1 00:00:00,040 --> 00:00:02,460 The following content is provided under a Creative 2 00:00:02,460 --> 00:00:03,970 Commons license. 3 00:00:03,970 --> 00:00:06,910 Your support will help MIT OpenCourseWare continue to 4 00:00:06,910 --> 00:00:10,660 offer high quality educational resources for free. 5 00:00:10,660 --> 00:00:13,460 To make a donation or view additional materials from 6 00:00:13,460 --> 00:00:17,390 hundreds of MIT courses, visit MIT OpenCourseWare at 7 00:00:17,390 --> 00:00:18,640 ocw.mit.edu. 8 00:00:26,320 --> 00:00:28,960 PROFESSOR: I think at the beginning of the semester we 9 00:00:28,960 --> 00:00:32,750 have kind of sketched out the broad plan. 10 00:00:32,750 --> 00:00:37,900 And the broad plan was to move kind of progressively from 11 00:00:37,900 --> 00:00:41,890 what are fundamentally individual decision making 12 00:00:41,890 --> 00:00:46,060 problems to thinking about more problems of the market. 13 00:00:46,060 --> 00:00:49,860 And we're going to try and do insurance, which is obviously 14 00:00:49,860 --> 00:00:53,265 something to do with markets. 15 00:00:59,620 --> 00:01:02,095 So here is by way of background. 16 00:01:06,430 --> 00:01:09,190 You probably remember a few years ago the world economy 17 00:01:09,190 --> 00:01:10,440 was in crisis. 18 00:01:12,980 --> 00:01:14,230 It may still be in one. 19 00:01:14,230 --> 00:01:16,430 But now we're told it's not. 20 00:01:21,170 --> 00:01:24,320 So this is a quote from the president of the World Bank. 21 00:01:35,460 --> 00:01:43,280 He's trying to make the case that the crisis in 2008, 2009 22 00:01:43,280 --> 00:01:46,225 was going to be a particular crisis for the world's poor. 23 00:01:51,140 --> 00:01:52,690 And that's not implausible. 24 00:01:52,690 --> 00:01:58,790 You might imagine that if you are that much closer to 25 00:01:58,790 --> 00:02:03,110 survival, you have fewer resources, then anything that 26 00:02:03,110 --> 00:02:05,590 goes wrong is likely to hurt you more. 27 00:02:05,590 --> 00:02:07,515 So that's not an implausible idea. 28 00:02:12,540 --> 00:02:18,680 I spent a couple of days with a New York Times reporter, the 29 00:02:18,680 --> 00:02:23,800 New York Times bureau chief in India, in the 30 00:02:23,800 --> 00:02:25,700 pursuit of this story. 31 00:02:25,700 --> 00:02:29,460 So I was going for something else, and she 32 00:02:29,460 --> 00:02:30,840 came along with me. 33 00:02:30,840 --> 00:02:40,160 And she was looking for people who had-- 34 00:02:40,160 --> 00:02:44,390 this was a part of rural India, a very poor part of 35 00:02:44,390 --> 00:02:45,440 rural India. 36 00:02:45,440 --> 00:02:50,910 And her whole idea was that she's going to go there and, 37 00:02:50,910 --> 00:02:54,280 like Zoellick, she was wondering how these people in 38 00:02:54,280 --> 00:02:59,400 the villages who go to the city to work as maybe 39 00:02:59,400 --> 00:03:01,320 laborers, how they would be affected 40 00:03:01,320 --> 00:03:04,440 by this global crisis. 41 00:03:04,440 --> 00:03:06,370 This is the New York Times. 42 00:03:06,370 --> 00:03:10,380 So she wanted to link up what's happening in poor parts 43 00:03:10,380 --> 00:03:13,210 in rural India with what's happening in New York. 44 00:03:13,210 --> 00:03:15,870 So that made perfect sense. 45 00:03:15,870 --> 00:03:19,970 And the problem was that nobody seemed to know there 46 00:03:19,970 --> 00:03:21,220 was a crisis. 47 00:03:23,630 --> 00:03:29,140 So she would go and ask people, so have you heard 48 00:03:29,140 --> 00:03:29,640 about this? 49 00:03:29,640 --> 00:03:31,870 There's a crisis in the world. 50 00:03:31,870 --> 00:03:34,360 Is that affecting your job prospects? 51 00:03:34,360 --> 00:03:39,450 And one striking fact was this was in a part of rural India 52 00:03:39,450 --> 00:03:41,860 that's pretty backward. 53 00:03:41,860 --> 00:03:47,670 The areas we were were mostly conservative, mostly families. 54 00:03:47,670 --> 00:03:50,610 A lot of the migrants had come home for a 55 00:03:50,610 --> 00:03:52,780 bustling religious festival. 56 00:03:52,780 --> 00:03:56,050 So a lot of the migrants were there. 57 00:03:56,050 --> 00:03:58,324 We could talk to them. 58 00:03:58,324 --> 00:04:02,671 And to the man, literally to the man, they said, no. 59 00:04:02,671 --> 00:04:03,600 What crisis? 60 00:04:03,600 --> 00:04:05,740 There are jobs for anybody who wants a job. 61 00:04:08,490 --> 00:04:12,020 So we went to the train station for migrants coming 62 00:04:12,020 --> 00:04:15,920 back from having lost their jobs in the cities. 63 00:04:15,920 --> 00:04:18,430 In fact, we found tons of migrants who were leaving for 64 00:04:18,430 --> 00:04:21,120 the city on the train. 65 00:04:21,120 --> 00:04:24,986 So basically the story never got written, and New York 66 00:04:24,986 --> 00:04:27,410 Times never had this story because there was never 67 00:04:27,410 --> 00:04:28,810 anything to be found. 68 00:04:28,810 --> 00:04:33,980 And it was kind of striking how disjointed these two world 69 00:04:33,980 --> 00:04:35,810 views were. 70 00:04:35,810 --> 00:04:37,980 Now, that doesn't mean-- 71 00:04:37,980 --> 00:04:40,850 I think it was clear that if you looked at the data, there 72 00:04:40,850 --> 00:04:43,670 were people who were losing jobs. 73 00:04:43,670 --> 00:04:47,590 Some construction projects had been shut down. 74 00:04:47,590 --> 00:04:53,690 There were certainly some jobs being lost. 75 00:04:53,690 --> 00:05:00,740 I think the real reason why this didn't show up in 76 00:05:00,740 --> 00:05:08,190 people's kind of intellectual map as a very big deal is not 77 00:05:08,190 --> 00:05:11,290 because some bad things were not happening. 78 00:05:11,290 --> 00:05:16,130 But it's more that they're used to having jobs being lost 79 00:05:16,130 --> 00:05:19,810 and having to find jobs and things like that as a normal 80 00:05:19,810 --> 00:05:22,010 part of their life. 81 00:05:22,010 --> 00:05:25,440 In other words, the amount of risk that they normally bear 82 00:05:25,440 --> 00:05:33,860 is so large relative to our perception of risk-- 83 00:05:33,860 --> 00:05:37,650 I'll show you some numbers in a bit-- our perception of risk 84 00:05:37,650 --> 00:05:40,370 that this was seen as, you know, normal turnover. 85 00:05:40,370 --> 00:05:42,510 Certainly some jobs were being-- but you 86 00:05:42,510 --> 00:05:44,020 find another the job. 87 00:05:44,020 --> 00:05:50,290 And the basic difference came from, I think, their 88 00:05:50,290 --> 00:05:54,780 calibration or what is unreasonable amount of risk. 89 00:05:57,720 --> 00:06:05,270 Our colleague, Rob Townsend who is an expert on Thailand, 90 00:06:05,270 --> 00:06:10,170 studied the Thai economic crisis of 1998. 91 00:06:10,170 --> 00:06:13,250 So this was a big deal in Thailand. 92 00:06:13,250 --> 00:06:18,800 I mean, there was like the Thai baht I think halved or 93 00:06:18,800 --> 00:06:19,670 more than half. 94 00:06:19,670 --> 00:06:21,170 I mean, it just grew. 95 00:06:21,170 --> 00:06:23,570 And the whole economy-- 96 00:06:23,570 --> 00:06:25,970 several banks came close to failing and had 97 00:06:25,970 --> 00:06:26,860 to be bailed out. 98 00:06:26,860 --> 00:06:29,620 All kinds of bad things happened. 99 00:06:29,620 --> 00:06:31,460 Rob Howard doesn't study the banks. 100 00:06:31,460 --> 00:06:35,130 He studies the people who live in poorer 101 00:06:35,130 --> 00:06:37,080 parts of northern Thailand. 102 00:06:37,080 --> 00:06:43,170 And he has a panel of people now for more 103 00:06:43,170 --> 00:06:45,670 than, I think, 12 years. 104 00:06:45,670 --> 00:06:49,890 But he had a long time he had been following these people, 105 00:06:49,890 --> 00:06:50,870 15 years something. 106 00:06:50,870 --> 00:06:54,080 He's been following the people for a very long time, 107 00:06:54,080 --> 00:06:57,540 families, and looking at the economic outcomes. 108 00:06:57,540 --> 00:07:02,010 So every few months, they go back to the same families and 109 00:07:02,010 --> 00:07:03,150 measure a bunch of stuff. 110 00:07:03,150 --> 00:07:04,800 And the same families are maintained 111 00:07:04,800 --> 00:07:06,140 for a very long time. 112 00:07:06,140 --> 00:07:08,320 It's a unique data set that he has. 113 00:07:08,320 --> 00:07:11,290 Now, one advantage of that data set is you can look at 114 00:07:11,290 --> 00:07:15,440 what happens in the crisis year relative to what happens 115 00:07:15,440 --> 00:07:18,420 in other years. 116 00:07:18,420 --> 00:07:20,710 You have a data set of the same families 117 00:07:20,710 --> 00:07:22,850 for a very long time. 118 00:07:22,850 --> 00:07:27,290 Just descriptively you may just ask what changed in the 119 00:07:27,290 --> 00:07:28,550 crisis year? 120 00:07:28,550 --> 00:07:33,210 And I think his number, which he presented this at a 121 00:07:33,210 --> 00:07:36,810 conference before he came to MIT-- and I had to be the 122 00:07:36,810 --> 00:07:37,810 commentator-- 123 00:07:37,810 --> 00:07:43,160 the number, in a sense, it was almost unbelievable 124 00:07:43,160 --> 00:07:44,370 to think about it. 125 00:07:44,370 --> 00:07:49,230 So he found that 2% of the variation in their income was 126 00:07:49,230 --> 00:07:51,200 attributable to the crises. 