1. Royal Economics Society Conference April 19th, 2011
Trinity College Dublin
Royal Economics Society Conference April 19th, 2011
Income Shocks and Household Risk-Coping Strategies:
Evidence from Vietnam
Carol Newman and Fiona Wainwright
Department of Economics, Trinity College Dublin

2. 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
Spatially covariant natural shocks
Natural disasters have been linked to:
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)

3. 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 the face of shocks
Risk management – managing ex ante the riskiness of the income generating process (income smoothing) – formal insurance, precautionary saving, income diversification
Risk coping – dealing ex post with the consequences of income loss (consumption smoothing) – insurance claims, depletion of the stock of saving or borrowing 3

4. What we do...
Present an ex post theoretical model within an inter-temporal utility maximizing framework which we use to explain household’s decisions to insure against idiosyncratic risk and save to protect against uninsurable aggregate risk
Using panel data from rural households in Vietnam we develop a test of the extent to which households smooth consumption over time and consider how this depends on the presence of insurance and savings instruments
We consider savings stocks in the form of liquid assets as a form of self-insurance or risk-coping strategy against aggregate and idiosyncratic shocks

5. Conceptual Framework (1)
HH is given a wealth endowment W in each period such that
With no insurance HH maximizes:
= precautionary savings level
= random variable representing exogenous natural shock
= exogenous idiosyncratic shock with known probability distribution
FOC:
Approximation for A:

6. Conceptual Framework (2)
With insurance HH maximizes:
= proportion of idiosyncratic risk that is covered
FOCs:
Approximation for A:

7. Conceptual Framework (3)
Summary of theoretical predictions:
Households save and purchase insurance to smooth consumption and so the realization of adverse income shocks should not affect consumption levels between one period and the next
Households with insurance will precautionary save less than those without given that the uncertainty associated with income due to idiosyncratic risks is eliminated
Policy implication:
Model predicts that households will precautionary save due to the uncertainty associated with future income levels and so they will consume less than they would in the absence of this uncertainty and will save less in the form of other more productive types of investments.

8. Empirical Considerations
Step 1: Test ability of households to consumption smooth in presence of idiosyncratic and aggregate shocks
Obtain parameters for a general consumption function that represents households consumption smoothing preferences
For households that experience no shocks estimate:
We use the estimated coefficients to predict household consumption in each period using the observed data on each explanatory variable in that period.
Test the hypothesis that there is no difference between the predicted and actual observed level of consumption
Failure to reject the null hypothesis provides evidence of consumption smoothing

9. Empirical Considerations
Step 2: Empirical exploration of mechanisms of consumption smoothing
Definition of shocks:
Exogenous spatially covariant shocks:
1) economic (for example, crop price changes, key input price changes/shortages)
2) natural (for example, floods, typhoons, droughts etc)
Idiosyncratic shocks:
3) insurable (for example, illness, injury or death of household member)
4) uninsurable (for example, crime/theft, divorce, family disputes etc)
Fixed Effects model

10. Data
Vietnamese Access to Resources Household Survey (VARHS) 2006, 2008 and 2010 – 12 rural provinces in Vietnam

12. Data
Vietnamese Access to Resources Household Survey (VARHS) 2006, 2008, 2010; 12 provinces of Vietnam covering 2,000 households in a balanced panel
Table 2a: Household Shocks and Recovery Statistics
2008
Shock
2008 Recovered
2010
2010 Recovered
Any Shock
56%
45%
50%
53%
Spatially covariant
73%
48%
71%
57%
Idiosyncratic only
13%
49%
38%
Both
30%
16%
60%
Change in asset values
Savings
Livestock
Crops
Borrowing
No shock
3,482
5,755
1,890 23
Shock
-1,078
8,053
3,787
3,906
7,923
-1,054
-2,902
-1,718
3,715
-1,903
-1,859
2,103 12

13. Purchased Voluntary Insurance
Data
55% of households have insurance in half of which are voluntarily purchased
Profile of households with formal insurance (selected results)
Dependent variable:
Purchased Voluntary Insurance
Time
2008
2010
Exogenous: Natural Shock
0.2996**
0.2099
Exogenous: Economic Shock
0.5389***
Idiosyncratic: Insurable Shock
0.2011
0.0296
Idiosyncratic: Uninsurable Shock
0.1130
0.0410
Number of shocks suffered
***
Recovered from prior shock
0.0375
0.0837
Stock Of Savings Dummy
0.2241***
0.3469***
Livestock Dummy
0.0740
Borrowings Dummy
0.1266*
Crop Stores Dummy
0.1097
Total Wealth (VND)
0.1115***
0.1861***
Income (VND)
0.0007**
0.0005**
Education Level of Household Head
0.1891***
0.2193*** 13

