

Upcoming CGD research will offer new ideas on how some of these barriers to implementing digital payment systems can be overcome and will explore the use of digital technology—particularly its role in identification—in achieving development outcomes in more detail.