From Risk-Coping to Consumption Smoothing : For a Suitable Rationale for Survival Economies

From Risk-Coping to Consumption Smoothing:For a Suitable Rationale for Survival Economies Flavio Pinto Siabato University of Flensburg, Institute for International Management, Flensburg, Germany

Introduction • Context: Survival Economies and Overexploitation of Natural Resources • Pervasive Poverty: • Does the economic theory has something to do? • Contributions • What the theory distorts • Pooling risk and smoothing consumption: goal and mean?

The Problem • Do peasants realize their efforts are for coping with risk at all times? • Do scholars realize peasants are smoothing consumption as goal? • Evidence: • “…such studies (Bhalla 1980; Wolpin 1982; Paxon 1992) suggest a considerable degree of consumption smoothing behavior” (Rosenzweig and Wolpin, 1993, p.224). • “…net purchases are significantly more likely to occur when income is high than when income is low, consistent with what appears to be an implication of a consumption-smoothing motive” (ibid, p.228). • “A growing body of evidence has shown that, while household income in developing countries varies greatly, consumption is remarkably smooth (e.g., Townsend (1994), Morduch (1991), Paxson (1992), Jacoby and Skoufias (1997))” (Fafchamps and Lund, 2003, p.261-2).

The Risk Coping Rationale: • Aversion to risk suffices to guarantee the convexity of preferences

Peasants strategies Smoothing Diversifying Accumulating Sharing Institutions The Risk Coping Rationale Risk is everywhere and always for peasants All the strategies are for coping with risk Peasants are risk-averse Risk Aversion explains all the inefficiencies of peasant economies

To reveal peasants’ attitudes toward risk (Refs) Attitudes imply behavior The Risk Coping Research Agenda To assess risk impacts (Refs) Risk is everywhere and always for peasants Peasants are risk-averse To determine actual strategies (Refs) Peasants strategies Smoothing Diversifying Accumulating Sharing Institutions To analyze how strategies complement and substitute each other (Refs) ...

Contents: • Failures of the Risk-Coping Rationale in Peasants’ Economies: • Risk • Consumption • Elements of a New Rationale: • Consumption Smoothing • Risk Behavior • Survival Strategies • The External Variables of Risk Behavior • Accessibility: The Internal Variables of Risk Behavior • Peasants Strategies • Conclusions: From Survival Strategies to Development

The Gap between Risk Preferences and Risk Behavior • In theory: • Attitudes toward risk should map in-to risk behavior • Context influences the evolution of preferences toward risk, but not current preferences • Implications: • Attitudes toward risk are disclosed from economicexperiments where individuals play lotteries • Payoffs as in real world • From these experiments a generalized appraisal has emerged: Peasants are risk-averse actors (Refs)

The Gap between Risk Preferences and Risk Behavior • However: “… even when all agents have identical risk preferences, differential risk behavior would still obtain if the agents have differential access to capital” (Eswaran et al., 1990, p.473). “Masson (1972)offered the keen insight that imperfections in capital markets can induce a risk-neutral individual to behave as if he were risk averse... The neglect of this potentially useful idea is perhaps due to the fact that the approach Masson adopts does not allow a clear separation between risk behavior resulting from purely psychological attitudes towards risk (i.e., risk preferences) on the one hand, and external (market) factors such as the degree of perfection of capital markets on the other”. (ibid, p.474).

The Gap between Risk Preferences and Risk Behavior • However: “The differential behavior towards risk… is explained by a set of socioeconomic variables that characterize peasant households in Bangladesh.” (Shahabuddin et al. 1986, p.122). Eswaran and Kotwal more generally declare (1990, p. 480) “differences in risk behavior need not arise from differences in preferences. They may, instead, be due to differences in abilities to pool risks across time”.

The Incapability of the Theory to Predict Risk Attitudes from Welfare • In theory, the relative aversion to risk increases as the Welfare increases. Again, the theory fails for peasants: “…the ability to smooth out consumption over time … may be an important determinant of risk bearing capacity … individuals with identical risk preferences, those with greater amounts of consumption credit will have greater capacity to absorb risk”. (Eswaran and Kotwal, 1990, p.473). “Eswaran and Kotwal (1990) show that credit constrained households will be more willing to sacrifice income for less risk than other households, even if their risk preferences are ex-ante the same” (Dercon, 1998 p.3). “…evidence was presented that households with relatively low livestock holdings were willing to allocate significantly more of their land to sweet potatoes, a low risk, low return crop than households with large livestock holdings”. (ibid, p.14).

