Growth and Shocks: evidence from rural Ethiopia

Using panel data from villages in rural Ethiopia, the paper studies the determinants of consumption growth (1989-97), based on a microgrowth model, controlling for heterogeneity. Consumption grew substantially, but with diverse experiences across villages and individuals. A key focus is on whether shocks affect growth. Rainfall shocks have a substantial impact on consumption growth, and its impact presists for many years. There also appears to be a significant, persistent growth impact from the large-scale famine in the 1980s, as well as substantial externalities from the presence of road infrastructure. The findings related to the persistent effects of rainfall shocks and the famine crisis imply that welfare losses due to the lack of insurance and protection measures are well beyond the welfare cost of short term consumption fluctuations.

Income risk, coping strategies and safety nets

Rural and urban households in developing countries face substantial idiosyncratic and common risk, resulting in high income variability. Households in risky environments have developed sophisticated (ex-ante) risk-management and (ex-post) risk-coping strategies, including self-insurance via savings and informal insurance mechanisms to do so while formal credit and insurance markets appear to contribute only little to reducing income risk and its consequences. Informal credit and insurance, however incomplete, helps to cope with risky incomes. Despite these strategies, vulnerability remains high, and is reflected in fluctuations in consumption. It is clear therefore, that further development of safety nets will be necessary. In this paper, we focus on the opportunities available to households to use risk-management and risk-coping strategies, and on the constraints on their effectiveness. Fluctuations in consumption usually imply relatively high levels of transient poverty. High income risk may also be a cause of persistent poverty. The failure to cope with income risk is not only reflected in household consumption fluctuations but affect nutrition, health and education and contribute to inefficient and unequal intrahousehold allocations. Deaton’s model provides a useful description of the advantages of self-insurance. Policy conclusions may be limited however. In practice, assets are risky, not safe. The covariance of asset values and income due to common shocks makes self-insurance a far less useful strategy than it seems. We quantify the consequences of holding risky assets that are covariate with incomes, using simulations. Access to relatively safe and profitable assets, which might be useful for consumption smoothing, may also be limited. Lumpiness in assets may be a reason why the poor cannot protect themselves easily via assets. Policies that influence asset market risks could be beneficial to households attempting to deal with shocks. Policies could include providing more attractive and diversified savings instruments. Microfinance initiatives should put savings for self-insurance on the agenda. Macroeconomic stability during income downturns would also allow selfinsurance to function better. Income smoothing can be achieved by income portfolio adjustments. In practice relatively little income smoothing (even via income portfolio adjustments) is achieved by poorer households. Income diversification for effective risk-reduction appears limited. Observed diversification patterns are often not aimed at reducing risk. Households face entry constraints to enter into profitable activities. Income risk reduction often comes at a cost. Income skewing is likely if less protection is offered by investing in assets. The long-term consequences for the asset-poor are lower average incomes and a higher income gap relative to asset-rich households. Observing specialisation does not necessarily imply that the household follows a high-risk strategy. Also, entry constraints may limit the diversification that can be achieved, leaving only low-return activities free to the poor. Income portfolios must be seen in relation to the asset portfolio and other options available: a risky, specialised portfolio may mean lower consumption risk than a diversified portfolio, depending on the asset position. Finally, several income-based strategies are only be invoked when a crisis looms. These (income)‘coping’ or ‘survival’ strategies are especially important when the shock is economy-wide. There has been increasing interest in the empirical analysis of informal risk-sharing and theoretical modelling on the sustainability and consequences of these arrangements. Risk-sharing can be viewed as the cross-sectional equivalent of consumption smoothing over time. In the absence of enforcement problems, the existence of better savings opportunities and a public safety net providing transfers when common shocks occur, could improve welfare without crowding out the informal insurance arrangement. A transfer-based safety net is, however, likely to crowd out private (precautionary) savings. Informal insurance arrangements are likely to have to be self-enforcing, imposing sustainability constraints. Circumstances in which risk-sharing arrangements may be sustained are, inter alia: a low discount rate of the future, high frequency of interactions, situations in which idiosyncratic shocks are more frequent relative to other shocks. Evaluating the effects of alternative coping mechanisms such as savings, or of policy interventions such as providing better savings instruments or public safety nets, needs to take into account their effect on incentives to sustain the agreement rather than to go it alone. It is possible that opportunities for precautionary savings or a public safety net would actually be welfare reducing and displace the informal insurance arrangement by more than one to one. Any policy intervention that improves an individual’s position outside a private group-based informal risk-sharing arrangement may provide incentives to break down the informal arrangement. Targeted interventions that target only some members of communities or groups could be particularly counterproductive. Groupbased savings schemes could provide a useful alternative or complement if one is concerned about crowding-out. The possibly negative welfare effects can be avoided. Whether the crowding-out and potential negative welfare effects of interventions on informal insurance mechanisms are significant is an empirical question. If common shocks are dominant and if groups and communities rather than just individuals are targeted, these negative effects are likely to be less significant. Standard quantitative poverty analysis assumes that consumption is smooth. If smoothing is not possible, especially when large negative shocks occur, then alternative measures of poverty and vulnerability need to be explored. If interiii temporal data are available, broader definitions can be used to describe vulnerability. Aggregate measures of ‘vulnerability’ can be obtained. Targeting assistance to the vulnerable population requires specific kinds of information. Analysing the characteristics of households experiencing chronic or transient poverty, or in general, their consumption fluctuations, can provide this information. Panel data are required for this analysis. If policies are exogenous to the risk management and coping strategies, then information on how households handle income risk is irrelevant. However, policies may affect household opportunities to cope with risk (e.g. by changing exit options from informal insurance). In that case, how households cope with risk is relevant for the design of policies, in turn increasing data requirements. If effective safety nets and other consumption risk-reducing policies require detailed knowledge of existing risk-reducing actions by households, then surveys need information on physical, human and social capital, on shocks, as well as on opportunities in labour, product and asset markets. Panel and cross-section surveys could be used to collect relevant information. The complexity of consumption-risk reducing strategies implies that a simple indicator is unlikely to be available. Measures of vulnerability would typically require detailed data, including from panels. Some indicators that aim to describe vulnerability are typically flawed. The emphasis on the ability to cope with risk via assets, human capital and informal insurance and on the opportunities available, marks a convergence of different disciplines, bridging gaps with more qualitative approaches.