127 00:07:51,200 --> 00:07:54,455 The 2% of the variation of income in these families-- 128 00:07:57,870 --> 00:08:00,730 so if you look at a family, his income varies every year, 129 00:08:00,730 --> 00:08:01,910 every six months. 130 00:08:01,910 --> 00:08:06,590 So you can just look at the total variation in income. 131 00:08:06,590 --> 00:08:09,610 And then you can attribute a particular part 132 00:08:09,610 --> 00:08:12,160 of that to the crisis. 133 00:08:12,160 --> 00:08:14,170 What was extra in a crisis? 134 00:08:14,170 --> 00:08:16,980 And I think his calculation was about 2% 135 00:08:16,980 --> 00:08:20,365 more for the crisis. 136 00:08:20,365 --> 00:08:24,000 The reason I make that point is not to say that the poor 137 00:08:24,000 --> 00:08:29,370 are very, very well off, but the opposite, that their 138 00:08:29,370 --> 00:08:36,669 normal exposure to risk is so high that this additional 139 00:08:36,669 --> 00:08:40,390 piece that come from global crises is an extremely small 140 00:08:40,390 --> 00:08:42,289 part of it. 141 00:08:42,289 --> 00:08:46,870 I think the way to think about it is that there's a ton of 142 00:08:46,870 --> 00:08:50,330 risk that any poor person bears all the time. 143 00:08:50,330 --> 00:08:53,290 And then there's some stuff that happens which we think 144 00:08:53,290 --> 00:08:57,410 are important like what's happening in New York and the 145 00:08:57,410 --> 00:09:00,520 important for MIT. 146 00:09:00,520 --> 00:09:02,740 MIT, as soon as the crisis hit, the first thing that 147 00:09:02,740 --> 00:09:05,580 happened is that we used to get free lunch on Mondays and 148 00:09:05,580 --> 00:09:07,090 Tuesdays and that was shut down. 149 00:09:07,090 --> 00:09:10,310 So it was very important. 150 00:09:10,310 --> 00:09:11,720 We got some risk from that. 151 00:09:11,720 --> 00:09:15,090 But if you think of these people, they're not getting 152 00:09:15,090 --> 00:09:16,820 any free lunches in any case. 153 00:09:16,820 --> 00:09:19,895 And so the amount of uncertainty that they deal 154 00:09:19,895 --> 00:09:27,710 with on a day to day basis dwarfs any uncertainty that 155 00:09:27,710 --> 00:09:36,390 might come from specific episodes like the Thai banking 156 00:09:36,390 --> 00:09:39,410 crisis of 1998. 157 00:09:39,410 --> 00:09:40,360 Do you have question? 158 00:09:40,360 --> 00:09:43,382 Somebody had their hand up for a moment. 159 00:09:43,382 --> 00:09:45,189 AUDIENCE: Do we have evidence from other 160 00:09:45,189 --> 00:09:46,340 places besides Thailand? 161 00:09:46,340 --> 00:09:48,147 Because, I guess, popularly speaking, a lot of people talk 162 00:09:48,147 --> 00:09:52,256 about the loss decades in Latin America and how bad that 163 00:09:52,256 --> 00:09:55,707 was, you know, for people's ability to generate 164 00:09:55,707 --> 00:09:56,693 livelihoods. 165 00:09:56,693 --> 00:10:01,130 So I'm just wondering if we really have a lot of evidence 166 00:10:01,130 --> 00:10:04,100 that this is really a broad phenomenon. 167 00:10:04,100 --> 00:10:06,400 PROFESSOR: So I think there are two parts 168 00:10:06,400 --> 00:10:07,100 to what you're saying. 169 00:10:07,100 --> 00:10:08,820 Both are important. 170 00:10:08,820 --> 00:10:13,430 One is do we have evidence from other countries? 171 00:10:13,430 --> 00:10:17,470 Second is part of the reason why this population is 172 00:10:17,470 --> 00:10:21,840 different is that Thailand is a lot less 173 00:10:21,840 --> 00:10:24,930 urbanized than Mexico. 174 00:10:24,930 --> 00:10:33,370 So many more people in Thailand operate in the 175 00:10:33,370 --> 00:10:37,660 traditional underdeveloped economic mode, which is that 176 00:10:37,660 --> 00:10:41,110 they are self employed, they have a farm, 177 00:10:41,110 --> 00:10:42,360 something like that. 178 00:10:49,950 --> 00:10:53,540 So let me give you a different example, which is maybe even 179 00:10:53,540 --> 00:10:54,500 more revealing. 180 00:10:54,500 --> 00:10:56,930 This is taking me a little further [INAUDIBLE], but it's 181 00:10:56,930 --> 00:10:58,170 interesting. 182 00:10:58,170 --> 00:11:02,150 So there's a study by one of our ex students of what 183 00:11:02,150 --> 00:11:06,490 happened in the Indonesian crisis of 1998, which happened 184 00:11:06,490 --> 00:11:07,980 for the same reason. 185 00:11:07,980 --> 00:11:13,850 And there the Indonesian rupiah devalued by a factor of 186 00:11:13,850 --> 00:11:17,510 three, which is a huge amount of devaluation. 187 00:11:17,510 --> 00:11:19,310 So something really big happened to 188 00:11:19,310 --> 00:11:21,060 the Indonesian economy. 189 00:11:21,060 --> 00:11:28,940 So turns out that the real incomes of anybody in 190 00:11:28,940 --> 00:11:32,630 Indonesia who was mainly a rice farmer went up during 191 00:11:32,630 --> 00:11:33,500 this crisis. 192 00:11:33,500 --> 00:11:35,960 The reason is that suddenly the 193 00:11:35,960 --> 00:11:37,645 currency devalued massively. 194 00:11:41,290 --> 00:11:45,740 What happens when the currency devalues and you're in rice? 195 00:11:45,740 --> 00:11:47,720 Well, rice is a trade-in good. 196 00:11:47,720 --> 00:11:51,240 Its price goes up relative to non trade-in goods. 197 00:11:51,240 --> 00:11:54,400 So your hair cut prices don't go up, but rice prices go up 198 00:11:54,400 --> 00:11:55,720 because rice is traded. 199 00:11:55,720 --> 00:12:00,130 So these rice farmers actually were better off in the 200 00:12:00,130 --> 00:12:02,920 Indonesian crisis than they were before. 201 00:12:02,920 --> 00:12:06,050 He then looks at, well, how do they react? 202 00:12:06,050 --> 00:12:12,340 And the thing he's looking at is people attending Koranic 203 00:12:12,340 --> 00:12:15,070 reading classes as well as the outcomes. 204 00:12:15,070 --> 00:12:17,540 And the basic reason he's interested in them is he 205 00:12:17,540 --> 00:12:20,780 thinks that this is a social support mechanism. 206 00:12:20,780 --> 00:12:24,450 Who start attending Koranic reading classes? 207 00:12:24,450 --> 00:12:26,410 It's the people who are not rice farmers. 208 00:12:26,410 --> 00:12:29,860 It's the government employees, teachers, anybody who has a 209 00:12:29,860 --> 00:12:30,910 fixed income. 210 00:12:30,910 --> 00:12:32,360 They are the ones who lost. 211 00:12:32,360 --> 00:12:35,530 And then the people who were farmers, they actually were 212 00:12:35,530 --> 00:12:36,310 better off. 213 00:12:36,310 --> 00:12:40,630 And they were actually less likely to attend Koranic 214 00:12:40,630 --> 00:12:42,620 classes during the crisis. 215 00:12:42,620 --> 00:12:47,400 So in other words, again, a lot of people in a country 216 00:12:47,400 --> 00:12:51,740 like Thailand or Indonesia are basically farming dependent. 217 00:12:51,740 --> 00:12:55,820 And those people have very different risk patterns from 218 00:12:55,820 --> 00:12:58,280 the urban employees. 219 00:12:58,280 --> 00:12:59,940 Latin America is very different. 220 00:12:59,940 --> 00:13:03,180 Latin America is massively richer also then Indonesia, 221 00:13:03,180 --> 00:13:04,430 for example. 222 00:13:06,670 --> 00:13:10,140 Peru is three times richer than Indonesia, per capita 223 00:13:10,140 --> 00:13:12,810 income, at least in dollar terms. 224 00:13:12,810 --> 00:13:20,000 It's also much more urbanized with a labor force. 225 00:13:20,000 --> 00:13:22,370 So I'm sure the lost decade happened. 226 00:13:22,370 --> 00:13:26,070 I'm sure that a lot of urban workers in each of these 227 00:13:26,070 --> 00:13:27,690 countries gets hurt. 228 00:13:27,690 --> 00:13:30,550 The main point I'm trying to make here is that there's also 229 00:13:30,550 --> 00:13:33,460 a whole bunch of people in these countries who bear a 230 00:13:33,460 --> 00:13:36,840 huge amount of risk even when there is nothing happening in 231 00:13:36,840 --> 00:13:38,120 the world economy. 232 00:13:38,120 --> 00:13:47,510 And those are people who are farmers, who are laborers in 233 00:13:47,510 --> 00:13:57,170 construction, people who sometimes get a job helping 234 00:13:57,170 --> 00:14:00,320 out in farms, these kind of people, landless laborers or 235 00:14:00,320 --> 00:14:01,140 different kinds. 236 00:14:01,140 --> 00:14:04,610 These people have a very different risk pattern than 237 00:14:04,610 --> 00:14:10,860 the urban workers who tend to be the people who are directly 238 00:14:10,860 --> 00:14:14,050 hurt by big global shocks. 239 00:14:14,050 --> 00:14:16,410 So there was not that there were people not hurt, it's 240 00:14:16,410 --> 00:14:19,560 just there were, for many of the people that [INAUDIBLE] 241 00:14:19,560 --> 00:14:24,090 Rob Townsend was studying, all kinds of stuff were happening 242 00:14:24,090 --> 00:14:26,530 in their lives. 