Abstract

This dissertation investigates the way in which potential and actual shocks influence economic conditions and choices of the Indonesian rural households. The analysis focuses on three main issues. First, we explore which strategies are chosen for different types of shocks. Second, we investigate which are the specific mechanisms adopted in the face of the most common shock (crop loss), and the consequences on consumption. Finally, we analyze the consequences of risk and shocks on a particularly important household decision: how much to invest in children education. Three sets of main conclusions emerge from this dissertation. First, we have learned that when facing a shock, households choose risk coping strategies by comparing responses with each other rather than with a common benchmark. In such a situation of non-exclusive and dependent multiple responses, the widely used Marginal Logit Model (MLM) suffers from a number of limitations. The two models we developed to take into account these specificities appear to outperform the MLM in describing these type of choices. The second main conclusion relates to the evidence that the choices between different coping strategies markedly differ between poor and non-poor households. In the face of shocks, the former appear to behave in a very different way. In general, rich households smooth consumption relative to income, whereas the need to accumulate savings to both build a buffer stock of assets and self-finance profitable investments leads poor people to rely more on ex post income smoothing strategies (taking an extra job) and to use part of this extra labour income to preserve their level of assets, even reducing consumption if necessary. Finally, it is necessary to deepen our knowledge of the long-run consequences of shocks, particularly with respect to the human capital formation of children. We found that the impact of uncertainty on schooling decisions is more subtle than suggested by much of the existing development literature. Taking into account that withdrawal from school is an absorbing state, that is children cannot re-enroll once they stop going to school, temporary interruptions in child schooling have long term impacts on the child human capital. Given irreversibility of withdrawal from school, in the face of household income variability parents are more likely to send children to school to give them the option to continue with higher schooling levels in the future (and hence earn higher earnings when they become adults).