Income risk, coping strategies and safety nets

This paper discusses the different strategies households use to cope with their livelihood risk. It focuses on income-based strategies, on assets as self-insurance and on informal insurance arrangements. It states that households are constrained in using these strategies. Income-based strategies are limited because of entry-constraints into profitable activities, leaving the poor to concentrate on low return, low risk activities. Self-insurance is limited by access to assets and poor functioning of asset markets when a crisis hits the household. Informal insurance arrangements are affected by sustainability constraints, often excluding the poor from these arrangements; furthermore, economy-wide shocks cannot be handled by these arrangements.

Economic policies could contribute to better protection against risk. Improved working of asset markets and macroeconomic stability would contribute to the Usefulness of self-insurance. Increased access to alternative economic activities and increased opportunities could allow income-based strategies to be strengthened. Public safety nets might be thought to provide a useful alternative; however they are likely to result in some crowding out and even a decline in average welfare, since incentive effects could affect the sustainability of informal insurance arrangements. Initiatives to develop safety nets should take into account existing risk-coping strategies. Issues of the net welfare effects and crowding-out are relevant. Strengthening self-insurance may remain an insufficiently explored alternative, such as via group-based savings More empirical research, however, if necessary to assess the functioning of informal risk-sharing arrangements and the consequences of interventions thereof.

Obtaining estimates on the vulnerable population rather than the currently poor is very data intensive, requiring panel data. Measures of transient and chronic poverty could provide useful descriptions for policy analysis. Cross-section surveys could also provide useful insights. In particular, they could provide information on the underlying determinants of the risk-reducing strategies, in the form of physical, human and social capital. They also could inform about the opportunities available to households, currently and during past crises. Qualitative studies could provide useful insights but incorporating some of these concerns in large quantitative household surveys is likely to yield important pay-offs in terms of better understanding of changes in welfare and vulnerability, and in terms of optimal policy design.

[From the author]