Between the State and the Market: Can Informal Insurance Patch the Safety Net?

Most households in low-income countries deal with economic hardships through informal insurance arrangements between individuals and communities rather than through publicly managed programs or market-provided insurance schemes. Households may, for example, draw on savings, sell physical assets, rely on reciprocal gift exchanges, or diversify into alternative income-generating activities. These mechanisms can be highly effective in the right circumstances, but most recent studies show that informal insurance arrangements are often weak. Poor households, in particular, have substantial difficulties coping with even local, idiosyncratic risks. Public policy can help reduce vulnerability by encouraging private, flexible coping mechanisms while discouraging those that are fragile or that hinder economic and social mobility. Promising policies include creating self-regulating workfare programs and providing a supportive setting for institutions working to improve access to credit, crop and health insurance, and safe and convenient saving opportunities. Many low-income countries, from Sub-Saharan Africa to Southeast Asia, have suffered major natural disasters and political upheavals in the 1990s. These events remind observers of a reality hidden in official poverty statistics: that the condition of poverty is linked closely to vulnerability. Many poor households are exposed regularly to risks from illness, harsh weather, political instability, and economic mismanagement. Concern with vulnerability may be both intrinsic and tied to implications for income generation as well as to the longer-term consequences for the health and education of children (Jacoby and Skoufias 1997; Hoddinott and Kinsey 1998; Rose 1999). 1 Fear of risk can lead poor households to forgo potentially valuable new technologies and profitable production choices. Rosenzweig and Binswanger (1993), for example, use data from rural South India to show that an increase in risk (as measured by an increase of one standard deviation in the coefficient of variation of the