Designing Shock Protection for Vulnerable Households:
A How-to Guide
Jonathan ZinmanDartmouth College
BASIS CRSP Policy ConferenceImpact Evaluation of Innovations in Rural Finance
June 13, 2006
Overview of TalkWhat are shocks?
Why should we focus on interventions to help “smooth” shocks?
What works?: Don’t know much, but on the right track:• Scientific standard the right one given stakes• Research adds value: what works and why
What do we need to know? (The substance):1. Are there underlying frictions in micromarkets? Failures?2. How do our targeted consumers/entrepreneurs make decisions?3. What works?
– (Traditional evaluation approach answers only a small part of #4 at best)
How do we get there? The process:• Experimentation and the learning organization• Real innovations guided by science and practitioner experience
Why Worry About Shocks?• Temporary setbacks should be smoothed
– Long-run prospects unaffected• Smoothing = getting households, businesses, “back on
their feet”• Failure/inability to smooth is inefficient:
– Utility is concave in consumption: a little consumption means a lot (of marginal utility)
• Starving is very “costly”– Don’t want viable businesses to fail
• Irreversible investment problem; high continuation value– Discourages risk-taking
• Stock options example
• “Safety net” for permanent shocks
How Do People/FirmsDeal With Shocks?
• Saving (for a rainy day)• Borrowing (on the rainy day)• Insurance (its raining cash)
Why Should WeWorry About Shocks?
• Some reason (arguably ample reason) to believe that microfinance and microinsurance markets don’t function well– Information asymmetries– Consumer biases
• Undersaving…. Underinsuring?• Overborrowing on sunny days
– Inadequate safety net• Especially in LDCs• Incomplete formal markets » perverse consequences? (crowd-out
informal)• Theory also shows that when markets are missing,
shocks can have disastrous consequences– Poverty traps– Debt traps
Why Should WeWorry About Shocks?
• Much more theory, practice than conclusive evidence here
• Evidence is somewhat indirect: when shocks happen, how well can households smooth/recover?– Shocks are a problem: Gertler and Gruber AER 2002
& Gertler et al 2004– Shocks not a big problem (informal markets/networks
do the job): Townsend 1995, etc.– Morduch 2002 (World Bank Observer) reviews
Can Micromarket Interventions Help?
• The little available evidence suggests yes:– Gertler et al: microcredit and health shocks
• Ongoing BASIS-funded research, including….– Karlan-Zinman 2006:
• more consumer credit access » avoid shocks, smoother consumption
What works?
• “More research needed….”– Scientific standard appropriate given level of
resources committed to development projects– Randomized-control trials= gold standard– Research adds value, saves donor money in
medium-haul• What works….
– Work relative to what? (opportunity cost)– Replicate effective interventions
• Why (doesn’t) work?– Guide next round of innovations
So What Do We Need to Know?The Three Questions:
1. Are there market frictions?2. How do targeted folks make decisions?3. What works?• #s 1-2 about whether and how to design
interventions that works– the “R” in R&D
• # 3 about what works– Evaluation as traditionally defined
So What Do We Need to Know?
1. Are there market frictions?• Important because tells use whether and
how to intervene• Example: asymmetric information
– Biggest motivation for microfin/insurance– But little empirical evidence– Moral hazard and adverse selection have
different practical and policy implications• E.g., invest in enforcement? Screening?
Asymmetric Information: Progress
• Karlan-Zinman 2005: randomize offered/actual/and future rate in a consumer credit market (Manfred)
• Gine-Karlan-Zinman 2006: randomize premiums offered on private hospitalization insurance (Omar)
• Karlan-Mullainathan-Zinman: randomize enforcement (Diego)
So What Do We Need to Know?
2. How do targeted folks make decisions?• “If we build it, will they come?”• What should we build in the first place?• Example: are people “rational” or
“psychological”?• Impacts how market, price, design
products
Client Decision Making: Progress
• Example: Say you want to help people save (or access credit or insurance) to help protect against shocks….
• Only “psych” agents want commitment devices (Omar: SEED; also anti-smoking)
• Only “psych” agents may respond more to marketing/presentation than to price (BKMSZ, with Manfred)
• “Rational” will benefit from expanded access to consumer credit, “psych” may not (Manfred)
Smoothing and Targeting
• Thinking about specific motivations for intervention (Questions 1-2) raises another key question:
• Whom should we target?– Why has consumer credit been the bastard
stepchild of microcredit?
Why not Target Consumers?
• Pat answer: consumer credit not “productive”– But theory and (a bit of) evidence suggest that
benefits from smoothing are large, and that micromarkets could help
– Evidence shows that “entrepreneurial” credit used for cons’n smoothing (Menon) and vice versa (Karlan-Zinman; credit cards in the U.S.)
Why Not Target Consumers?
• Pat answer: consumers don’t know what’s good for them. Biases lead to overborrowing (BKMSZ; Stango-Zinman)– But consumer = “the business” in closely-held
firms– Do people wear different hats?– Are entrepreneurs more rational than their
wage-earning counterparts?
Question 3. What Works?
• What is “what”?....• Product “design”, market “access” has many
elements:– Pricing– Other contract terms (e.g., loan maturity)– Risk assessment– Enforcement– Product development– Product presentation (marketing and sales)– Targeting
What Works?Beyond Evaluation: Experimentation
• What helps consumers deal with shocks?– All of our related projects answer this question– We test specific interventions/innovations. More
examples:• Does access to health insurance improve well-being?
(ongoing)• Expanding consumer credit supply DOES improve well-being
(Manfred)• Does expanding access to microcredit via credit scoring
improve household well-being? (Reggie)– But approach is more ambitious than traditional
evaluation
What Works?Beyond Evaluation: Experimentation
• Traditional evaluation:– After-the-fact– Often ad-hoc
• Experimentation– Ground-floor and continuous
• “architecture” vs. “inspection” approach– Build in tests of the “why” questions as well– Feed back into design and operations– Experiment again
Experimentation &the Learning Organization:
A Virtuous Cycle
Evaluate
Innovate
Experiment
Experimentation asProcess Innovation
• Experimentation does more than answer the 3 questions
• Can transform organizations– Mircomarkets: democratize finance– Experiments: democratize scientific approach
to business, policy
Experiments are Process Innovation:The Learning Organization
• Experiments make organizations more:– Strategic– Systematic– Scientific– Capable– Examples: Green Bank; ICICI; Other credit card
companies; H&R Block; Amazon)• Experimental approach also makes knowledge
transfer easier: methodology and assumptions are transparent
Summing Up
• Research adds value:– What works and why– Helps with evaluation and design
• What we need to do:– Answer the 3 questions
• Frictions/failures?• Decision Making by our targets?• What works?
Summing Up
• How we do it: process innovation– Learn by doing– Learn from doing– The “learning organization”….
Experimentation &the Learning Organization:
A Virtuous Cycle
Evaluate
Innovate
Experiment