Goal Means Consumption Smoothing as Risk-Coping Strategy Risk is everywhere and always for Peasants Peasants are Risk-averse Peasants’ Strategies Smoothing Diversifying Accumulating Sharing Institutions

Consumption Smoothing as Risk-Coping Strategy

Consumption Smoothing as Risk-Coping Strategy • More Evidence: “…such studies (Bhalla 1980; Wolpin 1982; Paxon 1992) suggest a considerable degree of consumption smoothing behavior”. (Rosenzweig and Wolpin, 1993, p.224). “…net purchases are significantly more likely to occur when income is high than when income is low, consistent with what appears to be an implication of a consumption-smoothing motive”. (ibid, p.228). “A growing body of evidence has shown that, while household income in developing countries varies greatly, consumption is remarkably smooth (e.g., Townsend (1994), Morduch (1991), Paxson (1992), Jacoby and Skoufias (1997))”. (Fafchamps and Lund, 2003, p.261-2).

Consumption Smoothing as the Main Goal of Survival Economies “... the program indicated that the primary objective of rural households is to ensure family basic needs and in particular food consumption against frequent and severe income shocks”. (Nguyen, 1998, p.19). “... As Deaton (1991) has shown, these households will save even if the return to liquid assets is negative. The reason is that their motive for saving is not to take advantage of financial opportunities but rather to set up a buffer of stock that helps them smooth consumption and deal with emergencies.” (Fafchamps, 1999, ch. 3, p.40).

Consumption Smoothing as the Main Goal of Survival Economies : “…net purchases are significantly more likely to occur when income is high than when income is low, consistent with what appears to be an implication of a consumption-smoothing motive”. (Rosenzweig and Wolpin, 1995, p.228). “Fafchamps and Kurosaki (1997) estimate a structural model of joint production and consumption choices using data from five Pakistani villages. They uniformly reject the hypothesis that consumption preferences do not affect production choices, thus providing rigorous empirical support for the food security model”. (ibid, p.11).

Theories for Enhancing Consumption Smoothing. The Safety-first Rule. Why it Fails? • Roy (1952) • Peasants do not try to maximize their utilities, but “to maximize their chances to survive” (Shahabuddin et al., 1986, p.123) • They act following rules that lead them to reach their fixed goals • Theoretically questioned • Wiens (1977, p. 48) ”if one accept this, one must be prepared to argue that farm employers and landlords act in collusion with farm laborers and tenants to maintain a wage level that is higher than would be determined by competitive equilibrium” • Experimentally rejected • Binswanger (1982) and Shahabuddin et al. (1986) proved the safety-first rule doesn’t predict peasant behavior. • Biases • The safety-first rule became a normative approach

Theories for Enhancing Consumption Smoothing. The Safety-first Rule. Why it Fails? • Sources of Failures • Are peasants not Utility maximizers? • What they want is not what they can • Inconsistences between the main peasants’ concern, and the method used to reveal their preferences: • Dillon and Scandizzo (1978, p.431): the “socioeconomic characteristics shaping risk attitudes were farmer’s age, income, household size and ethical attitude to betting”. • Shahabuddin et al. (1986) say: “two classes of variables have been used to measure the socio-economic and structural characteristics of the farm households: the age of the head of the household, family size and level of schooling attained by the household head. The second category includes the income related items: farm size, off farm income of the entire household and the total value of the households assets” (p.127).

Risk Behavior and the Ability to Smooth Consumption • If consumption smoothing is a goal beyond risk-coping, and all other strategies are (means) for smoothing consumption, what’s about Risk (behavior/attitudes)? • Considerations • Survival Economies • The effective attitudes toward risk have necessarily to reflect the household’s assessment of the ability to smooth consumption

Risk Behavior and the Ability to Smooth Consumption • Implications • Risk aversion for survival individuals has to be defined in order to account the role of the consumption smoothing motive • Risk behavior is not dictated by inner preferences, but principally by external factors (not Wealth as a whole) • The assessment of the possibilities to take a risk accounts all such physical, economic and institutional existences that peasants realize can be used to secure the smoothness of their consumption

Risk Behavior and the Ability to Smooth Consumption • Risk Behavior for Survival Individuals: • It is defined as the outcome of the perception of the ability to secure a smooth consumption in front of a risky decision. • Actual attitudes toward risk are defined by the horizon of smoothness of their consumption • The aversion of peasants is to fall below a minimal consumption

Risk Behavior and the Ability to Smooth Consumption • Players that realize a risky action will not affect their consumption smoothness, may behave as risk neutral or risk lovers • Whether they decide to behave as risk neutral or risk lovers, it will depend on inner attitudes toward risk • Players that realize their consumption horizon is not secure, are forced to gamble in risky actions.

