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