THE DEVELOPMENT FIELD AGRICULTURAL & RESOURCE ECONOMICS UNIVERSITY OF CALIFORNIA AT BERKELEY

Risk and Consumption Smoothing

Exposure to risk can be quite debilitating for poor subsistence farmers. The research of this group looks at the techniques rural households in developing countries use to limit the risk they face. We also look at how one can identify vulnerable households for the purpose of targeting. Recent work by Sarah Baird and Ethan Ligon looks at the effect of transportation costs on consumption patterns of households in Viet Nam. In particular, she focuses on the idea that if transportation costs account for a large percentage of the idiosyncratic risk that these households face, this implies that this risk is largely driven by spatial variation in prices. Given this underlying relationship, she then develops a model that connects price variation to idiosyncratic risk and uses panel data from Viet Nam to ask the question to what extent can the risk faced by producers and consumers in Viet Nam be attributed to local price variation? To answer this question she draws on the consumption smoothing literature (ie. Townsend (1994)) and looks at the ability of households in Viet Nam to insure themselves against spatial and temporal price variation. However, instead of using expenditures as the dependent variable, as is the usual practice in the risk literature, she uses measures of quantity in an attempt to get rid of the problem of confusing variation in prices with variation in quantities. Preliminary evidence suggests that the local price does affect the local quantity consumed, indicating households are not able to fully hedge risk across space. Recent work by Xiangyi Meng looks at how guanxi networks (i.e connections) are used for insurance purposes in rural China. He also tries to explain spatial correlation/independence of household consumption patterns by introducing transportation costs as one friction, and looks at how this friction is different from other frictions. Xiangyi also studies the social status migrant workers (temporary residents) in cities, their returns to education, and their exposure to risks. Ethan Ligon and Laura Schechter construct a measure of "vulnerability" which allows us to quantify the welfare loss associated with poverty as well as the loss associated with exposure to risk (Ligon & Schechter 2003). They find that poverty and risk play roughly equal roles in reducing welfare in Bulgaria in 1994. Aggregate shocks are more important than idiosyncratic sources of risk, but households headed by an employed, educated male are less vulnerable to aggregate shocks than are other households. In a related paper the authors compare a variety of different vulnerability measures suggested in the recent literature and a variety of approaches to estimate these various measures (Ligon & Schechter 2004). They use Monte Carlo experiments to explore the performance of differente estimators with different measures, under different assumptions regarding the underlying economic environment. They come up with a set of guidelines for practioners as to which measure of vulnerability and which estimator should be used in different situations. They find that estimating vulnerability measures is simple and is much more informative than are static poverty measures provided the practitioner has at least two rounds of panel data. Principal investigators: Ethan Ligon Associated researchers: Sarah Baird, Xiangyi Meng, and Laura Schechter