Academic journal article Journal of Southeast Asian Economies

Risk, Uncertainty and Consumption-Smoothing Mechanisms: Evidence from Thai Household Socio-Economic Panel Data

Academic journal article Journal of Southeast Asian Economies

Risk, Uncertainty and Consumption-Smoothing Mechanisms: Evidence from Thai Household Socio-Economic Panel Data

Article excerpt

1. Introduction

Households in developing countries, mainly in rural areas, often face immense risk from both idiosyncratic and covariate shocks. Their income stems, either directly or indirectly, from agriculture. Consequently, their incomes are highly uncertain due to changes in weather, diseases, pest attacks and price volatility. These idiosyncratic and covariate shocks may lead to consumption insecurity, leaving some people with a lowered standard of living, which, in turn, acutely threatens their subsistence. Theoretically, income fluctuation is not expected to affect household consumption if credit and insurance markets are complete, or alternative mechanisms for dealing with risk exist.

As is the case in most developing countries, credit and insurance markets in Thailand are incomplete, especially for poor households and those based in rural areas. (1) Formal credit and insurance arrangements are seldom available for these households as a result of information asymmetry (Stiglitz and Weiss 1981). Therefore, finding alternative ways to smooth consumption is the second-best response to market failure.

A large body of literature indicates that households in developing countries make use of a wide variety of smoothing mechanisms. Alderman and Paxson (1992) have divided these mechanisms into two main strategies:

(i) "risk management strategies" (or income-smoothing), used to protect households from adverse income shocks before they occur, by making conservative production or employment choices and diversifying economic activities; and

(ii) "risk coping strategies" (or consumption-smoothing), which are effected after shocks have occurred. Examples are: borrowings and savings; depletion and accumulation of non-financial assets; the adjustment of labour supply; and the employment of formal and informal insurance arrangements (Morduch 1995).

In the context of the Thai economy, Paulson and Townsend (2005) group formal and informal financial institutions for credit and insurance markets into six categories. The first category, formal institutions, includes commercial banks and finance companies. The second category, village institutions and organizations, incorporates production credit groups, rice banks and buffalo banks. The third includes formal loans from the Bank of Agriculture and Agricultural Cooperatives (BAAC). The BAAC customers whose loans are secured through joint liability arrangements make up the fourth group. Moneylenders are the fifth. Finally, rotating savings and credit associations (ROSCAs) make up the sixth group. Additionally, it is also common for households to borrow from relatives and neighbours.

In addition to the abovementioned institutions, data from the Ministry of Finance Household Debt Survey (MOF survey) reveal that Thai households, especially poor households, still use a variety of risk-management and risk-coping mechanisms just like most households in developing countries. These strategies include selling livestock and stored rice, cutting household expenditure, selling non-financial assets such as land and jewellery, working more hours and migrating elsewhere for work opportunities (Rungruxsirivom 2007). The MOF survey data indicate that a number of households also diversify their income sources, implying the use of a risk-management mechanism. (2) Furthermore, like most developing countries and despite the existence of such mechanisms, consumption fluctuations in Thai households--especially poor households--remains high. The Thai government has, therefore, launched various programmes to broaden each household's accessibility to credit sources. Some examples are village funds, people's bank cash handouts, sufficient economy funds and universal health care.

Despite the awareness of the importance of both private and public insurance mechanisms, research on the effectiveness of these mechanisms in protecting Thai households from adverse shocks is surprisingly scant. …

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