Insurance against Poverty An end to riskinduced poverty traps in Ethiopia

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Insurance against Poverty An end to
risk-induced poverty traps in Ethiopia?

• Stefan Dercon
• University of Oxford
• and WIDER, United Nations University

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Insurance against Poverty

• Research funded by the World Institute of
  Development Economics Research
• Team of 20 researchers, lead by Stefan Dercon
• Study forthcoming Oxford University Press, Spring
  2004.

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Background

• The world community has set itself ambitious
  targets on poverty, the Millennium Development
  Goals
• Despite progress in many contexts and countries,
  at times disappointing progress

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Background (ctd)

• What about Ethiopia?
• History of Risk and Shocks
• Continuing poverty persistence and destitution
• Drought and other shocks still disrupting
  livelihoods and the economy

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Purpose

• To argue that the lack of insurance and
  protection is a cause of persistence in poverty
• To explain how risk implies that policies to
  stimulate aggregate growth may still leave many
  behind
• To broaden the discussion about policy options,
  beyond just safety nets, and the importance of
  learning and building on indigenous insurance
  mechanisms

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Questions

• 1. Diagnosis How important is risk for poverty?
• 2. Elements of a Cure What to do?

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Central Thesis

• Reducing vulnerability is good for growth and
  crucial for poverty reduction
• Insurance against poverty is more than a safety
  net

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Structure

• 1. The Cost of Risk the link between risk,
  shocks and poverty persistence
• 2. Developing Social Protection learning from
  indigenous institutions
• 3. Beyond Safety Nets

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Risk and Poverty

• Developing countries face pervasive risk and
  shocks, including drought, health and economic
  shocks
• Short term humanitarian cost is important.
• Evidence suggests transient poor are
  substantial group

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Transient poverty

• Study in 15 villages in rural Ethiopia, in
  1994-95, three rounds
• About 45 percent below national poverty line in
  each round
• About two-thirds poor in each period, but about
  one third moving in and out of poverty
• substantial part related to shocks

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But misleading

• Transient poverty is not the same as the
  poverty cost of risk
• Transient poverty suggests that bouncing back
  is painless, and that people are myopic
• Starting point people actively try to ensure
  their own survival and future

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Responses to risk

• Households respond to risk using sophisticated
  mechanisms
• Risk management shaping the risks they face by
  choosing particular activities (diversification,
  low risk activities)
• Risk coping coping with the consequences of high
  risk, e.g. using savings and mutual support
  networks

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The cost of risk

• These strategies are costly in terms of mean
  returns, and therefore long term poverty (ex-ante
  impact)
• Low risk activities and assets have a low return
• Asset poor households have to keep risk lowest
• Despite strategies, still large impact when
  shocks occur, involving losses in assets, health,
  skills, further limiting poverty reduction
  possibilities (ex-post impact)

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The cost of risk ex ante

• Ex-ante impact?
• India, Tanzania 25 percent loss in mean return
  of the poor relative to the rich due to assets
  and income portfolio choices
• Less adoption of new technology in India due to
  risk
• Zimbabwe risk reduced capital accumulation by up
  to 40 percent, largely linked to ex-ante
  behaviour

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The cost of risk ex-ante

• Evidence from rural Ethiopia?
• diversification but constrained by access to
  resources, resulting in very low return
  portfolios by the most vulnerable (dungcakes,
  charcoal,)
• a policy of fertiliser adoption in agriculture
  via uninsured credit with strict credit contract
  enforcement?

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The cost of risk ex-post

• Ex-post impact?
• China, Bulgaria, Household income growth rates
  affected for long periods (5-10 years) after
  serious shock
• evidence on nutrition and education of children
  e.g. in Zimbabwe after drought, up to 7 percent
  lower lifetime earnings due to lower height and
  lower school attainment
• children taken out of school with possible
  permanent effects (India, Indonesia)

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The cost of risk ex-post

• Ethiopia? Evidence on growth in food consumption
  between 1989 and 1997 in 6 villages.
• Bad rainfall shocks have long-lasting impact
  (lower growth for 5-10 years)
• Extent of suffering during famine in 84-85
  affects growth in the 1990s!

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Conclusion the cost of risk

• Evidence from many contexts, including Ethiopia,
  points to risk-induced poverty persistence and
  possibly even
• poverty traps
• situations from which no escape is possible
  using own means and resources, even if there is
  substantial growth in the economy

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Implication for Policy?

• Risk is a cause for poverty traps, for untapped
  profitable opportunities and for lower growth,
  or
• The return to social protection is substantial
• Public action to reduce vulnerability is good for
  equity AND efficiency/growth

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Structure

• 1. The Cost of Risk the link between risk,
  shocks and poverty persistence.
• 2. Developing Insurance against Poverty learning
  from indigenous institutions.
• 3. Beyond Safety Nets.

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How?