243 00:14:26,530 --> 00:14:27,870 These were all farmers. 244 00:14:27,870 --> 00:14:29,420 And lots of them were-- 245 00:14:29,420 --> 00:14:31,420 all kinds of stuff were happening in their life, many 246 00:14:31,420 --> 00:14:32,550 of them very bad. 247 00:14:32,550 --> 00:14:36,580 And this was just a small piece of that big story. 248 00:14:36,580 --> 00:14:40,510 That's the point that I think is worth emphasizing is that 249 00:14:40,510 --> 00:14:44,930 there's just much diversity, and there's so much risk. 250 00:14:44,930 --> 00:14:49,360 So basically what are the sources of risk? 251 00:14:49,360 --> 00:14:52,410 I think the biggest single risk is just being a farmer. 252 00:14:52,410 --> 00:14:55,730 If you're a farmer, you'll face huge amount of risk. 253 00:14:55,730 --> 00:15:00,230 What do you face risk from? 254 00:15:00,230 --> 00:15:03,170 What's a main source of risk? 255 00:15:03,170 --> 00:15:04,150 AUDIENCE: Bad harvests. 256 00:15:04,150 --> 00:15:05,790 PROFESSOR: Bad harvests. 257 00:15:05,790 --> 00:15:07,315 How do you get bad harvests? 258 00:15:07,315 --> 00:15:08,770 AUDIENCE: [INAUDIBLE] rainfall. 259 00:15:08,770 --> 00:15:12,640 PROFESSOR: Rainfall, bugs, you know, locusts. 260 00:15:15,190 --> 00:15:19,060 If you're a farmer, you're used to dealing with a huge 261 00:15:19,060 --> 00:15:19,870 amount of risk. 262 00:15:19,870 --> 00:15:25,380 I mean, by our standards of the kind of risk that tenures 263 00:15:25,380 --> 00:15:30,010 professors face-- of course, maybe 264 00:15:30,010 --> 00:15:31,750 that's an extreme example. 265 00:15:31,750 --> 00:15:33,900 They have a huge amount of year to year 266 00:15:33,900 --> 00:15:35,530 variation in income. 267 00:15:39,700 --> 00:15:47,200 Even those who don't have a farm, most of 268 00:15:47,200 --> 00:15:48,930 them are casual labours. 269 00:15:48,930 --> 00:15:52,500 The poor in most countries, in poor 270 00:15:52,500 --> 00:15:54,650 countries, are casual laborers. 271 00:15:54,650 --> 00:15:57,620 Casual laborers meaning they don't have a contract. 272 00:15:57,620 --> 00:15:59,610 They have a daily job. 273 00:15:59,610 --> 00:16:06,650 The typical way you get a job is in a city you stand at a 274 00:16:06,650 --> 00:16:13,150 street corner and somebody who needs someone to move boxes 275 00:16:13,150 --> 00:16:16,150 comes and picks up 50 people and takes them somewhere. 276 00:16:16,150 --> 00:16:20,770 So it's extraordinarily casual, meaning at a given 277 00:16:20,770 --> 00:16:22,510 day, you may not get a job. 278 00:16:22,510 --> 00:16:28,990 And many of these people are not employed more than 15, 16 279 00:16:28,990 --> 00:16:29,840 days a month. 280 00:16:29,840 --> 00:16:32,320 So this is a very, very common fact. 281 00:16:32,320 --> 00:16:34,340 And there's lots of uncertainty there. 282 00:16:34,340 --> 00:16:38,350 Some days, some months you maybe get unlucky and you just 283 00:16:38,350 --> 00:16:40,240 got there late or something, and then 284 00:16:40,240 --> 00:16:41,250 you missed your chance. 285 00:16:41,250 --> 00:16:46,410 So the amount of uncertainty that you have if you are kind 286 00:16:46,410 --> 00:16:50,390 of a casual laborer in a developing country is huge 287 00:16:50,390 --> 00:16:53,190 because its the uncertainty of in any given day you have a 288 00:16:53,190 --> 00:16:57,315 probability of, let's say, three out of four 289 00:16:57,315 --> 00:16:58,770 of getting a job. 290 00:16:58,770 --> 00:17:01,070 And the other days you don't. 291 00:17:01,070 --> 00:17:04,770 And so if you look at daily income, daily income is 292 00:17:04,770 --> 00:17:07,280 extraordinarily variable for most of these people. 293 00:17:07,280 --> 00:17:09,849 And it's just mechanically almost. 294 00:17:12,460 --> 00:17:17,250 Somebody shows up at that street corner and, you know, 295 00:17:17,250 --> 00:17:21,700 they ask you to get on the truck and go with him, and he 296 00:17:21,700 --> 00:17:23,480 needs 10 people today rather than 15. 297 00:17:23,480 --> 00:17:24,770 You don't get a job. 298 00:17:24,770 --> 00:17:28,810 So this is just a core level of risk in this life, which is 299 00:17:28,810 --> 00:17:31,990 very different from thinking about the kind of risk we 300 00:17:31,990 --> 00:17:35,480 think about most of the time in a more 301 00:17:35,480 --> 00:17:37,590 developed country context. 302 00:17:37,590 --> 00:17:39,110 There's no social protection. 303 00:17:39,110 --> 00:17:43,310 The other side of that is there's no social protection 304 00:17:43,310 --> 00:17:46,630 or almost no social protection. 305 00:17:46,630 --> 00:17:52,950 So one way to think about this is-- 306 00:17:58,400 --> 00:17:59,856 this is wage volatility. 307 00:18:03,150 --> 00:18:05,730 This is how much your wages vary. 308 00:18:05,730 --> 00:18:07,690 And this is not day to day variation. 309 00:18:07,690 --> 00:18:13,770 This is year to year variation across a set of countries. 310 00:18:13,770 --> 00:18:15,390 This is real wages. 311 00:18:15,390 --> 00:18:19,770 So the poorest country is Myanmar. 312 00:18:19,770 --> 00:18:26,840 And basically you can plot a line and that line has 313 00:18:26,840 --> 00:18:28,800 essentially-- 314 00:18:28,800 --> 00:18:36,910 if you increase raw GDP by one, you halve the risk, 315 00:18:36,910 --> 00:18:38,160 something like that. 316 00:18:41,360 --> 00:18:45,370 So this is conditional on getting a job. 317 00:18:45,370 --> 00:18:47,460 I said the big part of the uncertainty is you 318 00:18:47,460 --> 00:18:48,630 just don't get a job. 319 00:18:48,630 --> 00:18:51,890 But then the real wages are extremely unstable as well. 320 00:18:51,890 --> 00:18:55,170 Part of the reason they're unstable comes from this other 321 00:18:55,170 --> 00:19:00,300 fact, which is this. 322 00:19:00,300 --> 00:19:01,740 This is food prices. 323 00:19:01,740 --> 00:19:07,540 And if you spend 60% of your income on food, food prices 324 00:19:07,540 --> 00:19:10,000 matter a huge amount. 325 00:19:10,000 --> 00:19:13,550 One big piece of risk that people have been facing is 326 00:19:13,550 --> 00:19:16,640 just what's happening to food prices. 327 00:19:16,640 --> 00:19:18,990 So food prices have gone-- 328 00:19:18,990 --> 00:19:25,120 as you can see, 2007, they peaked. 329 00:19:25,120 --> 00:19:30,430 The dollar food index went up to 200. 330 00:19:30,430 --> 00:19:35,660 It came down to 140 then went up, bounced around, and has 331 00:19:35,660 --> 00:19:36,910 been climbing since. 332 00:19:40,960 --> 00:19:51,870 So that's a 60% change in the food price in a year-- 333 00:19:51,870 --> 00:19:52,396 not 60. 334 00:19:52,396 --> 00:19:53,860 Sorry. 335 00:19:53,860 --> 00:19:55,940 It's a change from 140 to 200. 336 00:19:55,940 --> 00:19:57,620 So that's a change of 30%. 337 00:20:00,693 --> 00:20:11,950 And if you spend 60% of your income on food then that's of 338 00:20:11,950 --> 00:20:16,720 the order of, like, losing 20% of your 339 00:20:16,720 --> 00:20:18,360 income in a given year. 340 00:20:18,360 --> 00:20:22,610 So just food price variation will itself have consequence. 341 00:20:22,610 --> 00:20:25,310 Now, wages probably adjust, so that's probably an 342 00:20:25,310 --> 00:20:26,610 overestimate of that. 343 00:20:26,610 --> 00:20:29,780 But still, you can see one major source of uncertainty 344 00:20:29,780 --> 00:20:33,410 comes from just the fact the food prices go up massively 345 00:20:33,410 --> 00:20:35,120 sometimes and come down. 346 00:20:35,120 --> 00:20:37,910 With up and down it's risk that you see. 347 00:20:37,910 --> 00:20:41,400 There's also a trend which is worrying in general is the 348 00:20:41,400 --> 00:20:45,950 food prices seem to be going up systematically over the 349 00:20:45,950 --> 00:20:48,210 last some years. 350 00:20:48,210 --> 00:20:51,580 What is a bit misleading about that trend is that food prices 351 00:20:51,580 --> 00:20:55,450 had fallen for the previous 35 years or something. 352 00:20:55,450 --> 00:20:57,860 Food prices had fallen. 353 00:20:57,860 --> 00:21:02,760 So since 1970 to 2005, food prices had basically 354 00:21:02,760 --> 00:21:06,000 systematically fallen slightly, and then 355 00:21:06,000 --> 00:21:06,700 it's been going up. 356 00:21:06,700 --> 00:21:08,920 So this is a bit misleading, this picture. 357 00:21:08,920 --> 00:21:10,960 But still, there's lots of uncertainty. 358 00:21:10,960 --> 00:21:13,020 The thing I want to emphasize here is not levels but 359 00:21:13,020 --> 00:21:14,020 uncertainty. 360 00:21:14,020 --> 00:21:17,030 Food prices bounce around a lot. 361 00:21:17,030 --> 00:21:19,790 If you're poor, that's a very big piece of your income. 362 00:21:25,000 --> 00:21:39,970 So just to think about this analytically, risk also 363 00:21:39,970 --> 00:21:44,630 matters very much depending on where you are, for example, in 364 00:21:44,630 --> 00:21:46,340 your production cycle. 