Economic reform, growth and the poor: evidence from rural Ethiopia.

Using micro-level panel data from villages in rural Ethiopia, the paper uses standard decompositions of income changes and develops a new decomposition of poverty changes to analyse the determinants of growth and poverty changes during a period of economic reform (1989-95). Consumption grew and poverty fell substantially, but the experience was mixed. I find that common and idiosyncratic shocks mattered, but that the main factors driving income changes are relative price changes, resulting in changes in the returns to land, labour, human capital and location. A regression-based decomposition of the changes in poverty shows that the poor have benefited on average more from the reforms than the non-poor households. But the experience of the poor is mixed: one group of the poor in 1989, with relatively good land, labour and location, outperformed all other households, while another group with much poorer endowments and location experienced virtually unchanged and persistent poverty.

Designing insurance for the poor:

Poverty reduction, Hunger, Insurance, microfinance/credit, Safety nets,

Growth and Shocks: evidence from rural Ethiopia

Using panel data from villages in rural Ethiopia, the paper studies the determinants of consumption growth (1989-97), based on a microgrowth model, controlling for heterogeneity. Consumption grew substantially, but with diverse experiences across villages and individuals. A key focus is on whether shocks affect growth. Rainfall shocks have a substantial impact on consumption growth, and its impact presists for many years. There also appears to be a significant, persistent growth impact from the largescale famine in the 1980s, as well as substantial externalities from the presence of road infrastructure. The findings related to the persistent effects of rainfall shocks and the famine crisis imply that welfare losses due to the lack of insurance and protection measures are well beyond the welfare cost of short term consumption fluctuations.

