Poverty Risk Assessment

Risk and vulnerability to poverty has received renewed attention in recent years. Vulnerability to poverty is an important dimension of poverty and deprivation, but it is also a cause of deprivation. There is evidence on the permanent effects of shocks on nutrition and incomes. Risk-reducing actions to avoid risk are also causing permanently higher poverty. Risk-reducing actions to avoid risk are also causing permanently higher poverty. The presence of poverty traps and other forms of persistence means that reducing vulnerability will have an important impact on poverty reduction. It is this mounting evidence that has encouraged economists to give renewed attention to the issues of risk and vulnerability. The result is a simple understanding of how risk may translate in vulnerability and in poverty, and checklist of sources of risk that should be incorporated in thinking about vulnerability.

Poverty is increasingly acknowledged to be multidimensional. There is no limit to other dimensions of poverty, such as educational opportunities, mortality, nutrition and health. Broader dimensions, such as exclusion and the fear and weakness in experiencing poverty are valid dimensions to consider as well. Risk relates to events possibly occurring, beyond the direct control of individuals and households. The focus in work on vulnerability should be on downside risk. Vulnerability is not just a function of the environment a person lives in: it is the product of risk, of person’s conditions but also of his/her actions. Households and communities are units of conflict and co-operation, a dimension that is important in applying the analysis.

The framework distinguishes three levels, from assets, over incomes generated from these assets to outcomes and capabilities. Each transformation from one level to the next involves active decisions.

Each level and the transformation considered involve risk.

Households and individuals have assets, such as labour, human capital, physical capital, social capital, commons and public goods at their disposal to make a living. Assets are used to generate income in various forms, including earnings and returns to assets, sale of assets, transfers and remittances. Households actively build up assets, not just physical capital but also social or human capital, as an alternative to spending. Incomes provide access to dimensions of well-being: consumption, nutrition, health, etc., mediated by information, markets, public services and non- market institutions. Generating incomes from assets is also constrained by information, the functioning of markets and access to them, monopoly, the functioning of non-market institutions, governing bodies, public service provision and public policy.

Poor households are seen in this framework as weighing current survival and well-being, with decisions affecting their future possibilities. They are typically severely constrained in their options by their assets and the conditions they face.


Risks are faced at various levels in this framework. They do not just relate to environmental factors. Risks involve also markets, public policy and social capital. Assets, their transformation into incomes and in turn their transformation into dimensions of well-being are all subject to risk. Assets are subject to risk themselves. Examples include destruction due to environmental factors or conflict, the erosion of human capital due to health or unemployment, the collapse of asset markets and values, problems with property rights and their enforcement, risks in social capital and access risk to public goods and commons.

The transformation of assets into income is also subject to risk. Beyond obvious but important factors such as climate or health, one should focus on price risk, to access of rationed inputs, risks of exclusion from informal or formal safety nets, problems related to contract enforcement and risks to changes in policy. Entitlements from incomes are also mediated by risk, including price risk but also and importantly, risks related to imperfect information and to the provision of public goods and services, especially since they often are rationed.

Risks related to policy, public services, access to commons and public goods, risks to access and the functioning of social capital and risks of exclusion from formal and informal safety nets are largely ignored. Different risks are quite different in size, likelihood and frequency over time. Different characteristics of risk have different implications for the ability to cope with them, as well as for policy. Characteristics include the extent of state dependence or correlation over time, whether the shocks are rare but very large, whether the shocks are occurring at the same time across individuals, rather than individual-specific.

Vulnerability is determined by the options available to households and individuals to make a living, the risks they face and their ability to handle this risk. Any policy to try to reduce vulnerability must start from understanding the nature of the vulnerability faced by individuals, households and communities. The framework may then provide a checklist. This will require an understanding of how observed outcomes are linked to incomes and assets. Furthermore, one must develop an understanding of the different sources of risks faced by household and their relative importance. Finally, one needs to study how risk affects assets, incomes and entitlements, ex-ante and ex-post, requiring a study of ways individuals, households and communities cope with risk.

Policies to reduce vulnerability will include standard poverty reduction policies, aimed at improving levels and trends in well-being, but will need to be supplemented with policies focusing on risk and on fluctuations in well-being, such as related to seasonality.
The World Development Report 2000/01 acknowledges that vulnerability reducing policies should be more than safety net policies, but convincingly argue to start from the observed strategies used by individuals, households and communities. Optimal policy design should aim to strengthen, complement and replace existing strategies to obtain maximal reduction in vulnerability. Replacement of traditional mechanisms is not necessarily problematic, although more needs to be known about the extent to which, how these changes are occurring and their net impact.

Markets are means of linking people both spatially and over time. Shocks that otherwise would have afflicted only ‘island’ economies are now transmitted across a larger group of people. Markets replace some ‘natural’ shocks by seemingly ‘man-made’ shocks. The transmission process in integrated economies would mean that large economic shocks are passed on relatively fast, via relative price changes. It can be stated that despite high growth and poverty reduction in the economies, vulnerability to poverty following large shocks had remained relatively high. The main effects appear to have been the long term reduction in health and education investments by parents in their children, in order to cope in the short run.

Traditional coping mechanisms, such as via mutual insurance, is likely to come further under pressure with economic mobility, wealth differentiation, changing age profiles.
Another source of increased vulnerability could be safety net policies themselves, however well- intentioned. For example, with imperfect coverage by or limited scope of the safety net, support to some individuals may result in negative externalities on others, via the breakdown of reciprocal arrangements. In fact, it is possible that it even results in some households being more vulnerable than without due to the uncertainties of the formal safety net.
Any policy to reduce vulnerability requires clear commitment and credibility. In the first place, it must be predictable.

Assets
Examples of Risk (a)
•loss of skills due to health or unemployment
•land tenure insecurity, uncertain titles to other assets
•asset damage due to climate, war or disaster
•access to commons and unclear commitments regarding public goods
•violations of commitment and trust
•loss in value of financial assets or pension funds linked to inflation, stock market or exchange rate collapses.

Incomes
Examples of Risk (b)
•output risk due to climatic shocks, disease, conflict
•output price risk
•covariance in incomes and asset prices
•risk in asset returns from savings andinvestment (including inflation)
•uncertain access to inputs or cash flow support during production
•imperfect enforcement of contracts, such as payment for goods or services rendered
•uncertainty about enforcement of informal arrangements, including informal protection – for example, transfers and remittances may not materialise
•uncertainty regarding rationing in public support, for example, risk of exclusion from safety net
•imperfect information and knowledge about opportunities
•risks in policy environment – credibility and commitment to continue policies


Well-being - ‘Capabilities’
Examples of Risk (c)
•price risk in food markets
•food availability and rationing risk
•uncertain quality of public provision in health and education
•uncertainty about rationing scheme employed in health or education
•imperfect knowledge about health and nutrition ‘production’ (uncertainty about right answer)

Extracted from:
Dercon, S., Assessing Vulnerability to Poverty, paper for DfID, August 2001. The full documet can be found at:
http://www.economics.ox.ac.uk/members/stefan.dercon/