365 00:21:46,340 --> 00:21:52,800 So a reason why risk is amplified is when-- 366 00:21:56,130 --> 00:22:00,823 the fact that you get hit by a shock then effects your 367 00:22:00,823 --> 00:22:04,120 ability to productive, which then affects your income, 368 00:22:04,120 --> 00:22:05,370 which then affects your ability to be 369 00:22:05,370 --> 00:22:06,510 productive, et cetera. 370 00:22:06,510 --> 00:22:09,900 So there is potentially a vicious cycle that can be set 371 00:22:09,900 --> 00:22:13,220 off by a shock. 372 00:22:13,220 --> 00:22:14,770 When would that happen? 373 00:22:14,770 --> 00:22:19,455 Well, we have introduced this idea of an 374 00:22:19,455 --> 00:22:22,830 S-shape production function. 375 00:22:31,310 --> 00:22:33,460 Have we read [? Ebutina's ?] 376 00:22:33,460 --> 00:22:34,710 story? 377 00:22:37,420 --> 00:22:39,220 What's the story? 378 00:22:39,220 --> 00:22:42,526 AUDIENCE: It's about a woman who used to own a small 379 00:22:42,526 --> 00:22:46,334 business with her husband in which they had a kind of 380 00:22:46,334 --> 00:22:51,634 garment manufacturing company, which they had a bad contract 381 00:22:51,634 --> 00:22:54,094 which caused them to go bankrupt. 382 00:22:54,094 --> 00:22:56,062 And that led to a divorce. 383 00:22:56,062 --> 00:23:00,490 They tried to restart the company before divorcing. 384 00:23:00,490 --> 00:23:02,887 They restarted the company with limited funds and bought 385 00:23:02,887 --> 00:23:04,782 a bunch of shorts that they packaged and 386 00:23:04,782 --> 00:23:05,995 were going to sell. 387 00:23:05,995 --> 00:23:09,390 But that fell through, led to a divorce. 388 00:23:09,390 --> 00:23:12,785 The woman has the children living with her parents, and 389 00:23:12,785 --> 00:23:16,190 they're just in absolute poverty now. 390 00:23:16,190 --> 00:23:16,940 PROFESSOR: Yeah. 391 00:23:16,940 --> 00:23:20,670 So the thing to emphasize there in that story is that 392 00:23:20,670 --> 00:23:24,400 this particular kind of shock she faced was a contract 393 00:23:24,400 --> 00:23:25,630 enforcement shock. 394 00:23:25,630 --> 00:23:28,950 She had two shocks, both of which where basically-- 395 00:23:28,950 --> 00:23:34,780 so the first one was someone she had basically sold on 396 00:23:34,780 --> 00:23:41,240 credit defaulted and therefore didn't pay back the money. 397 00:23:41,240 --> 00:23:43,900 And she had taken a loan to finance that. 398 00:23:43,900 --> 00:23:47,140 So that kind of put her into trouble. 399 00:23:47,140 --> 00:23:53,260 Then she got an order to supply shorts to, I think, a 400 00:23:53,260 --> 00:23:54,370 retail store. 401 00:23:54,370 --> 00:23:56,750 And then they defaulted on that. 402 00:23:56,750 --> 00:23:58,020 They refused to take the shorts. 403 00:23:58,020 --> 00:24:04,960 So when we met her, she had a huge pile of shorts. 404 00:24:04,960 --> 00:24:08,120 They were sitting inside her house surrounded by a pile of 405 00:24:08,120 --> 00:24:16,760 shorts, like, a lot of shorts, 12,000 shorts or something. 406 00:24:16,760 --> 00:24:19,850 So she lost a whole bunch of money on that as well. 407 00:24:22,750 --> 00:24:26,410 The point is that what is also striking about her story is 408 00:24:26,410 --> 00:24:28,820 this dynamic. 409 00:24:28,820 --> 00:24:32,545 So what this picture does-- 410 00:24:36,430 --> 00:24:40,540 so it's like that S-shaped curve. 411 00:24:40,540 --> 00:24:45,190 S is maybe an exaggeration. 412 00:24:45,190 --> 00:24:47,500 That's a mapping from your wealth today 413 00:24:47,500 --> 00:24:50,010 to your wealth tomorrow. 414 00:24:50,010 --> 00:24:53,650 So that tells you given today's wealth what tomorrow's 415 00:24:53,650 --> 00:24:55,580 wealth would be. 416 00:24:55,580 --> 00:24:58,300 So let's take that as given. 417 00:24:58,300 --> 00:25:16,790 And now the main point of drawing it that way is that if 418 00:25:16,790 --> 00:25:19,070 you think of what's happening around the point, P-- 419 00:25:21,850 --> 00:25:25,210 look around the point, P. Think of a part that starts 420 00:25:25,210 --> 00:25:30,226 just above P. Where's that part going? 421 00:25:30,226 --> 00:25:31,723 AUDIENCE: [INAUDIBLE]. 422 00:25:31,723 --> 00:25:33,220 PROFESSOR: Explain. 423 00:25:33,220 --> 00:25:34,790 AUDIENCE: To the second intersection up there. 424 00:25:34,790 --> 00:25:35,400 PROFESSOR: Right. 425 00:25:35,400 --> 00:25:40,860 Any part that start to the right of P, you can see that-- 426 00:25:40,860 --> 00:25:45,190 like the one example that's drawn, the way to analyze this 427 00:25:45,190 --> 00:25:49,170 is to think you start with a particular wealth. 428 00:25:49,170 --> 00:25:52,980 That generates that wealth tomorrow. 429 00:25:52,980 --> 00:25:56,040 That wealth is the same. 430 00:25:56,040 --> 00:25:58,810 So tomorrow's wealth then becomes today's wealth. 431 00:25:58,810 --> 00:26:02,600 The way you do that is you map that to the 45 degree line, 432 00:26:02,600 --> 00:26:04,890 and you look at wealth that will be. 433 00:26:04,890 --> 00:26:09,210 And that sequence is just going up to the point where 434 00:26:09,210 --> 00:26:10,460 the second intersection is. 435 00:26:12,950 --> 00:26:15,630 Who doesn't understand this picture? 436 00:26:15,630 --> 00:26:17,760 I'll explain again because we'll come 437 00:26:17,760 --> 00:26:19,079 back to this picture. 438 00:26:27,070 --> 00:26:28,290 OK. 439 00:26:28,290 --> 00:26:31,040 I'll assume that you're comfortable with this picture. 440 00:26:34,380 --> 00:26:37,440 I'm not surprised, but just in case. 441 00:26:37,440 --> 00:26:41,225 And then what's key is that if you're the other side of P, 442 00:26:41,225 --> 00:26:44,160 you're going the other way. 443 00:26:44,160 --> 00:26:46,980 So if you're close to P and you get hit by a shock, your 444 00:26:46,980 --> 00:26:49,670 wealth goes down by a small amount. 445 00:26:49,670 --> 00:26:52,470 That's not where it stops. 446 00:26:52,470 --> 00:26:56,310 Your wealth goes up by a small amount, you go up a long way. 447 00:26:56,310 --> 00:26:58,210 Your wealth goes down by a small amount, you 448 00:26:58,210 --> 00:27:00,420 go down a long way. 449 00:27:00,420 --> 00:27:03,650 So there's a natural amplification. 450 00:27:03,650 --> 00:27:07,240 If the production technology looks like that, then there's 451 00:27:07,240 --> 00:27:10,120 a natural amplification of a shock. 452 00:27:10,120 --> 00:27:12,770 A small shock turns into a big shock here. 453 00:27:12,770 --> 00:27:14,140 That's the point of that picture. 454 00:27:25,140 --> 00:27:28,090 So now it's very difficult for her to get out because 455 00:27:28,090 --> 00:27:34,690 basically she's never generating enough surplus to 456 00:27:34,690 --> 00:27:40,030 make the investment she needs to get the next period's 457 00:27:40,030 --> 00:27:41,180 output to be high enough. 458 00:27:41,180 --> 00:27:43,840 So she's always, like, cutting back and cutting back and 459 00:27:43,840 --> 00:27:46,040 cutting back. 460 00:27:46,040 --> 00:27:49,950 So, in other words, not only is there a lot of risk, 461 00:27:49,950 --> 00:27:52,360 there's a lot of technologies in the world which 462 00:27:52,360 --> 00:27:53,850 amplify that risk. 463 00:27:53,850 --> 00:27:58,510 So we already talked about another 464 00:27:58,510 --> 00:28:00,470 aspect of it last time. 465 00:28:00,470 --> 00:28:01,720 What was that? 466 00:28:01,720 --> 00:28:05,920 Another aspect of risk, kind of an amplification of risk. 467 00:28:05,920 --> 00:28:07,560 What happens? 468 00:28:07,560 --> 00:28:09,280 It's not quite an amplification. 469 00:28:09,280 --> 00:28:12,840 We talked about what happens during drought. 470 00:28:12,840 --> 00:28:14,090 Who was here? 471 00:28:20,310 --> 00:28:23,775 AUDIENCE: During droughts the girl's more likely to be 472 00:28:23,775 --> 00:28:25,280 [INAUDIBLE]. 473 00:28:25,280 --> 00:28:26,160 PROFESSOR: Allowed to die. 474 00:28:26,160 --> 00:28:27,110 AUDIENCE: [INAUDIBLE]. 475 00:28:27,110 --> 00:28:29,690 PROFESSOR: You were going to say allowed to die? 476 00:28:29,690 --> 00:28:31,050 Are you looking for that word? 477 00:28:31,050 --> 00:28:32,570 AUDIENCE: Yeah. 478 00:28:32,570 --> 00:28:35,440 PROFESSOR: It's an awkward word. 479 00:28:35,440 --> 00:28:36,280 Yeah, exactly. 480 00:28:36,280 --> 00:28:44,600 So another aspect of this risk is that you sometimes respond 481 00:28:44,600 --> 00:28:46,520 to it in drastic ways. 482 00:28:46,520 --> 00:28:51,480 So one of the drastic ways you might respond is by-- 483 00:28:51,480 --> 00:28:53,110 why are you trying to do that? 484 00:28:53,110 --> 00:29:02,880 Because you know that essentially if you have two 485 00:29:02,880 --> 00:29:06,680 children, you can't feed either of them, both of them 486 00:29:06,680 --> 00:29:14,855 are going to starve and be hurt, the long run, health 487 00:29:14,855 --> 00:29:15,780 will be hurt. 488 00:29:15,780 --> 00:29:19,315 So you kind of switch your money to one of them. 489 00:29:19,315 --> 00:29:24,570 And that's another way in which you sort of maybe create 490 00:29:24,570 --> 00:29:25,650 a long term problem. 