Social Protection, Efficiency and Growth

Social protection can play an important role in poverty reduction and making growth inclusive of the poor. At times, it is also argued that social proection can directly contribute to growth and economic efficiency. The paper revisits the evidence on the cost of social protection to reduce poverty, and its contribution to efficiencey and growth. As social protection may overcome market failures in credit and insurance, the paper also considers the role of alternatives, such as micro-credit and micro-insurance. The evidence on social transfers (in cash or in kind, conditional or not) suggests that while they have substantial poverty and euity impacts, their efficiency and growth impact is unlikely to be high-not dissimilar to the limited growth impacts of microcredit. The implication is that the main motivation for the social trabsfers must lie in their equity or poverty impacts. The evidence on contigent transfers, made in response to shocks such as illness, drought or unemployment, as in social insurance, is that their contribution to resolving market failures may be higher, leading to potentially more substantial gains, especially where children are targeted. Given the problems with developing market-based solutions via micro-insurance, there is a strong case for social protection initiatives in this area from an efficiency point of view, to complemnet contributions-based social insurance and micro-insurance inititaives. Conditions in conditional cash transfers can also be used to enhance efficiencey gains, for example if conditions target activities or investments with clear soical externalities. the paper ends with three areas where tyhere could be potentiall high growth impacts: social protecion focusing on children, especially before the age of five; social protection meausres to make migration smoother and cities more attractive places to live for low skilled workers, possibly via urban workforce schemes focusing on urban community asset building; and social protection targeted at adolescents and young adults, including transfers conditional on training focused on urban labour market transitions. in all these cases standard cash transfers may be too blunt to have high impacts, suggesting the need for more context-specific 'smarter' social protection schemes.

Vulnerability: a micro perspective

High downside risk to income and livelihoods is part of life in developing countries. Climatic risks, economic fluctuations, and a large number of individual-specific shocks leave these households vulnerable to severe hardship. The paper explores the links between risk, vulnerability and poverty, taking a micro-level perspective. Risk does not just result in variability in living standards. There is increasing evidence that the lack of means to cope with risk and vulnerability is in itself a cause of persistent poverty and poverty traps. Risk results in strategies that avoid taking advantage of profitable but risky opportunities. Shocks destroy human, physical and social capital limiting opportunities further. The result is that risk is an important constraint on broad-based growth in living standards in many developing countries. It is a relatively ignored part when designing anti-poverty policies and efforts to attain the Millennium Development Goals. The paper discusses conceptual issues, the evidence and the policy implications.

Globalization and Marginalization in Africa: Poverty, Risk and Vulnerability in rural Ethiopia

Increased openness is seen by some as a panacea for development while for others it is a recipe for disaster for the poor. Using the example of Ethiopia, this paper discusses some of the key challenges faced by some of the poorest African countries to beneficially engage in the world economy. Worldwide income growth has largely bypassed many African countries, and large parts of their populations risk increasing marginalization. This paper documents the challenges faced by one of these countries, Ethiopia, by highlighting first the impact of a first wave of liberalization in the early 1990s, using the evidence from a rural panel data set. It was found that while liberalization had some positive effects in this particular period, the benefits were largely confined to those with good assets, not least in terms of geography and road infrastructure. In subsequent years, access to infrastructure seems to have been causing even further growth and poverty divergence within rural Ethiopia. This evidence suggests that access to better infrastructure and communications will be key to have beneficial effects of further liberalization and engagement with the world econoy. Finally, we find some evidence that liberalization has shifted the nature of risks towards a higher incidence of market related risks with an impact on households, such as sudden output price collapses or input price increases. While it is not possible to infer from this that vulnerability to poverty has necessarily increased, one would need to recognize that these shifts in risk will require different responses from households themselves and from policy makers.

Risk, Growth and Poverty: what do we know, what do we need to know?

This note has three objectives: first, it aims to take stock of the nature of the evidence available and on the links between uninsured risk and shocks on the one hand, and growth and poverty on the other, both at a macro and micro level. Secondly, it makes a number of suggestions of the type of work that could be fruitfully implemented. Finally, it tries to strike a balance between the needs for the policy maker and the requirements for academic scrutiny of evidence, in offering suggestions for priorities in work.

Chronic Poverty and All That: The Measurement of Poverty over Time

We explore how to measure poverty over time, by focusing on trajectories of poverty rather than poverty at a particular point in time. We consider welfare outcomes over a period in time, consisting of a number of spells. We offer a characterization of desirable properties for measuring poverty across these spells, as well as an explicit discussion of three issues. First, should there be scope for compensation so that a poor spell can be compensated for by a non-poor spell? Second, is there scope for discounting or should all spells be equally valued? Third, does the actual sequence of poor spells matter, for example whether they are consecutive or not? We offer a number of measures that implicitly offer different answers to these questions, in a world of certainty. Finally, we also offer an extension towards a forward-looking measure of vulnerability, defined as the threat of poverty over time, that incorporates risk. An application to data from Ethiopia shows that especially the assumption of compensation results in different inference on poverty.poverty, chronic poverty, poverty dynamics, Ethiopia