Poverty persistence and informal risk management: Micro evidence from urban Ethiopia

Two factors that have received limited attention in poverty dynamic studies are the role of risk in causing poverty mobility and attrition bias. Controlling for the attrition bias, we study poverty dynamics in urban Ethiopia with an emphasis on the effect of idiosyncratic shocks and informal risk management strategies. We used a unique panel data spanning a decade. Our results show the adverse impact of uninsured idiosyncratic shocks on welfare. We find unemployment of household head propels households to persistent poverty. We also observe poor households using ineffective risk management strategies which have negative consequences on welfare than their non-poor counterparts. Further, we find strong poverty state dependence which is mainly driven by households' heterogeneity. The overall results of our study suggest that public insurance programmes that support poor households during 'bad times' may improve welfare by providing consumption insurance. Indeed, policies focusing on household heterogeneities such as exposure to risk, lack of education, personal skills and capacities, could have long lasting effects.

JEL Classification: D14; I32; O12

Keywords: Poverty persistence, idiosyncratic shock, endogenous switching model