Subjective Income Expectations and Risks in Rural India

Income risks and expectation about future income play a fundamental role in the decision making of households. The analysis of income risk is particularly important for developing countries, where incomes are more volatile than developed countries, and credit and insurance markets are inadequately developed, limiting opportunities available to households to diversify their risks. When households have inadequate opportunities to diversify their risks, income risks may lead to relatively high fluctuations in consumption and thus greater levels of transient poverty. This may also lead to a poverty trap, as poor households may enter low-risk, low-return activities, and low-return and less capital-intensive activities. This paper analyses the pattern and determinants of (perceived) expected income and income risk in rural India. It uses unique primary survey data eliciting subjective income distribution from households in twelve villages in Bihar. The sample consists of 659 households with approximately 4,100 household members. The survey was designed to elicit the cumulative distribution function (cdf) of future household income. Using this information, it constructs household-specific subjective expected future income, its variance and coefficient of variation. It finds that both expected future income and income risks (variance and coefficient of variation) differ substantially across households. Both expected future income and its variance increase with current income, however, there is a significant negative association between the coefficient of variation of future income and current income, suggesting that low-income households face greater variability in their income. Upper caste households and households reliant on non-agricultural income have significantly higher expected future income and variance. To the extent income risks lead poor households to choose low income and low risk activities, public policies designed to reduce these risks, such as provision of insurance (e.g. rainfall insurance) and easier availability of consumer credit are likely to have a significant effect on poverty and inequality. Microfinance institutions and nongovernmental organizations can play an important role in the provision of insurance and labour market information. Public investment in irrigation, better weather information, and employment guarantee schemes, such as the National Rural Employment Guarantee Act, can reduce income and consumption risk.