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Economic Strengthening for the Very Poor (ES4VP)

Understanding Household Economic Vulnerability

Economic strengthening comprises a portfolio of interventions to reduce the economic vulnerability of households – meaning their ability to cope with the effects of the various risks they face – and thereby improve their resiliency to future shocks. The economic concepts around household risk are fundamental to understanding the nature and effects of economic strengthening interventions.

HOUSEHOLD ASSETS

Assets represent the resources that households can employ to meet their basic needs and to generate income. Five categories of assets are typically used[1]:

  • Human: labor, skills, knowledge, and health
  • Physical: tools, equipment, consumer goods
  • Financial: cash and cash-equivalents in the form of savings, insurance, and credit
  • Natural: land, water, forests, fisheries
  • Social: kinship and community networks, membership of formalized groups
 

Figure 1.         Five Types of Household Assets

An asset-based view of households is fundamental to understanding economic vulnerability and supporting more effective economic strengthening interventions. First, understanding a household’s assets prioritizes their strengths (what they have) rather than their weaknesses (what they need). Second, assets represent both the basis of a household’s livelihood as well as the resources they can draw on in a time of need. Finally, the diversity of household assets explicitly highlights the importance of social capital and social networks, especially when the household has low levels of other assets. Social capital is often overlooked, underestimated, or neglected in economic strengthening – yet it may be the most powerful asset available to a highly vulnerable household.


HOUSEHOLD ECONOMIC MODEL 

 

Figure 2.         Household Economic Model

USAID’s AIMS project elaborated a conceptual model of the household economic portfolio[2] to better understand how households manage and cope with risk to their economic activities (refer to Figure 2). This model comprises (1) the set of economic assets available to the household (human, physical, and financial), (2) the set of household activities (production, consumption, and investment), and (3) the circular flow of interaction between household assets and activities (outflows from assets as inputs/expenditures for household activities and inflows to assets as income and other additions from household activities). Households can further augment their assets through two primary channels: accessing credit through lenders (commercial relationships) and a range of resources through social networks (non-commercial relationships). This model underscores the following salient features:

  • Household activities, including household maintenance activities, can only be supported through available household assets.
  • Household assets can only be replenished or increased through remunerative household activities or by accessing credit providers and social networks.
  • Accessing credit providers and social networks implies some degree of reciprocity where loans must be repaid (often with interest) and social obligations fulfilled (often in a non-monetary manner).
  • Where access to credit is limited, social networks are extremely important for households to manage the assets they have available to support household activities.

Poor households exhibit unique characteristics that are also incorporated into this model:

  • Households tend to have incomplete information about markets or imperfect access to markets, increasing the level of uncertainty and risk associated with decisions around household activities.
  • Because the same assets can be employed for both production and consumption, household decisions to allocate resources for production activities will also consider the potential impact on consumption activities – which is contrary to assumptions in neoclassical economic theory and traditional models of enterprise decision-making.
  • Households will tend to engage in multiple production activities in order to (1) obtain an acceptable level of income, (2) spread income more evenly throughout the year, (3) meet the needs of home consumption (i.e., subsistence activities) and earning cash, and (4) diversify income sources as a way of managing risk.
  • Lower levels of assets correspond to a higher degree of vulnerability because households have fewer mechanisms for managing risks and coping with potential shocks.

 

HOUSEHOLD RISK MANAGEMENT

Households manage risk and potential shocks through two primary strategies[3]. The first category, risk reduction strategies, intends to reduce the household’s exposure to risk and to smooth the flow of income into the household. The second category, loss management strategies, seeks to improve the household’s ability to cope with loss after a shock has occurred and to smooth household consumption. The following tables were adapted from a report entitled Household Economic Streghtning in Tanzania produced by the USAID. 

Table 1. Risk Reduction Strategies to Smooth Income in Case of a Shock

Selecting low-risk activities

Low-risk economic activities have a lower probability of loss or failure and tend to require a lower investment, which avoids competing with household consumption activities. However they are typically less profitable than higher-risk activities and contribute less to replenishing or growing the household’s asset base. Households with fewer assets tend to select lower-risk activities, which may be lead to a downward spiral.

Diversifying activities

Selecting multiple unrelated economic activities may reduce a household’s overall risk should any individual activity fail. Multiple activities may also help ensure a more continuous or even flow of income into the household throughout the year, especially when individual activities are seasonal in nature. Diversification is most effective in reducing risk when individual activities are unrelated, for instance combining agricultural activities, nonagricultural activities, and wage labor.

Building insurance mechanisms 

If market-based insurance products are unavailable, accumulating savings and assets are important self-insurance strategies for a household to draw upon in the event of a loss. Moreover, households tend to actively seek and maintain social networks to access resources in case of loss or spread risk through sharing. Another potential insurance mechanisms is access to credit for consumption smoothing – in this case it is the access to rather than the use of credit which is the main risk reduction strategy.

 Loss management strategies follow a predictable sequence of stages corresponding to the magnitude of the shock with respect to the household’s assets. 

Table 2.   Loss Management Strategies to Smooth Consumption after a Shock

Stage 1

Using insurance and reversible mechanisms

  • Increasing wage labor and temporary migration for employment
  • Liquidating self-insurance assets such as cash savings and physical assets accumulated for their value (typically food stocks and livestock)
  • Borrowing from formal and informal credit markets
  • Using social and kinship networks
  • Reducing consumption and investments in health and education

Stage 2

Disposing of key productive assets

  • Selling land, tools, equipment, and other assets that generate income for the household
  • Borrowing at extremely high interest rates
  • Further reducing consumption and investments in health and education

Stage 3

Destitution

  • Relying on charity
  • Breaking up the household
  • Migrating

 It is important to understand that production and consumption are closely interlinked in poor households because their scarce assets can be allocated to either activity. Accordingly, they tend to manage risk to ensure that a loss of income will not reduce their consumption capacity – meaning a strong preference for risk reduction strategies. However, if such households have access to strong loss management strategies, they will see less of a need to prioritize risk reduction strategies. This phenomenon has fundamental implications for understanding household decision-making and designing effective economic strengthening interventions.[4]

 

 

 



[1] DFID (1999). Though the concept is not unique, the Sustainable Livelihoods Approach as developed and employed by DFID provides a solid overview of the five types of household assets.

[2]  M. Chen and E. Dunn (1996).

 

[3] E. Dunn, N. Kalaitzandonakes, and C. Valdivia (1996).

[4] HH Econ Strengthening in Tanzania Jason Wolfe (p. 3-6)