Income Shocks and Household Risk-Coping Strategies: Evidence from Vietnam

1. Central Institute for Economic Management, Hanoi, Vietnam, July 2nd, 2010 Report prepared under Danida BSPS Program in collaboration with CIEM and UoC. Vietnam Access to Resources Household Survey (VARHS) 2006 and 2008. Income Shocks and Household Risk-Coping Strategies: Evidence from Vietnam Fiona Wainwright1 , Carol Newman1 and Finn Tarp2 1Department of Economics, Trinity College Dublin, 2 Department of Economics, UoC

2. Research Question • Vulnerability to shocks is a dominant feature of household livelihoods in developing economies: • Negative effect on welfare (income, wealth, health, etc.) • Vulnerability to poverty • Key challenge is maintaining satisfactory levels of consumption • Research question: What strategies do rural households in Vietnam employ to avoid consumption shortfalls caused by adverse income shocks?

3. Motivation (1) • Literature highlights fact that exposure to income risk remains a serious cause of poverty in developing countries (Fafchamps, 2009) • Nature of the shock incurred impacts on ability to cope (Dercon, 2002) • Idiosyncratic shocks • Aggregate shocks • Aggregate shocks have been linked: • Declines in agricultural yields and incomes (Porter, 2008) • Persistent effects on nutrition of children (Alderman et al., 2006) • School attendance and enrolment (Jacoby and Skoufias, 1997) • Evidence suggests that idiosyncratic shocks are more common but can be smaller and easier to deal with (Townsend, 1994; Mordoch, 2001; Udry, 1991)

4. Motivation (2) • Idiosyncratic shocks can be insured at community level or through formal insurance contracts • However, in developing economies formal insurance markets are not well developed • Aggregate shocks are difficult to collectively insure and are rarely covered by formal insurance contracts • Households must find alternative ways to smooth consumption in face of idiosyncratic shocks • Risk management – managing ex ante the riskiness of the income generating process (income smoothing) – formal insurance or precautionary saving • Risk coping – dealing ex post with the consequences of income loss (consumption smoothing) – insurance claims, depletion of the stock of saving or borrowing

5. Key Contributions 1. Investigate the interplay between insurance, savings and households’ ability to smooth consumption 2. Investigate precautionary savings as a form of self-insurance or risk-coping strategy against different types of shocks

6. Empirical Considerations • Step 1: Using the VARHS 2006-2008 we test the ability of households to consumption smooth in the presence of idiosyncratic and aggregate shocks, formal insurance and precautionary saving • Estimate standard household consumption equation for 2006 • Use this equation to predict what household consumption would be if nothing changed between 2006 and 2008 using observed data • Compare what the model predicts with actual observed level of consumption • If there is no difference then households manage to consumption smooth • Test is preformed for various household groupings

7. Empirical Considerations • Step 2: Empirical exploration of mechanisms of consumption smoothing • Empirical model for each HH asset is represented by: • Taking first differences eliminates any time invariant unobserved HH heterogeneity • Inclusion of district fixed effects controls for regional specific differences including differences in the quality of institutions, the variance of returns, access to credit and insurance markets, etc. • Include controls for financial prudence and test for significance of various interactions between insurance and shocks

8. Data Vietnamese Access to Resources Household Survey (VARHS) 2006 & 2008; 12 provinces of Vietnam covering 1,483 households in a balanced panel Household Shocks and Recovery Statistics

9. Data • Factors influencing recovery from a shock (selected results)

10. Data • Household Asset Holdings and Insurance – selected statistics

11. Data • Profile of households with formal insurance (selected results)

12. Empirical Results + households consume less than predicted - households consume more than predicted • Stage 1: Consumption Smoothing t-tests

13. Empirical Results + households consume less than predicted - households consume more than predicted • Stage 1: Consumption Smoothing t-tests (continued)

14. Empirical Results • Main result from Stage 1: • Ability of households to smooth consumption when faced with income shocks is highly correlated with whether they have formal insurance and their level of savings and asset holdings. • Motivation for Stage 2: • How exactly do households cope?

15. Empirical Results • Stage 2: Empirical model of risk coping • Savings (selected results)

16. Empirical Results • Stage 2: Empirical model of risk coping • Livestock (selected results)

17. Empirical Results • Stage 2: Empirical model of risk coping • Crops (selected results)

18. Empirical Results • Stage 2: Empirical model of risk coping • Borrowing (selected results)

19. Summary of findings • Ability to smooth consumption is highly correlated with insurance and asset holdings • Theory suggests that households insure against idiosyncratic shocks but not against natural shocks • We find evidence in support of this: • Households deplete savings stocks in response to natural shocks but not idiosyncratic shocks

20. Summary of findings • Insurance markets do not fully cover idiosyncratic risks • Livestock and crop stores are depleted by households who face idiosyncratic shocks • However, households that claim off of their insurance deplete assets to a lesser extent • Borrowing not an important buffer suggesting that households may be credit constrained • When faced with economic shocks households do borrow, in particular from informal sources

21. Thank you Questions and comments welcome

22. Central Institute for Economic Management, Hanoi, Vietnam, July 2nd, 2010 Report prepared under Danida BSPS Program in collaboration with CIEM and UoC. Vietnam Access to Resources Household Survey (VARHS) 2006 and 2008. Income Shocks and Household Risk-Coping Strategies: Evidence from Vietnam Fiona Wainwright1 , Carol Newman1 and Finn Tarp2 1Department of Economics, Trinity College Dublin, 2 Department of Economics, UoC