Consumption under Uncertainty: Full Insurance and Price Variation in Vietnam

Households in developing countries live in high risk environments and are potentially vulnerable to weather shocks, illness and other causes of income variability. We draw on the full-insurance literature and look at the ability of households in Vietnam to smooth consumption when faced with idiosyncratic shocks to income, but we modify the standard model in several ways. Instead of looking at consumption in terms of expenditures, the focus in this paper is on quantities consumed. We also allow households to consume different bundles of goods. These modifications allow us to investigate whether the apparent rejection of full insurance in the literature can be explained by spatial variation in prices. We develop a simple model that leads to an estimation equation which we test using panel data from Vietnam. We reject full insurance across all goods, although the degree of insurance varies across goods. This result is robust to controlling for selection and using either commune or household level prices. We also find little difference in the ability of poor and non-poor households to smooth consumption; however, we do find that households in the North are less able to smooth consumption than those in the South. These results suggest that policies to improve risk sharing in Vietnam must not only focus on improving mechanisms to share risk between locations, such as lowering transportation costs, but also look to strengthen institutions within a given location. Special thanks to Ethan Ligon for guidance on this project from its beginnings. Thank you to Edward Miguel and Elisabeth Sadoulet for helpful comments and thanks to seminar participants at UC Berkeley for their numerous suggestions. Department of Agricultural and Resource Economics, University of California at Berkeley, 207 Giannini Hall Berkeley, CA 94720; Tel: (510) 289-0071; Fax: (510) 6438911 E-mail: [email protected].