491 00:29:25,650 --> 00:29:29,660 Maybe one of those children doesn't die, but she starves 492 00:29:29,660 --> 00:29:34,300 and grows up as someone who has a handicap all her life. 493 00:29:34,300 --> 00:29:37,960 So you amplify lots of shocks by taking these extreme 494 00:29:37,960 --> 00:29:39,990 decisions under these conditions. 495 00:29:39,990 --> 00:29:44,940 So this is just saying that when you think 496 00:29:44,940 --> 00:29:46,500 that you can't really-- 497 00:29:46,500 --> 00:29:51,110 so balancing risk is difficult if you don't 498 00:29:51,110 --> 00:29:52,030 have a lot of money. 499 00:29:52,030 --> 00:29:53,280 It's not surprising. 500 00:29:57,030 --> 00:30:00,120 Moreover, here's an interesting fact. 501 00:30:08,060 --> 00:30:11,500 So this means stress, right? 502 00:30:11,500 --> 00:30:18,330 It doesn't just mean that something happens to me. 503 00:30:18,330 --> 00:30:19,926 I also worry about it. 504 00:30:27,655 --> 00:30:29,905 It would be amazing if you didn't worry about the fact 505 00:30:29,905 --> 00:30:32,550 that, you know, tomorrow you might have to starve one of 506 00:30:32,550 --> 00:30:33,800 your children. 507 00:30:38,250 --> 00:30:40,240 So risk means worry. 508 00:30:43,355 --> 00:30:47,400 Now, it turns out that when you worry, your body actually 509 00:30:47,400 --> 00:30:49,680 acts in a particular way. 510 00:30:49,680 --> 00:30:50,930 It generates cortisols. 511 00:30:58,720 --> 00:31:05,750 Cortisols are a body's kind of defense mechanism to keep it 512 00:31:05,750 --> 00:31:08,340 going under situations of stress. 513 00:31:08,340 --> 00:31:12,660 They are actually a natural response of the body to a 514 00:31:12,660 --> 00:31:15,080 situation of risk. 515 00:31:15,080 --> 00:31:19,690 It's probably, in a sense, a good reaction from the point 516 00:31:19,690 --> 00:31:23,970 of view of certain types of survival. 517 00:31:23,970 --> 00:31:27,210 But there's a lot of lab experiments where basically 518 00:31:27,210 --> 00:31:29,720 what they do is they stress people out. 519 00:31:29,720 --> 00:31:31,920 So I think the one that-- 520 00:31:34,840 --> 00:31:40,220 there's a bunch of them with Princeton students, who are 521 00:31:40,220 --> 00:31:43,070 not exactly the world's poorest. 522 00:31:43,070 --> 00:31:45,560 But the way these experiments go is 523 00:31:45,560 --> 00:31:48,920 they give you an endowment. 524 00:31:48,920 --> 00:31:53,970 And then they take away some of that endowment. 525 00:31:53,970 --> 00:31:56,650 And somehow people get stressed out when you do that. 526 00:32:00,000 --> 00:32:03,300 Even if, obviously, you're a Princeton student. 527 00:32:03,300 --> 00:32:04,920 It's not that you're going to run out of food. 528 00:32:04,920 --> 00:32:06,870 There's plenty of food in the dining halls. 529 00:32:06,870 --> 00:32:12,830 And your lifetime income is unlikely to be affected by the 530 00:32:12,830 --> 00:32:15,810 fact that you lost $5 in this experiment. 531 00:32:15,810 --> 00:32:18,870 But people get stressed out when you put them into these 532 00:32:18,870 --> 00:32:20,110 situations. 533 00:32:20,110 --> 00:32:25,090 And then the experiment is to make them play games, sort of, 534 00:32:25,090 --> 00:32:28,130 like, problem solving games. 535 00:32:28,130 --> 00:32:31,240 And you get a massive reduction in their problem 536 00:32:31,240 --> 00:32:32,470 solving ability. 537 00:32:32,470 --> 00:32:33,620 Maybe they're not MIT students. 538 00:32:33,620 --> 00:32:36,150 Maybe they're just not as good at it. 539 00:32:36,150 --> 00:32:41,270 But still you see that they do really badly when you put them 540 00:32:41,270 --> 00:32:45,100 under stress, so, like, little bit of stress, some fake 541 00:32:45,100 --> 00:32:47,510 stress, basically. 542 00:32:47,510 --> 00:32:50,020 They were going to get $10 and instead they end 543 00:32:50,020 --> 00:32:51,520 up with $2 or something. 544 00:32:51,520 --> 00:32:54,690 And that kind of stress already makes them take really 545 00:32:54,690 --> 00:32:56,580 bad decisions. 546 00:32:56,580 --> 00:33:00,050 You might imagine if you had real stress. 547 00:33:00,050 --> 00:33:01,690 Your child could starve. 548 00:33:04,250 --> 00:33:05,660 Your mother could die. 549 00:33:05,660 --> 00:33:07,860 You could lose your job. 550 00:33:07,860 --> 00:33:09,850 You're not going to be taking a lot of good 551 00:33:09,850 --> 00:33:11,466 decisions under that. 552 00:33:11,466 --> 00:33:12,432 Yep? 553 00:33:12,432 --> 00:33:15,330 AUDIENCE: In the experiment was the endowment or money 554 00:33:15,330 --> 00:33:17,201 related at all to the outcome of the games? 555 00:33:17,201 --> 00:33:19,890 Or was it just like they were [INAUDIBLE]? 556 00:33:19,890 --> 00:33:20,480 PROFESSOR: No. 557 00:33:20,480 --> 00:33:21,070 These are separate. 558 00:33:21,070 --> 00:33:22,930 So the games were the games. 559 00:33:22,930 --> 00:33:29,090 But before the games, you created some general 560 00:33:29,090 --> 00:33:30,650 unpleasantness for them. 561 00:33:30,650 --> 00:33:35,120 They thought they would get A but they get B or something. 562 00:33:35,120 --> 00:33:37,000 One of the rules of experiments is you can't make 563 00:33:37,000 --> 00:33:38,000 people worse off. 564 00:33:38,000 --> 00:33:40,530 So these people were not made-- 565 00:33:40,530 --> 00:33:42,450 they were first given some money, and then some of that 566 00:33:42,450 --> 00:33:45,930 money was somehow taken away from them. 567 00:33:45,930 --> 00:33:49,430 So this was like somehow even that got them so stressed out 568 00:33:49,430 --> 00:33:52,530 that they started playing games badly. 569 00:33:52,530 --> 00:33:52,970 Melissa. 570 00:33:52,970 --> 00:33:54,613 AUDIENCE: How do you know that it's not just that they're 571 00:33:54,613 --> 00:33:56,421 like, oh, this is a stupid experiment? 572 00:33:56,421 --> 00:33:58,146 If I do well, they're just going to take it 573 00:33:58,146 --> 00:33:58,886 away from me again. 574 00:33:58,886 --> 00:34:00,365 So I'm not going to make any effort. 575 00:34:05,300 --> 00:34:08,040 PROFESSOR: How do I know? 576 00:34:08,040 --> 00:34:10,290 Because I think they believed the experimenters. 577 00:34:10,290 --> 00:34:12,620 I don't think that they thought that-- 578 00:34:12,620 --> 00:34:15,870 so they were told from the beginning that when you join 579 00:34:15,870 --> 00:34:21,949 this experiment there will be some uncertainty that's going 580 00:34:21,949 --> 00:34:24,790 to be created for you. 581 00:34:24,790 --> 00:34:29,190 So the experiment was done relatively carefully to avoid 582 00:34:29,190 --> 00:34:30,840 the possibility that they think this 583 00:34:30,840 --> 00:34:34,050 is just a mad world. 584 00:34:34,050 --> 00:34:37,320 I think most experimenters worry about that, which is you 585 00:34:37,320 --> 00:34:40,590 come and tell me first that we'll do this to you, and then 586 00:34:40,590 --> 00:34:42,150 I'm going to do that to you. 587 00:34:42,150 --> 00:34:42,949 You start worrying. 588 00:34:42,949 --> 00:34:46,880 But then there's a nice field experiment actually in Kenya 589 00:34:46,880 --> 00:34:52,170 which is measuring cortisol levels across people when they 590 00:34:52,170 --> 00:34:55,719 receive, I think, some microcredit 591 00:34:55,719 --> 00:34:57,380 or some other program. 592 00:34:57,380 --> 00:34:59,300 I haven't seen the results from it yet. 593 00:34:59,300 --> 00:35:03,590 But I've heard the results are again very similar, that 594 00:35:03,590 --> 00:35:05,800 you're going to get people under 595 00:35:05,800 --> 00:35:10,200 stress take bad decisions. 596 00:35:10,200 --> 00:35:14,300 So the advantage of doing it in the field is that they're 597 00:35:14,300 --> 00:35:18,540 getting real help with their stress. 598 00:35:18,540 --> 00:35:20,920 And when they get the real help with their risk, they 599 00:35:20,920 --> 00:35:23,880 actually take better decisions. 600 00:35:23,880 --> 00:35:24,800 It's less artificial. 601 00:35:24,800 --> 00:35:31,120 But I think this fact is quite crucial in understanding a lot 602 00:35:31,120 --> 00:35:34,666 of decision making among poor people because they are under 603 00:35:34,666 --> 00:35:36,240 a huge amount of stress. 604 00:35:36,240 --> 00:35:40,055 And then we're expecting them to maximize utility over, you 605 00:35:40,055 --> 00:35:43,810 know, the rest of their lives and figure out which financial 606 00:35:43,810 --> 00:35:47,000 investment to make and, you know, how to educate their 607 00:35:47,000 --> 00:35:49,900 children and all of these decisions and 608 00:35:49,900 --> 00:35:51,510 get all of them right. 