This paper examines attitudes to risk and the ability to manage risk as two separate stages in the vicious circle of poverty - a process that both causes and is caused by chronic poverty. We have investigated attitudes to risk employing an incentive-compatible research design among small-scale farmers in Ethiopia, Uganda and Andhra Pradesh (India).
The evidence presented in this paper suggests that the vicious circle of poverty should be represented as follows. Due to the precarious conditions in which asset-poor small- scale farmers operate in poor countries, and in the absence of insurance markets, adequate risk management requires diverse livelihoods with low covariate risk between the factors that cause the uncertainty of income streams associated with each activity.
Failing risk management strategies are bound to lead to a depletion of the (small) physical, human and social capital buffer, thereby increase the likelihood of income poverty in any given year, and thereby increase the likelihood of chronic poverty. A state of mind brought about by chronic poverty, which we measure with an index of perceived vulnerability, reduces one's willingness to undertake the risky investment that may offer an escape from poverty, which completes the circle. A research focus on risk attitudes allows one to see that the conservative or even inert entrepreneurship that traps its practitioners into low risk/low return activities is not necessarily evidence of their irrationality, incompetence or backwardness, but may well be a manifestation of a finely balanced survival algorithm. Testing for the presence of such a survival algorithm requires that one abandons the axioms of the dominant theory in economics of risky choice (expected utility theory) and enters the realms of decision-weighting models. We find strong evidence in favour of the descriptive superiority of such models in our data of precisely the kind that the survival algorithm implies; which is all the more remarkable, since risk experiments until date (in high-income countries) confirm decision-weighting models as we do, but find at the same time that the mirror image of the kind of weights we find describes their data best.
Risk attitudes in the ‘vicious circle of poverty’, presented at Staying Poor: Chronic Poverty and Development Policy, Institute for Development Policy and Management, University of Manchester, 7-9 April 2003. Chronic Poverty Research Centre (CPRC), Manchester, UK, 28 pp.