MOYALE, Ethiopia — After hearing about new types of fertilizer that could potentially increase his seasonal crop yields by a sizeable amount, Eyob decided that they weren’t for him. Eyob understood that using the fertilizer may allow him to produce more than his normal subsistence style farming habits do. Furthermore, while poor, he did have some small measure of savings held in the form of physical assets.
So, why did he decide against an investment that may have helped to eventually bring his family out of poverty? To Eyob, it was simply too risky of an investment to make.
Idiosyncratic risk is a part of everyone’s life, and when things go poorly the consequences can hurt. This is a particularly potent reality for the world’s poor.
According to the 2014 World Development Report, the poor lead riskier lives than those with higher incomes, and when economic shocks occur, they are more heavily affected. In the world’s least developed economies where informal employment rates are high and stable income is not assured, risk often dominates financial decision making.
When assessing whether or not to purchase the fertilizer, Eyob had to take a lot of potential scenarios into consideration. What if the rains didn’t come this year? What if food prices continued to rise? What if his wife or one of his children fell ill and required medical treatment? What if the new techniques did not work as well as expected?
Eyob’s physical holdings represent his safety net against such scenarios, and if he liquidates them to invest in something new, he makes himself more financially vulnerable to a wide variety of shocks that could result in sending his family into deeper poverty. As a result, the poor tend to be highly reserved when it comes to investing in new technologies and to testing out new best practice techniques within their respective market activities.
Once a certain level of subsistence is reached, studies show that fear of economic shocks creates barriers to further development. Even when investments seem promising, families will often choose to forgo the opportunity for the short run promise of stability. The result is a high level of missed potential for growth and large numbers of individuals remaining in poverty.
Part of the cause of risk aversion rests in lack of access to adequate educational support concerning new technologies and new opportunities for growth. Yet, evidence from India suggests that increases in education alone are not enough to push past risk barriers. A 2009 study on household risk management found that positive results were best witnessed when formal insurance markets not only existed, but were also subsidized by the central government.
In 2011 Oromiya, Eyob’s home region in Ethiopia, faced severe drought leading to increases in food insecurity. Indeed, concerns of drought are a main reason listed by Ethiopian farmers as to why investments are not made in new inputs. One issue that Eyob faces is a lack of access to subsidized formal rainfall insurance, which would ensure that his losses due to low rain levels would be covered.
Randomized testing in Ghana has shown that subsidized rainfall insurance can result in significant increases in small farm agricultural output. When the potential for risk is smoothed through insurance, then more financial assets are freed for new investment opportunities. Farmers in Ghana are much more likely than their counterparts in Ethiopia to invest in fertilizers, new seed varieties and pesticides, and corresponding studies in India demonstrate similar results.
The same holds true for other vital markets, such as healthcare. If one of Eyob’s children were to fall ill, he could expect to see a cut in his consumption spending by 10 percent for the year with continued financial instability for the next five years (the average effect of a serious illness on an Ethiopian household).
Stable insurance markets coupled with government subsidization and general education campaigns focusing on available opportunities will better allow those living in extreme poverty to escape risk-induced poverty traps, and move past traditional “safe” subsistence living styles.
While the World Bank does not highlight risk management as a cure-all for poverty reduction, it is presented as a mechanism that is not only vital for safeguarding existing growth, but as tool that can be used to fuel new growth by unlocking the investment potential of Eyob and the rest of the world’s poor.
– Ty Butler