609 00:35:51,510 --> 00:35:53,600 You might imagine that one of the things that happens when 610 00:35:53,600 --> 00:35:55,200 you're under a lot of stress is you get 611 00:35:55,200 --> 00:35:56,810 these decisions wrong. 612 00:35:56,810 --> 00:35:59,520 And if you get the decisions wrong that obviously has long 613 00:35:59,520 --> 00:36:03,070 term consequences for your life-- so one other sense in 614 00:36:03,070 --> 00:36:09,030 which risk affects you is by making you take bad decisions. 615 00:36:09,030 --> 00:36:10,794 Yeah. 616 00:36:10,794 --> 00:36:13,478 AUDIENCE: But isn't it often the case that for the poor the 617 00:36:13,478 --> 00:36:17,382 options are in many cases very limited and, for example, if 618 00:36:17,382 --> 00:36:21,336 plant harvest fails, a lot of people will just move to other 619 00:36:21,336 --> 00:36:24,580 areas or do labor? 620 00:36:24,580 --> 00:36:27,075 And they also have few sources of credits. 621 00:36:27,075 --> 00:36:30,797 So if the crop fails, then this will at least give people 622 00:36:30,797 --> 00:36:31,775 [INAUDIBLE] credit. 623 00:36:31,775 --> 00:36:36,176 So does decision making actually understress actual 624 00:36:36,176 --> 00:36:41,790 figure very highly in decision [INAUDIBLE]? 625 00:36:41,790 --> 00:36:43,160 PROFESSOR: I think the answer is yes. 626 00:36:43,160 --> 00:36:46,810 I mean, I think at the beginning of the semester we 627 00:36:46,810 --> 00:36:49,610 looked at, for example, just consumption 628 00:36:49,610 --> 00:36:50,890 decisions of the poor. 629 00:36:54,100 --> 00:36:57,590 What we saw there was that they were spending large 630 00:36:57,590 --> 00:37:00,850 amounts of money on things that they didn't need to buy. 631 00:37:00,850 --> 00:37:03,620 So that's a very simple example. 632 00:37:03,620 --> 00:37:05,560 Taking their child to be immunized. 633 00:37:05,560 --> 00:37:09,380 Should I take him today or take him in a month? 634 00:37:09,380 --> 00:37:12,460 And if I don't do it today, if I'm fully forward looking, 635 00:37:12,460 --> 00:37:14,830 rational, I might decide, look, I might as will do it 636 00:37:14,830 --> 00:37:16,910 today because I'll never do it in the future. 637 00:37:16,910 --> 00:37:21,440 But if I'm subject to making bad decisions, I might easily 638 00:37:21,440 --> 00:37:25,000 make a decision on that. 639 00:37:25,000 --> 00:37:28,810 Should I spend the effort and the money to 640 00:37:28,810 --> 00:37:30,310 purify my water or not? 641 00:37:32,970 --> 00:37:36,570 I can miscalculate on that. 642 00:37:36,570 --> 00:37:37,920 I could think the risk is smaller 643 00:37:37,920 --> 00:37:40,240 than it is, for example. 644 00:37:40,240 --> 00:37:42,870 Actually, I would almost put it the other way around. 645 00:37:42,870 --> 00:37:46,230 I think we who live in-- 646 00:37:46,230 --> 00:37:49,350 rich people have most of the decisions taken 647 00:37:49,350 --> 00:37:50,280 out of their hands. 648 00:37:50,280 --> 00:37:53,790 For example, I don't remember taking any savings decision. 649 00:37:53,790 --> 00:37:57,810 Mostly my saving decisions are taken by MIT. 650 00:37:57,810 --> 00:38:01,040 And then there's some plan which I'm supposed to join. 651 00:38:01,040 --> 00:38:03,700 I joined that plan when I joined MIT, and I've not 652 00:38:03,700 --> 00:38:04,870 changed anything. 653 00:38:04,870 --> 00:38:06,580 I don't have to plan my retirement. 654 00:38:06,580 --> 00:38:12,560 I don't have any risk mostly. 655 00:38:12,560 --> 00:38:16,500 Unless I do something really awful, I don't lose my job. 656 00:38:16,500 --> 00:38:20,900 So I never take many decisions on, like, should I go look for 657 00:38:20,900 --> 00:38:22,190 a job there or there? 658 00:38:22,190 --> 00:38:25,670 I just come to my office and I'm done. 659 00:38:25,670 --> 00:38:31,600 I don't have the choice of not immunizing my children because 660 00:38:31,600 --> 00:38:35,050 to the extent that I want them to go to school, the school 661 00:38:35,050 --> 00:38:36,360 basically enforces that. 662 00:38:36,360 --> 00:38:37,840 You can't get your children to school 663 00:38:37,840 --> 00:38:41,110 without immunizing them. 664 00:38:41,110 --> 00:38:44,630 Most decisions of this class are taken out. 665 00:38:44,630 --> 00:38:45,360 I don't know [INAUDIBLE] 666 00:38:45,360 --> 00:38:46,410 water supply. 667 00:38:46,410 --> 00:38:49,460 I turn on the water, it's clean. 668 00:38:49,460 --> 00:38:51,750 I absolutely don't have to take that decision on. 669 00:38:51,750 --> 00:38:54,400 Should I purify this water before I give it 670 00:38:54,400 --> 00:38:55,640 to my son or not? 671 00:38:55,640 --> 00:38:57,510 It's a decision I don't have to take. 672 00:38:57,510 --> 00:38:57,790 Why? 673 00:38:57,790 --> 00:39:01,990 Because the water's infrastructure cleans before 674 00:39:01,990 --> 00:39:04,175 it reaches me. 675 00:39:04,175 --> 00:39:07,650 I get clean water, so I don't have to worry about that. 676 00:39:07,650 --> 00:39:11,160 I don't have to worry about whether or not my house can be 677 00:39:11,160 --> 00:39:15,630 made out of things which can catch fire because before the 678 00:39:15,630 --> 00:39:17,380 house can be built an, inspector comes 679 00:39:17,380 --> 00:39:18,740 and checks it out. 680 00:39:18,740 --> 00:39:22,890 And I'm not allowed to build a house that can catch fire. 681 00:39:22,890 --> 00:39:28,260 So there's so many respects in which I don't have any choices 682 00:39:28,260 --> 00:39:29,210 given to me. 683 00:39:29,210 --> 00:39:30,530 But if you're poor, you actually 684 00:39:30,530 --> 00:39:31,950 have a thousand choices. 685 00:39:31,950 --> 00:39:36,422 I mean, I actually think there are too many choices you have 686 00:39:36,422 --> 00:39:37,720 to make if you are poor. 687 00:39:37,720 --> 00:39:39,400 I mean, think of water. 688 00:39:39,400 --> 00:39:41,460 Every day you have to decide should I clean 689 00:39:41,460 --> 00:39:43,010 the water or not? 690 00:39:43,010 --> 00:39:47,230 That's a difficult choice to make on any given day. 691 00:39:47,230 --> 00:39:49,860 Yes, someone else had a-- yeah. 692 00:39:49,860 --> 00:39:54,270 AUDIENCE: So how much of that, though, can you attribute to 693 00:39:54,270 --> 00:39:57,210 bad decision making affected by cortisol? 694 00:39:57,210 --> 00:40:00,640 And how much of it is because of a basic misunderstanding of 695 00:40:00,640 --> 00:40:04,070 economics and utility and the future return on 696 00:40:04,070 --> 00:40:06,470 something like that? 697 00:40:06,470 --> 00:40:07,640 PROFESSOR: We don't know the answer to that. 698 00:40:07,640 --> 00:40:09,180 It's a very good question. 699 00:40:09,180 --> 00:40:11,640 One day we'll know the answer to that. 700 00:40:11,640 --> 00:40:15,340 Like, this whole cortisol stuff, we've only figured this 701 00:40:15,340 --> 00:40:17,290 out in the last two or three years. 702 00:40:17,290 --> 00:40:22,680 We're just beginning to get into these kinds of questions 703 00:40:22,680 --> 00:40:24,350 in a scientific way. 704 00:40:24,350 --> 00:40:27,170 Maybe in 15 years we'll know the answer to that question. 705 00:40:27,170 --> 00:40:31,460 Right now this is one thing that I think is very, very, 706 00:40:31,460 --> 00:40:34,800 very recent, this understanding, this connection 707 00:40:34,800 --> 00:40:38,970 with cortisol and decision making and then the fact that 708 00:40:38,970 --> 00:40:40,640 cortisol is related to risk. 709 00:40:40,640 --> 00:40:42,760 This whole thing is very recent. 710 00:40:42,760 --> 00:40:44,340 So I don't know the answer to it. 711 00:40:44,340 --> 00:40:45,860 It's a perfectly good question. 712 00:40:45,860 --> 00:40:46,420 I just don't know. 713 00:40:46,420 --> 00:40:47,670 AUDIENCE: OK. 714 00:41:08,960 --> 00:41:12,440 PROFESSOR: Now, obviously people don't take risks 715 00:41:12,440 --> 00:41:13,850 sitting down. 716 00:41:13,850 --> 00:41:16,900 They do stuff about it. 717 00:41:16,900 --> 00:41:23,695 So one thing you can do is you can borrow. 718 00:41:26,460 --> 00:41:30,480 You can go and say, look, I don't have any money today. 719 00:41:33,060 --> 00:41:35,160 The truck didn't pick me up. 720 00:41:35,160 --> 00:41:36,390 Why don't you give me some money? 721 00:41:36,390 --> 00:41:38,180 And certainly people do that. 722 00:41:38,180 --> 00:41:43,020 We'll see that it's pretty limited and very expensive. 723 00:41:43,020 --> 00:41:44,770 So the alternative is to save. 724 00:41:44,770 --> 00:41:46,020 So you can borrow. 725 00:41:46,020 --> 00:41:48,950 You can save. 726 00:41:48,950 --> 00:41:50,210 We'll come to insurance later. 727 00:41:52,745 --> 00:41:57,100 But mostly most people, they do one of a fairly limited 728 00:41:57,100 --> 00:41:58,350 number of things. 729 00:42:09,980 --> 00:42:15,310 Now, savings is a pretty good way to deal with-- 730 00:42:21,060 --> 00:42:26,360 so imagine that you face a lot of risk and you can't borrow. 