Doctoral Dissertation Research in Economics: Commitment Devices and Consumption Smoothing Over Illness in Western Kenya

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Poor households in developing countries are subject to considerable risk. Although thePermanent Income Hypothesis (PIH) predicts that households will fully adjust consumption tochanges in permanent income and smooth consumption over changes in transitory income,evidence suggests that both of these predictions may fail (Paxson, 1992; Fafchamps, Udry, andCzukas, 1998).The goal of this project is to identify the specific factors that might prevent households fromsmoothing consumption over changes in transitory income and to evaluate the effectiveness oftwo interventions designed to facilitate consumption smoothing. This project will focusspecifically upon income shocks caused by household illness.As credit is rare in developing countries, one obvious reason that households may be unable tosmooth changes in transitory income is that they lack a secure place to save. The first goal of thisproject will therefore be to provide a formal savings account to a randomly selected subset ofdaily income earners.Even with formal savings vehicles, however, households may be unable to save transitory incomeif their preferences for consumption are time-inconsistent. The second goal of this project will beto provide one of two types of commitment savings accounts to two randomly selected treatmentgroups. The first group will be offered target accounts that will feature a strictly enforced selfchosenweekly savings goal while the second group will be offered health accounts that willencourage withdrawals for health expenditures but discourage withdrawals for all other purposesby introducing relatively large withdrawal penalties for non-health purposes and eliminating suchpenalties for health withdrawals.This project will collect information on a variety of outcomes, including the difference in savingsbetween the treatment and comparison groups, the difference in the labor supplied between thegroups, and the extent to which the accounts serve to substitute for other, costlier types of incomesmoothing (such as choosing to invest in lower-yielding but less risky assets). The mostimportant outcome, however, will be the differential responsiveness of consumption to transitoryincome between the treatment and comparison groups. As this experiment is randomized at theindividual level, the effect of the standard savings accounts can be estimated directly from thedifferential responsiveness between the standard savings and comparison groups and the effect ofthe commitment savings accounts can be estimated from the differential responsiveness betweenthe commitment savings and standard savings groups.Intellectual MeritThis project will be of academic interest for several reasons. First, it will provide experimentalevidence on the specific mechanisms by which the Permanent Income Hypothesis tends to fail.Second, it will add to the growing literature on the empirical relevance of commitment savingsaccounts. Third, it will test the responsiveness of consumption to transitory changes in incomedue to health shocks, in contrast to most studies which focus upon shocks to agricultural incomecaused by changes in rainfall.Broader ImpactThe results obtained from this research could potentially also have valuable policy implications.First, providing such accounts could represent a novel approach in designing savings accounts indeveloping countries and in developing risk-coping mechanisms for poor households. Second, tothe extent that the accounts allow households to medically treat illness and so increase their laborincome, the accounts could represent a specific mechanism for increasing income by improvinghealth.