1 Risk and Asset Management in the Presence of Poverty Traps: Implications for Growth and Social Protection Christopher B. BarrettMichael R. Carter Cornell UniversityUniversity of Wisconsin

2 A Behavioral Approach to Poverty and Vulnerability Standard poverty lines –Element of arbitrariness & controversial –Problem even for forward looking ‘vulnerability measures’ Behavioral poverty line –Look for threshold around which behavior bifurcates (avoid arbitrariness) –‘Dynamic asset poverty threshold’ of poverty trap theory around which accumulation behavior bifurcates –Consistent with Calvo & Dercon vulnerability concept: “sense of insecurity, of potential harm people must feel wary of—something bad can happen and ‘spell ruin’ –Existence of such a threshold has important implications for the impacts of shocks, and for the design of social protection policies

3 Outline 1.Conceptual perspective on poverty traps and dynamic asset poverty threshold (or ‘Micawber threshold’) Club vs. Multiple Equilibria divergence Sources of multiple equilibria 2.Implications of Micawber threshold for household risk coping Asset smoothing Bifurcated accumulation dynamics 3.Empirical strategies for identifying Micawber threshold Threshold econometrics Direct elicitation of state dependent growth dynamics 4.Implications for policy and policy experiments Targeting Feasible experiments

4 Poverty Traps & the Micawber Threshold If shocks can spell ruin in a long term sense, –Suggests existence of multiple equilibria –Matches with empirical evidence from Lybbert et al. on Ethiopian pastoralists: those that fell below critical level with shock move to a lower long-run equilibrium than more fortunate neighbors Important to keep in mind that in general such divergence in experience can come from two sources: 1.Club Divergence when groups of individuals or countries that share similar intrinsic characteristics (e.g., time preferences, skills, geographic endowments) tend to converge to a living standard that is unique to their group or club. While there is convergence within clubs, there can be divergence between clubs 2.Multiple Equilibria Divergence can occur when there is no unique equilibrium for a individual or country. Instead, controlling for intrinsic characteristics, both a high and a low level equilibrium are available to the individual. Whether the individual or country reaches the high level equilibrium, or remains trapped at the low level equilibrium, depends on whether the country begins above or is able to boost itself over a critical minimum threshold level.

5 Poverty Traps & the Micawber Threshold Focus for the moment on multiple equilibria divergence Can occur at household level when 1.Access to capital is limited, and, 2.Locally increasing returns to wealth for reasons such as: The underlying income generating process directly exhibits increasing returns to scale Some high return production processes require a minimum project size; or Risk and financial market considerations cause lower wealth households to allocate their assets so as to make expected marginal returns to wealth lower for lower wealth households Key question then whether poor households decisions are driven by low marginal returns –Missing financial markets rule out discrete jumps –The dynamic asset poverty threshold becomes that critical level below which autarchic saving (diminished consumption despite low marginal returns) ceases to be feasible –Note that this becomes a behavioral poverty line –Distinguish this threshold from low level (poverty trap) equilibrium

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7 Shocks & Poverty Traps: Asset Smoothing & Long term Ruin Dynamic asset poverty threshold has direct implications for persistence of poverty (Carter & Barrett (forthcoming) propose a family of chronic poverty measures on this basis) In face of risk, threshold has two behavioral implications: 1.Asset Smoothing/Consumption destabilization Anecdotal evidence Theory of Zimmerman & Carter Hoddinott’s study of Zimbabwe (& human capital costs) Barrett et al. on Kenyan pastoralists (aside on puzzle of Fafchamps et al., 1998) 2.Long-term ruin in wake of asset shocks Carter et al. (2005) on Hurricane Mitch Note that both of these implications suggest ways of testing for presence of the dynamic asset poverty threshold Examine two recent approaches based on implication 2

8 Identifying the Micawber Threshold using Asset Dynamics Empirical identification of threshold faces many challenges, including: –Repelling point/point of bifurcation –Intrinsic characteristics that may shape ‘club’ may be latent –Aggregation of assets –Non-linearities/multiple regimes Note that an random shock potentially provides source of identification as it weakens the correlation between starting position and latent characteristics Consider a basic threshold model:

9 Identifying the Micawber Threshold: Honduras after Hurricane Mitch

10 Identifying the Micawber Threshold: Honduras after Hurricane Mitch

11 Identifying the Micawber Threshold: Honduras after Hurricane Mitch

12 Identifying the Micawber Threshold using Imagined Shocks & Self-control for Intrinsic Characteristics Honduras threshold estimates do not control for latent characteristics that likely correlated with initial positions Novel elicitation strategy of Barrett and Santos: –Same pastoralists studied by Lybbert et al. –Imagined Shocks –Self-control for latent characteristics Key results: –Hint of bifurcation in bad years –Key interaction between existence of multiple equilibria and estimated technical efficiency

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16 Implications for Policy & Policy Experiments In summary, shocks in the presence of poverty traps imply: –Long run micro (macro?) growth effects –Costly chronic poverty –Costly avoidance of persistent poverty (asset smoothing) Social protection policy built around this behavioral poverty line would appear to be: –Cost-effective –Imply unpleasant triage? Would also seem to imply that ex ante insurance/credible safety nets would have immediate behavioral implications Could this be the basis for experimentation? Also has implications for financial markets –Break logic of poverty trap –Localness of market versus type of shock –Experimental ideas (Peru)