731 00:42:26,360 --> 00:42:32,060 Your decision rule more or less should be the following. 732 00:42:34,830 --> 00:42:36,710 The optimal decision rule-- 733 00:42:36,710 --> 00:42:38,870 whether people can figure this out. 734 00:42:38,870 --> 00:42:42,670 It took a Princeton economist and a computer to 735 00:42:42,670 --> 00:42:43,930 figure this one out. 736 00:42:43,930 --> 00:42:45,410 So maybe people can't figure it out. 737 00:42:45,410 --> 00:42:46,860 But let's say they can. 738 00:42:46,860 --> 00:42:50,170 Then their decision rule should be to consume 739 00:42:50,170 --> 00:42:53,940 everything when your income is low, everything you have. 740 00:42:53,940 --> 00:42:56,620 And then as soon as your income crosses a certain 741 00:42:56,620 --> 00:43:01,210 threshold you should save the rest and you should build up a 742 00:43:01,210 --> 00:43:05,800 stock for those days when things go wrong. 743 00:43:05,800 --> 00:43:11,480 Problem is that if you get two or three bad years in a row, 744 00:43:11,480 --> 00:43:14,350 this doesn't protect you at all. 745 00:43:14,350 --> 00:43:17,810 And the next picture kind of shows that a little bit. 746 00:43:17,810 --> 00:43:19,100 So this is a simulation. 747 00:43:19,100 --> 00:43:20,880 This is nobody real. 748 00:43:20,880 --> 00:43:28,000 This is a simulation of what happens when you have income, 749 00:43:28,000 --> 00:43:29,250 consumption, and assets. 750 00:43:33,430 --> 00:43:36,080 So income is bouncing around. 751 00:43:39,590 --> 00:43:43,780 When income is high, you're accumulating assets. 752 00:43:43,780 --> 00:43:48,480 Then at some point, when income is low for a few years, 753 00:43:48,480 --> 00:43:51,960 your assets keep getting run down. 754 00:43:51,960 --> 00:43:53,260 Some point it hits zero. 755 00:43:53,260 --> 00:43:56,120 Then if you're lucky and income goes up right then, 756 00:43:56,120 --> 00:43:58,420 then you keep going up. 757 00:43:58,420 --> 00:44:01,280 Then your assets go up and you keep saving. 758 00:44:01,280 --> 00:44:02,070 You're fine. 759 00:44:02,070 --> 00:44:05,520 But sometimes you can see that, like in the middle, 760 00:44:05,520 --> 00:44:10,440 there is this place where income goes down sharply, and 761 00:44:10,440 --> 00:44:15,380 it goes down like there's several periods for which it's 762 00:44:15,380 --> 00:44:21,920 gone down, that sharp kind of knife, you know, 763 00:44:21,920 --> 00:44:24,250 right in the middle. 764 00:44:24,250 --> 00:44:26,420 And you can see that what's happened there is your assets 765 00:44:26,420 --> 00:44:28,550 have hit zero. 766 00:44:28,550 --> 00:44:31,220 And because your assets have hit zero, there's no way you 767 00:44:31,220 --> 00:44:38,050 can just pull down your assets and protect your consumption. 768 00:44:38,050 --> 00:44:39,500 There's nothing you can do about it. 769 00:44:39,500 --> 00:44:41,600 And that's when you see consumption really dropping. 770 00:44:41,600 --> 00:44:45,340 So most of the time you see consumption is a lot flatter 771 00:44:45,340 --> 00:44:46,590 than income. 772 00:44:49,130 --> 00:44:51,030 And that's what people find in the data. 773 00:44:51,030 --> 00:44:54,670 Consumption, in general, is very flat relative to income. 774 00:44:54,670 --> 00:44:56,940 But there are periods when it plunges. 775 00:44:56,940 --> 00:45:01,080 So if you get two or three bad shocks then it really hurts. 776 00:45:01,080 --> 00:45:05,290 One bad shock you can deal with but two or three and you 777 00:45:05,290 --> 00:45:06,450 run out of all assets. 778 00:45:06,450 --> 00:45:09,400 And then suddenly your consumption drops massively. 779 00:45:09,400 --> 00:45:14,200 So you protect your consumption for a few periods. 780 00:45:14,200 --> 00:45:17,420 But then if your shock continues then suddenly you 781 00:45:17,420 --> 00:45:18,230 get into starvation. 782 00:45:18,230 --> 00:45:21,650 So that picture is actually roughly what you find in the 783 00:45:21,650 --> 00:45:31,920 data, that people, at least two years in a row, maybe they 784 00:45:31,920 --> 00:45:32,930 just make it. 785 00:45:32,930 --> 00:45:34,000 Their consumption doesn't fall. 786 00:45:34,000 --> 00:45:39,130 The third year, if the rain again falls then they go into 787 00:45:39,130 --> 00:45:39,810 starvation. 788 00:45:39,810 --> 00:45:43,520 So that's a pattern that you see a lot, and that's exactly 789 00:45:43,520 --> 00:45:44,510 what you'd expect. 790 00:45:44,510 --> 00:45:49,240 People should try to protect their consumption until they 791 00:45:49,240 --> 00:45:55,100 can by, you know, running down assets and expect that next 792 00:45:55,100 --> 00:46:00,410 time income will recover. 793 00:46:00,410 --> 00:46:02,840 But income doesn't recover after several times then you 794 00:46:02,840 --> 00:46:04,090 get hit very badly. 795 00:46:04,090 --> 00:46:07,400 And that's sort of what we find also in the data. 796 00:46:07,400 --> 00:46:10,210 This is a pattern we also see in the data. 797 00:46:10,210 --> 00:46:14,280 Another thing you can do is try to work more. 798 00:46:23,180 --> 00:46:24,470 And everybody does that. 799 00:46:27,920 --> 00:46:33,450 You know, let's say there's a drought and you can't farm. 800 00:46:33,450 --> 00:46:34,950 You go and start to sell labor. 801 00:46:38,330 --> 00:46:41,250 Problem is when it's a drought, it's a drought for 802 00:46:41,250 --> 00:46:42,310 everybody else. 803 00:46:42,310 --> 00:46:44,510 Everybody's selling labor. 804 00:46:44,510 --> 00:46:45,760 What happens to wages? 805 00:46:48,894 --> 00:46:51,560 AUDIENCE: Well, they're much cheaper. 806 00:46:51,560 --> 00:46:53,320 PROFESSOR: So wages keep going down. 807 00:46:53,320 --> 00:46:58,850 So in particular it could very well be that in a drought 808 00:46:58,850 --> 00:47:03,290 everybody ends up trying to work so much and wages go down 809 00:47:03,290 --> 00:47:08,160 so much that that amplifies rather than reduces the risk 810 00:47:08,160 --> 00:47:10,680 because everybody tries to work. 811 00:47:10,680 --> 00:47:17,400 So I'm going to try and go and try and get work assuming that 812 00:47:17,400 --> 00:47:19,070 everybody else is not working. 813 00:47:19,070 --> 00:47:21,780 But when I try to go to get work, everybody 814 00:47:21,780 --> 00:47:22,810 else does as well. 815 00:47:22,810 --> 00:47:25,900 That drives down wages to the point where it could even be 816 00:47:25,900 --> 00:47:28,130 that it does nothing to protect me. 817 00:47:28,130 --> 00:47:31,740 I just end up working more and earning the same amount I 818 00:47:31,740 --> 00:47:34,210 would have earned otherwise. 819 00:47:34,210 --> 00:47:36,900 So this is something that is this real? 820 00:47:36,900 --> 00:47:41,040 So there's a paper by [INAUDIBLE] 821 00:47:41,040 --> 00:47:45,680 who basically looks at this. 822 00:47:45,680 --> 00:47:49,210 And what she does is she adds another wrinkle to it. 823 00:47:49,210 --> 00:47:53,820 So she says, well, how much you're going to do go out and 824 00:47:53,820 --> 00:48:00,360 look for a job versus sort of [? desave ?]? 825 00:48:00,360 --> 00:48:03,110 Depends on whether you have a bank account or not. 826 00:48:03,110 --> 00:48:05,240 So if you have money in your bank account, you're less 827 00:48:05,240 --> 00:48:09,600 likely to go out and find an extra job and more likely to 828 00:48:09,600 --> 00:48:13,200 live off your bank account or at least partly live off your 829 00:48:13,200 --> 00:48:14,130 bank account. 830 00:48:14,130 --> 00:48:16,770 So you're going to be less desperate to find work. 831 00:48:16,770 --> 00:48:18,980 That's going to drive wages down less. 832 00:48:18,980 --> 00:48:24,100 So what she does is she looks at what happens to wages in 833 00:48:24,100 --> 00:48:28,780 drought years versus non drought years in areas which 834 00:48:28,780 --> 00:48:31,850 have good banking services versus areas which don't have 835 00:48:31,850 --> 00:48:33,280 good banking services. 836 00:48:33,280 --> 00:48:34,890 So this is data from India. 837 00:48:34,890 --> 00:48:40,070 And she's comparing areas which have good banking 838 00:48:40,070 --> 00:48:43,230 services versus areas that don't have such good banking 839 00:48:43,230 --> 00:48:48,150 services and looking at the effect of that on wages in 840 00:48:48,150 --> 00:48:50,000 drought years versus non drought years. 841 00:48:52,630 --> 00:48:55,140 So in drought years wages are going to be lower. 842 00:48:55,140 --> 00:49:08,480 She's asking are wages that much lower in areas where the 843 00:49:08,480 --> 00:49:11,670 banking services are worse? 844 00:49:11,670 --> 00:49:15,620 Or alternately, are wages relatively less likely to fall 845 00:49:15,620 --> 00:49:20,450 in a drought year where banking services are better? 846 00:49:20,450 --> 00:49:23,010 Do you see the motivation for that? 847 00:49:26,030 --> 00:49:27,485 So that's the next table. 