Rural household in developing countries face substantial risk, including droughts, floods, and other weather events; policy shocks, such as changes in taxation and subsidies; and the death and illness of household members.
Such shocks can result in high losses of income through for example destruction of harvests or the associated lack of agricultural wage employment. Especially climatic shocks may also cause losses of productive assets and thus future income-generating capacity: land may disappear by a landslide and livestock may drown in a sudden flood. In the absence of formal insurance and well-functioning financial markets, people cope with these shocks through mutual support, cutting consumption, increasing work effort, or sales of assets. In addition, they may adjust their livelihood to avoid major losses by diversifying their activities and/or by engaging in relatively certain but low-income activities.
These strategies are costly and may perpetuate poverty. When your income is low, it is difficult to save sufficiently to invest in more profitable activities. Even if people can generate sufficient savings, they may not want to make the investment because it would involve additional risk, or they may need their savings to cope with the remaining shocks. In addition, shocks may throw people into poverty that were not previously poor, if their assets are destroyed or they are forced to sell assets to survive. Studying existing management and coping strategies, their consequences for household welfare, and potential alternatives can help break the paralyzing effect of risk on welfare improvements of the rural poor.