Risk Behavior and the Ability to Smooth Consumption • Implications for Modelling • The search of maximal utility is compatible with the search of a smooth consumption. • Consumption is a key variable of peasants’ utility functions • The level of household’s satisfaction is proportional to the confidence the peasant has about his consumption horizon

Risk Behavior and the Ability to Smooth Consumption • Changes in Risk Behavior • Fixed Attitudes toward risk for static world. • Risk aversion changes! (Refs)

Research Directions • There are not known attempts to model the economic behavior of individuals with changing preferences toward risk. • Under evolving approaches, the aversion to risk has been presented as the best long-term strategy for higher payoffs (March, 1993; Bearden, 2001; Niv et al., 2002). • But, what this approach may say about actors that become risk neutrals?

Research Directions • Keynes “believed that India was … a country impoverished by a preference for liquidity (produced by the desire to smooth consumption)” which stifled the “growth of real wealth” (Keynes, 1973, p.337)”. • Under evolving approaches, ... how preferences for liquidity have conformed? • provided a reliable context to smooth consumption, how these preferences can be transformed in peasant communities in order to promote the growth of real wealth?

The Role of Liquid Assets • Keynes delimitates one basic feature that assets and internal resources must hold, in order to effectively support the consumption smoothing motive. • This is one of the reasons why studies characterizing risk attitudes are inconclusive: not all the assets improve the chances to sustain a smooth consumption. • Land • Liquids are the only assets able to expand the possibilities to smooth consumption, or can be translated almost immediately into cash and food. • “Assets act like a buffer stock, protecting consumption against bad draws of income” Deaton (1991, p.1221).

Strategy’s Factors: the Variables of Risk Behavior and Its Accessibility • The External Variables of Risk Behavior • Markets • Physical Endowments • Facilities • Institutions

Strategy’s Factors: the Variables of Risk Behavior and Its Accessibility • Shahabuddin et al. (1986) say: “two classes of variables have been used to measure the socio-economic and structural characteristics of the farm households: the age of the head of the household, family size and level of schooling attained by the household head. The second category includes the income related items: farm size, off farm income of the entire household and the total value of the households assets” (p.127). • Dillon and Scandizzo (1978, p.431): the “socioeconomic characteristics shaping risk attitudes were farmer’s age, income, household size and ethical attitude to betting”. • Accessibility: The (Household) Variables of Risk Behavior • Job markets: Age, education level • Credit markets: land, wealth... • Agricultural markets: land suitability, crop technology, etc. • Assets markets: Entrance investments • Institutions: Fees, ...

Strategies for Smoothing Consumption • Strategies are complete plans of actions, developed on the External and Household variables of risk behavior • More than strategies, peasants play a multi-strategy game: • Smoothing strategies, • Diversifying strategies, • Accumulation strategies and • Participation in informal Institutions

Strategies for Smoothing Consumption • Sources of Consumption for peasant households, according their relative welfare. Dercon (1998, p 5, Table 1)

Summary

From Consumption Smoothing to Development • Policy Implications of the Consumption Smoothing Motive • If peasants act for coping risk, policies are for reducing risk • if peasants are engaged in smoothing consumption, there is a different sort of priorities • policies for development should first support the principal problem the peasants have to solve. • The search for optimal policies should consider how to overcome the pervasive preferences for liquids, something that threatens any possibility to grow

From Consumption Smoothing to Development • As Concluding Remark: some relationships between the peasant concern on consumption smoothing and development • “Famously, Keynes (1973, p.170) identified a “precautionary motive” as “…the desire for security as to the future cash equivalent of a certain proportion of total resources”. ... • Less famously, he also believed that India was “… a country impoverished by a preference for liquidity” which stifled the “growth of real wealth” (Keynes, 1973, p.337)”[1]. • [1]In Jalan and Ravallion (1978, p.2)

Thank you ...!