• Policy should not just be an post-crisis safety
  net still, it is important.
• Try to address problem ex-ante by menu of
  policies to strengthen ability of the poor to
  insure themselves
• Insurance against Poverty

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Learning from risk strategies

• Purpose finding better ways of providing
  protection and insurance
• Starting point learn from how people manage and
  cope with risk
• My focus indigenous institutions
• Learn from them, build on them?

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Indigenous risk-sharing

• Communities and networks providing insurance,
  reciprocal support
• Strength
• Embedded in communities, exploiting information
  and norms to avoid standard failures in providing
  insurance and protection
• Emerged as solution to lack of insurance, not
  imposed or captured by elite/state/NGOs

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Indigenous risk-sharing

• Weaknesses
• Limited to frequent, individual specific, not
  community-wide risks
• Marginal groups may well be excluded
• May not be able to withstand change

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Indigenous institutions

• BUT
• Emerging evidence that semi-formal indigenous
  groups stronger than informal networks with
  less exclusion and stronger to withstand change
• e.g. Iddirs in Ethiopia, but also funeral
  societies in Tanzania

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Indigenous institutions

• Study in rural Ethiopia (5 communities)
• Regular contributions, payout at funeral
• Often 10 or more groups per village
• Hholds members of on average 3 groups
• Inclusive and relatively stable groups
• Large asset holdings (mean400)
• Clear rules and regulations, elected committees

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Indigenous institutions STRATEGY for POLICY

• Strengthen these groups by offering more
  opportunities for insuring and protecting its
  members wider insurance, savings, asset
  creation.
• But careful balance is needed to avoid loss of
  all advantages of indigenous groups (including
  their independence, informational advantages,
  limited capture and flexibility to handle change).

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Structure

• 1. The Cost of Risk the link between risk,
  shocks and poverty persistence.
• 2. Developing Insurance against Poverty learning
  from indigenous institutions.
• 3. Beyond Safety Nets.

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Beyond safety nets

• Policy to reduce vulnerability to risk is
  typically reduced to a safety net, to reduce
  ex-post the welfare impact of a shock.
• BUT
• Conclusion 1 Reducing vulnerability is good for
  growth and crucial for poverty reduction
• Conclusion 2 Safety nets are relevant, but
  providing ex-ante opportunities to the poor to
  protect themselves is crucial

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TEXTBOOK POVERTY AND VULNERABILITY POLICY

• Attack poverty by strengthening ASSET BASE and
  ACCESS TO RESOURCES of the poor
• Encourage human capital formation (education,
  better health)
• Encourage physical capital formation (investment,
  new technology)
• Build complementary public goods (infrastructure,
  community goods)
• Attack vulnerability to risk by providing SAFETY
  NET in case a bad shock occurs.

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Ex-ante protection the missing link

• The poors attempts to accumulate these assets
  are easily undermined by shocks
• Too much is at stake for them to risk scare means
  by investing in an asset base that is easily lost
• E.g. losing livestock, facing destitution from
  loan repayments after shock, taking children out
  of school, etc.
• Offering insurance to protect asset base, by
  strengthening risk strategies

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Insurance against Poverty examples

• Strengthening risk coping
• Stimulating self-insurance, by offering better
  savings products, accessible to the poor (in kind
  and in cash)
• Building on indigenous insurance schemes (e.g.
  community or funeral societies)
• Developing insurance products suitable for the
  poor easy access, easy triggers e.g. rainfall
  insurance, possibly linked to credit for inputs

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Insurance against Poverty examples

• Strengthening risk coping (ctd)
• Better functioning of key markets when crisis
  hits (livestock, grain markets)
• Address the disproportionate attention to
  microcredit in favour of savings and insurance
• Strengthening risk management
• Reducing constraints on low risk diversification
  and asset formation, e.g. microcredit
• Fostering security of asset ownership, eg tenure
  security

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Ex-post measures

• Safety nets, post-crisis transfers have their
  place
• Some well-known issues
• -targeting
• -timing
• -form of support
• -public vs private asset creation

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Ex-post measures

• Beyond technical issues of delivery, key issue
  for our purposes
• CREDIBILITY that support will come when crisis
  hits, otherwise NO IMPACT on ability of the poor
  to take up risk and engage in risky, profitable
  opportunities.

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Safety nets in Ethiopia

• Just as anywhere in the world room for
  improvement on targeting, types of support and
  linking between asset formation and temporary
  support (relief versus development)

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Credibility of safety nets? covered by FFW/Food
Aid
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Insurance against Poverty how to deliver?

• A menu of ex-ante and ex-post measures, where all
  are fully credible to the poor an enforceable
  right to basic protection
• Needs open, transparent and sustainable
  institutions with clear regulatory framework to
  foster credibility
• With a clear role of aid and donor support to
  provide reinsurance of the system

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Purpose

• To argue that the lack of insurance and
  protection is a cause of persistence in poverty
• To broaden the discussion about policy options,
  beyond just safety nets, and learning and
  building on indigenous insurance mechanisms

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Central Thesis

• Reducing vulnerability is good for growth and
  crucial for poverty reduction
• Insurance against poverty is more than a safety
  net