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Consumption smoothing and the welfare cost of uncertainty

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  • Alem, Yonas
  • Colmer, Jonathan

Abstract

Separating the effects of uncertainty from realised events, and identifying the welfare effects of uncertainty, present a number of empirical challenges. Combining individuallevel panel data from rural Ethiopia with high-resolution meteorological data, we introduce a new proxy for income uncertainty - mean-preserving rainfall variability - and estimate that an increase in income uncertainty is associated with reductions in objective consumption and subjective well-being (SWB). Furthermore, 86% of the effect on SWB is attributed to the direct effects of uncertainty, consistent with a model of optimal expectations (Brunnermeier and Parker, 2005). In addition, we find that farmers in more uncertain environments are more resilient to realised rainfall shocks, consistent with a trade-off between optimism about the future and risk-management investments today. These findings suggest that the gains from further consumption smoothing are likely greater than estimates based solely on realised consumption fluctuations.

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  • Alem, Yonas & Colmer, Jonathan, 2018. "Consumption smoothing and the welfare cost of uncertainty," Ruhr Economic Papers 780, RWI - Leibniz-Institut für Wirtschaftsforschung, Ruhr-University Bochum, TU Dortmund University, University of Duisburg-Essen.
    • Handle: RePEc:zbw:rwirep:780
    DOI: 10.4419/86788908
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    Cited by:

    1. Jonathan Colmer, 2021. "Rainfall Variability, Child Labor, and Human Capital Accumulation in Rural Ethiopia," American Journal of Agricultural Economics, John Wiley & Sons, vol. 103(3), pages 858-877, May.
    2. Yonas Alem & Mathilde Maurel & Katrin Millock, 2016. "Migration as an Adaptation Strategy to Weather Variability: An Instrumental Variables Probit Analysis," Université Paris1 Panthéon-Sorbonne (Post-Print and Working Papers) hal-01955941, HAL.

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    More about this item

    Keywords

    income uncertainty; consumption smoothing; subjective well-being; rainfall variability;
    All these keywords.

    JEL classification:

    • I31 - Health, Education, and Welfare - - Welfare, Well-Being, and Poverty - - - General Welfare, Well-Being
    • O13 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development - - - Agriculture; Natural Resources; Environment; Other Primary Products
    • Q12 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Agriculture - - - Micro Analysis of Farm Firms, Farm Households, and Farm Input Markets
    • Q56 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Environmental Economics - - - Environment and Development; Environment and Trade; Sustainability; Environmental Accounts and Accounting; Environmental Equity; Population Growth

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