The Impact of Risk Aversion in Peasant Economies • Risk aversion is acknowledged the major source of inefficiencies in peasant economies (Moscardi and de Janvry, 1977; Jalan and Ravillion, 1978; Binswanger et al. 1980; Rosenzweig and Wolpin, 1993). • The aversion to risk explains why peasants prefer to crop resistant but low profitable crops (Feder, 1980; Zimmerman and Carter, 2003), • why they use lower contents of fertilizers (Brink and McCarl, 1978; Feder, 1980; Babcock, 1992; Murdoch, 1995; Bontemps and Thomas, 2000). • Risk aversion is used to explain why they use inefficient arrangements (Rosenzweig, 1988), and costly credit institutions (Warning et Sadoulet, 1998). • Risk aversion makes clear the inefficient share of liquid unproductive assets (Jalan and Ravallion, 1978), • the rejection to new technologies (Moscardi and De Janvry, 1977; Feder, 1980), and • the inefficient supply of food (Chavas and Holt, 1996).

The Research Agenda: Impacts • Feder, 1980; Hazell, 1982; Newbery and Stiglitz, 1982; Chavas and Holt, 1996; Bontems and Thomas, 2000; Lamb, 2003. • Back.

The Research Agenda: Attitudes toward Risk • Moscardi and de Janvry, 1977; Jalan and Ravallion, 1978; Dillon and Scandizzo, 1978; Binswanger, 1980, 1981, 1982; Hazell, 1982; Pope, 1982; Shahabuddin et al., 1986; Rosenzweig and Wolpin, 1993, p.241; Ansic and Keasey, 1994; Ban-Shira et al., 1997; Wik and Holden, 1998; Cummins, 1999; Nielsen, 2001; Binici et al., 2003; Miyata, 2003. • Antle, 1987. • Henrich and Mcelreath, 2002. • Back.

The Research Agenda: Strategies • Wiens, 1977; Kimball, 1988; Rosenzweig, 1988; Eswaran and Kotwal, 1990; Alderman and Paxson, 1992; Coate and Ravallion, 1993; Rosenzweig and Wolpin, 1993; Townsend, 1994; Besley, 1995; Murdoch, 1995, 1999, 2002; Udry, 1995; Czukas et al., 1996; Ligon, 1997; Ravallion and Chaudhuri, 1997; Nguyen, 1998; Warning and Sadoulet, 1998; Dercon, 1998, 2000, 2004; Fafchamps, 1999; Rose, 1999; Christiaensen and Boisvert, 2000; Barret, Reardon and Webb, 2001; Kurosaki, 2001; Fafchamps and Lund, 2003; Lamb, 2003; Zimmerman and Carter, 2003. • Back.

The Research Agenda: How Strategies Complement and Substitute each Other • Alderman and Paxon, 1992; Besley, 1995; Nguyen, 1998; Fafchamps, 1999; Rose, 1999; Dercon, 2000. • [1] Examples of such investigations are: Do the Poor Insure? A Synthesis of the Literature on Risk and Consumption Smoothing in Developing Countries (Alderman and Paxon, 1992), Nonfarm Income Diversification and Household Livelihood Strategies in rural Africa: Concepts, Dynamics, and Policy Implications (Barret, Reardon and Webb, 2001), Nonmarket Institutions for Credit and Risk Sharing in Low-Income Countries (Besley, 1995), Drought and Saving in West Africa: Are Livestock a Buffer Stock? (Czukas et al., 1996), Wealth, risk and activity choice: cattle in Western Tanzania (Dercon, 1998), ) Income risk, coping strategies and safety nets (Dercon, 2000), Implications of Credit Constraints for Risk Behavior in Less Developed Economies (Eswaran and Kotwal, 1990), Insurance Market Efficiency and Crop Choices in Pakistan, (Fafchamps and Kurosaki, 1997), Rural Poverty, Risk and Development, (Fafchamps, 1999), Risk-sharing networks in rural Philippines (Fafchamps and Lund, 2003), Risk, financial markets, and human capital in developing country (Jacoby and Skoufias, 1997), Farmers’ Cooperatives as Behavior Toward Risk (Kimball, 1988), Consumption Smoothing and the Structure of Risk and Time Preferences… (Kurosaki, 2001), Fertilizer Use, Risk, and Off-Farm Labor Markets in the Semi-Arid Tropics of India (Lamb, 2003), and more… • Back.

Failures: Attitudes toward Risk • Dillon and Scandizzo (1978), but principally Binswanger’s (1980, 1981, 1982), and others (Shahabuddin et al., 1986; Ansic and Keasey, 1994; Wik and Holden, 1998; Cummins, 1999; Nielsen, 2001; Binici et al., 2003; Miyata, 2003). • Back.

Changes in Risk Aversion • (D’Amato, 2005, p.13; Brandt and Wang, 2003). • Back.

From Risk-Coping to Consumption Smoothing : For a Suitable Rationale for Survival Economies