14. Empirical Results (1) Stage 1: Consumption Smoothing t-tests (2008)
Overall
No Insurance
With Insurance
< Median Liquid Assets
> Median Liquid Assets
< Median Income
> Median Income
Full sample
Actual
6.37
Predicted
6.16
Difference
0.215*** n
2,039
No shock
6.29
6.12
0.172***
892
Any shock
6.43
6.22
6.74
6.25
6.62
6.01
6.90
6.18
6.06
6.35
6.07
5.94
6.45
0.248***
0.154***
0.388***
0.173***
0.332***
0.072**
0.448***
1,147
687
460
604
542
609
538 14

15. Empirical Results (2)
Stage 1: Consumption Smoothing t-tests (2010) Continued
2008
Overall
No Insurance
With Insurance
< Median Liquid Assets
> Median Liquid Assets
< Median Income
> Median Income
Idio shock
Actual
6.51
6.36
6.73
6.25
6.89
5.99
7.00
Predicted
6.23
6.13
6.39
6.10
6.43
5.89
6.56
Difference
0.275***
0.231***
0.343***
0.152**
0.453***
0.093
0.447*** n
235
142 93
138
114
121
Nat shock
6.35
6.14
6.68
6.57
5.97
6.85
6.16
6.04
6.05
6.26
5.94
6.45
0.190***
0.098***
0.337***
0.073*
0.306***
0.035
0.395***
880
542
338
438
441
501
379 15

16. Empirical Results (3) Stage 1: Consumption Smoothing t-tests (2010)
Overall
No Insurance
With Insurance
< Median Liquid Assets
> Median Liquid Assets
< Median Income
> Median Income
Full sample
Actual
6.62
Predicted
6.23
Difference
0.390*** n
2,036
No shock
6.64
6.19
0.442***
1,014
Any shock
6.60
6.36
6.86
6.40
6.80
6.28
6.93
6.26
6.10
6.44
6.11
6.41
6.01
6.52
0.339***
0.258***
0.428***
0.284***
0.394***
0.271***
0.409***
1,022
535
487
519
502
523
499 16

17. Empirical Results (4)
Stage 1: Consumption Smoothing t-tests (2008) Continued
2010
Overall
No Insurance
With Insurance
< Median Liquid Assets
> Median Liquid Assets
< Median Income
> Median Income
Idio shock
Actual
6.53
6.29
6.92
6.20
6.93
6.13
6.97
Predicted
6.21
6.10
6.38
6.01
6.44
5.94
6.49
Difference
0.323***
0.195**
0.531***
0.188**
0.489***
0.184**
0.477*** n
231
143 88
127
104
121
110
Nat shock
6.63
6.39
6.87
6.47
6.78
6.32
6.94
6.28
4.46
6.15
6.41
6.03
6.54
0.348***
0.290***
0.407***
0.324***
0.370***
0.294***
0.404***
864
440
424
425
438
441
423 17

18. Empirical Results (5) Main result from Stage 1:
Households smooth consumption when faced with income shocks
Motivation for Stage 2:
What role do precautionary savings and insurance play?
Estimate:

19. Interaction:Insurance
Empirical Results (6)
Total Liquid Assets (Table 6 selected results)
(1)
Levels
(2)
(3)
(4)
(5)
Interaction:Insurance
(6)
Interaction: Trans
Income Shock
-0.166***
Exogenous Shock
-0.099**
Exog: Nat
-0.036
-0.034
-0.033
-0.005
Exog: Econ
-0.185*
-0.186*
-0.183*
Idiosyncratic Shock
-0.160***
-0.153***
Idio: Insurable
-0.134**
-0.155**
Idio: Uninsurable
-0.072
-0.070
-0.071
Transfers
0.022
0.024
0.020
0.019
0.036
Transfers*Nat
-0.041
Insurance Claim
-0.096
-0.092
-0.124*
Ins*Insurable Shock
0.159 19

20. Interaction:Insurance
Empirical Results (7)
Total Livestock Holdings (Table 7 selected results)
(1)
Levels
(2)
(3)
(4)
(5)
Interaction:Insurance
(6)
Interaction: Trans
Income Shock
-0.034
Exogenous Shock
0.023 -
Exog: Nat
0.001
0.007
0.106
Exog: Econ
0.050
0.053
0.064
0.057
Idiosyncratic Shock
-0.154*
-0.155*
Idio: Insurable
-0.184**
-0.266***
-0.181**
Idio: Uninsurable
-0.069
-0.064
-0.062
Transfers
0.024
0.026
0.027
0.096
Transfers*Nat
-0.150
Insurance Claim
-0.279**
-0.281**
-0.282**
-0.398***
Ins*Insurable Shock
0.632** 20

21. Interaction:Insurance
Empirical Results (8)
Total Savings (Table 8 selected results)
(1)
Levels
(2)
(3)
(4)
(5)
Interaction:Insurance
(6)
Interaction: Trans
Income Shock
-0.243***
Exogenous Shock
-0.191***. -
Exog: Nat
-0.194***
-0.192***
-0.193***
-0.334***
Exog: Econ
-0.074
-0.067
-0.081
Idiosyncratic Shock
-0.137*
Idio: Insurable
-0.156*
-0.154*
Idio: Uninsurable
-0.001
Transfers
-0.133**
-0.132**
-0.130**
-0.206***
Transfers*Nat
0.206*
Insurance Claim
-0.179**
-0.178**
-0.175**
-0.174**
-0.172**
-0.170**
Ins*Insurable Shock
-0.013 21

22. Interaction:Insurance
Empirical Results (9)
Cash Savings (Table 8a selected results)
(1)
Levels
(2)
(3)
(4)
(5)
Interaction:Insurance
(6)
Interaction: Trans
Income Shock
-0.253***
Exogenous Shock
-0.173**. -
Exog: Nat
-0.165**
-0.160**
-0.294***
Exog: Econ
-0.208
-0.192
Idiosyncratic Shock
-0.200**
-0.198**
Idio: Insurable
-0.225**
-0.226**
-0.222**
Idio: Uninsurable
-0.011
-0.010
Transfers
-0.209***
-0.210***
-0.213***
-0.276***
Transfers*Nat
0.188*
Insurance Claim
-0.166*
-0.161*
-0.159*
-0.158*
-0.160*
-0.154*
Ins*Insurable Shock
0.009 22

23. Interaction:Insurance
Empirical Results (10)
Borrowing (Table 10 selected results)
(1)
Levels
(2)
(3)
(4)
(5)
Interaction:Insurance
(6)
Interaction: Trans
Income Shock
1.073***
Exogenous Shock
0.878*** -
Exog: Nat
0.655***
0.657***
0.640**
Exog: Econ
0.899***
0.897***
0.901***
Idiosyncratic Shock
0.903***
0.883***
Idio: Insurable
0.871***
Idio: Uninsurable
0.570*
0.573*
Transfers
0.235
0.222
0.236
0.227
Transfers*Nat
0.021
Insurance Claim
0.010
0.018
0.001
-0.002
-0.050
Ins*Insurable Shock
0.229 23

24. Summary of findings
Households smooth consumption in the face of adverse income shocks
Precautionary savings are an important mechanism
Households deplete their total stock of liquid assets in response to exogenous economic shocks and idiosyncratic insurable shocks
Financial savings, particularly cash and gold held at home, act as important buffers in the face of spatially covariant natural shocks
Insurance markets play an important role in easing the depletion of livestock holdings in response to idiosyncratic shocks while external transfers are important for risk-coping in the face of natural disasters
Borrowing is increased when households are faced with idiosyncratic and spatially covariant shocks, particularly for wealthy households.

25. Conclusions and Future Work
Savings and insurance instruments are important for consumption smoothing where there are income risks
Savings for precautionary purposes may lead to lower welfare outcomes in the long run given that they result in lower levels of consumption and use up resource that could be put to more productive uses
This is exacerbated by the fact that, as predicted by our theoretical model, the uncertainty associated with income shocks may lead households to save excessively in these forms
The presence of insurance instruments reduces the need to draw down some forms of precautionary savings in the event of adverse income shocks but there is strong evidence to suggest that insurance markets do not fully cover idiosyncratic risks
Future work will investigate the interplay between consumption and investment decisions by risk averse households where income is uncertain and insurance markets fail.

26. Questions and comments welcome
Thank you
Questions and comments welcome

27. Royal Economics Society Conference April 19th, 2011
Trinity College Dublin
Royal Economics Society Conference April 19th, 2011
Income Shocks and Household Risk-Coping Strategies:
Evidence from Vietnam
Carol Newman and Fiona Wainwright
Department of Economics, Trinity College Dublin