848 00:49:39,630 --> 00:49:45,675 So when crop yield goes up, which is basically rainfall-- 849 00:49:49,490 --> 00:49:52,320 so this is always with district fixed effect. 850 00:49:52,320 --> 00:49:55,370 So we're comparing the same district over time, the wage 851 00:49:55,370 --> 00:49:59,840 in the same district over time over this period 1956 to '87. 852 00:49:59,840 --> 00:50:06,160 Over these 31 years we are comparing the same district in 853 00:50:06,160 --> 00:50:07,600 a drought year and a non drought year. 854 00:50:12,320 --> 00:50:15,420 Banking is something that improved over time. 855 00:50:15,420 --> 00:50:20,860 So, in particular, if you look in the last column, banking is 856 00:50:20,860 --> 00:50:23,950 also something that's changing over time. 857 00:50:23,950 --> 00:50:28,480 And she's controlling for that. 858 00:50:28,480 --> 00:50:32,950 And then she's asking is it the case that where the 859 00:50:32,950 --> 00:50:41,640 banking is better, the effect of a good yield in increasing 860 00:50:41,640 --> 00:50:43,610 wages is smaller? 861 00:50:43,610 --> 00:50:46,660 That's the same question as the affect of bad yield in 862 00:50:46,660 --> 00:50:51,360 decreasing wages is also going to be smaller. 863 00:50:55,110 --> 00:50:59,120 The effect of yield on wages, is it smaller in districts 864 00:50:59,120 --> 00:51:06,580 which have better banking services? 865 00:51:09,230 --> 00:51:13,330 And that negative in crop yield interactive with 866 00:51:13,330 --> 00:51:18,060 banking, that negative role in the middle says that, yes, the 867 00:51:18,060 --> 00:51:24,190 effect of yield on wages is smaller where banking is 868 00:51:24,190 --> 00:51:27,480 better, as you'd expect. 869 00:51:27,480 --> 00:51:28,730 People are less desperate. 870 00:51:28,730 --> 00:51:33,130 They can go to the bank instead of, you know, working. 871 00:51:33,130 --> 00:51:35,220 And, therefore, the fallen wages is 872 00:51:35,220 --> 00:51:36,470 smaller in those places. 873 00:51:40,460 --> 00:51:41,540 We talked about saving. 874 00:51:41,540 --> 00:51:43,240 We talked about borrowing. 875 00:51:43,240 --> 00:51:46,890 There's a third thing you could do. 876 00:51:46,890 --> 00:51:48,260 Or we talked about saving. 877 00:51:48,260 --> 00:51:49,240 We talked about borrowing. 878 00:51:49,240 --> 00:51:50,430 We talked about working. 879 00:51:50,430 --> 00:51:52,492 There's a fourth thing we could do. 880 00:51:52,492 --> 00:51:54,810 Oops. 881 00:51:54,810 --> 00:51:56,060 That was dangerous. 882 00:51:58,470 --> 00:52:06,900 The fourth thing you could do is you could try to do things 883 00:52:06,900 --> 00:52:08,150 to avoid risk. 884 00:52:11,330 --> 00:52:15,675 So what's an example of doing something to avoid risk? 885 00:52:29,670 --> 00:52:32,900 AUDIENCE: Maybe diversify where you're investing. 886 00:52:32,900 --> 00:52:35,000 PROFESSOR: Diversify where you're investing. 887 00:52:35,000 --> 00:52:36,790 Give me an example. 888 00:52:36,790 --> 00:52:39,430 That sounds right but general principle. 889 00:52:39,430 --> 00:52:42,202 Give me an example of what you mean by diversify. 890 00:52:42,202 --> 00:52:44,990 AUDIENCE: Maybe, for example, if you're a farmer, you have 891 00:52:44,990 --> 00:52:47,614 to [INAUDIBLE] of crops maybe. 892 00:52:47,614 --> 00:52:48,598 So that if some fail-- 893 00:52:48,598 --> 00:52:49,090 PROFESSOR: Right. 894 00:52:49,090 --> 00:52:56,370 So one example would be imagine there's two crops, 895 00:52:56,370 --> 00:52:57,640 sugar cane and wheat. 896 00:52:57,640 --> 00:53:01,880 Sugar cane is much more profitable. 897 00:53:01,880 --> 00:53:07,090 But wheat and sugar cane are subject to independent risk. 898 00:53:07,090 --> 00:53:12,330 So when sugar cane dries up, that doesn't affect wheat. 899 00:53:12,330 --> 00:53:15,200 And when wheat dries up, that doesn't affect sugar cane. 900 00:53:15,200 --> 00:53:17,790 Different things affect them. 901 00:53:17,790 --> 00:53:21,015 Then by having a little bit of sugar cane and a little bit of 902 00:53:21,015 --> 00:53:23,740 wheat, you have less risk. 903 00:53:23,740 --> 00:53:26,210 But, of course, you're paying in income. 904 00:53:26,210 --> 00:53:29,130 You'll be taking less income because sugar cane is more 905 00:53:29,130 --> 00:53:31,050 productive. 906 00:53:31,050 --> 00:53:34,340 So one thing people do is they diversify. 907 00:53:34,340 --> 00:53:38,790 Like a very interesting paper from many years ago showing 908 00:53:38,790 --> 00:53:41,630 they diversified in many, many complex ways. 909 00:53:41,630 --> 00:53:44,880 One thing that was very interesting is you'll find 910 00:53:44,880 --> 00:53:51,280 that in many countries, actually, you'll find that the 911 00:53:51,280 --> 00:53:56,450 plots people crop are not adjacent. 912 00:53:56,450 --> 00:53:58,090 And that seems to make no sense. 913 00:53:58,090 --> 00:54:04,230 Why would I farm over here for the morning, walk three 914 00:54:04,230 --> 00:54:07,610 kilometers over there and farm in the afternoon? 915 00:54:07,610 --> 00:54:10,400 That doesn't seem to make any sense unless you think that 916 00:54:10,400 --> 00:54:13,160 there are something like micro climates. 917 00:54:13,160 --> 00:54:17,810 So it might rain here when it's not raining there. 918 00:54:17,810 --> 00:54:21,520 Maybe when a bug attacks here, it doesn't attack over there. 919 00:54:21,520 --> 00:54:24,135 So even though you're growing the same crop, you grow it 920 00:54:24,135 --> 00:54:27,810 over several plots and the plots are not contiguous. 921 00:54:27,810 --> 00:54:34,030 You walk from plot to plot to avoid having exactly being in 922 00:54:34,030 --> 00:54:34,690 the same place. 923 00:54:34,690 --> 00:54:37,120 Because if you're in the same place then the same rainfall 924 00:54:37,120 --> 00:54:40,760 patterns, the same bugs, you're subject to them. 925 00:54:40,760 --> 00:54:43,790 If you had multiple plots in different places, you can 926 00:54:43,790 --> 00:54:44,860 avoid that. 927 00:54:44,860 --> 00:54:47,530 Now, that's of course wasteful because you're spending a lot 928 00:54:47,530 --> 00:54:49,680 of time walking, and you should have been spending that 929 00:54:49,680 --> 00:54:51,120 time farming. 930 00:54:51,120 --> 00:54:53,910 But at least you reduce risk. 931 00:54:53,910 --> 00:55:01,030 So the general principle is that you do many, many things 932 00:55:01,030 --> 00:55:06,110 to, like, diversify, have many crops, many plots, many jobs. 933 00:55:09,720 --> 00:55:16,220 There's a study of how many professions a family can have. 934 00:55:16,220 --> 00:55:20,360 And I think the maximum number in the study was 27. 935 00:55:20,360 --> 00:55:22,900 They were doing 27 different things. 936 00:55:22,900 --> 00:55:29,090 They were small things like going to the pond and 937 00:55:29,090 --> 00:55:31,825 harvesting muscles. 938 00:55:34,560 --> 00:55:35,710 You do that in the morning. 939 00:55:35,710 --> 00:55:39,375 Then you go and collect the firewood for sale. 940 00:55:42,660 --> 00:55:47,690 Then your son goes and takes the cow to the field, and your 941 00:55:47,690 --> 00:55:49,850 daughter feeds the chicken. 942 00:55:49,850 --> 00:55:52,360 So you had to add up all those little things. 943 00:55:52,360 --> 00:55:54,800 But they were doing 27 different professions. 944 00:55:54,800 --> 00:55:59,010 I think was the number if I remember right. 945 00:55:59,010 --> 00:56:03,840 But that's basically sort of an extreme version of this, 946 00:56:03,840 --> 00:56:06,310 avoiding risk by doing a little bit of many, many, 947 00:56:06,310 --> 00:56:07,560 many, many, many things. 948 00:56:10,220 --> 00:56:11,930 That's good. 949 00:56:11,930 --> 00:56:13,260 It allows you to avoid risk. 950 00:56:17,240 --> 00:56:28,840 But it's bad because you end up doing things which are not 951 00:56:28,840 --> 00:56:31,120 particularly productive. 952 00:56:31,120 --> 00:56:33,590 You don't do the sugar cane even though sugar cane is much 953 00:56:33,590 --> 00:56:35,180 more productive than wheat. 954 00:56:35,180 --> 00:56:38,480 So you lose money, and that keeps you poor. 955 00:56:38,480 --> 00:56:44,050 So it's estimated that it does not weather risk. 956 00:56:44,050 --> 00:56:48,200 And so if you didn't change your crop mix to deal with the 957 00:56:48,200 --> 00:56:52,600 risk, you would make 30% more money. 958 00:56:55,790 --> 00:56:58,570 So that's big. 959 00:56:58,570 --> 00:57:00,790 Basically the stuff that you're doing to protect 960 00:57:00,790 --> 00:57:03,210 against the risk is reducing your income by 30%. 961 00:57:07,850 --> 00:57:10,940 Another thing that it does is that because you're doing so 962 00:57:10,940 --> 00:57:12,910 many things, you don't-- 963 00:57:12,910 --> 00:57:15,610 we [? are not ?] good at any one of them. 964 00:57:15,610 --> 00:57:18,740 One way to get good at a profession is by working very 965 00:57:18,740 --> 00:57:21,620 hard at it, learning the job. 966 00:57:21,620 --> 00:57:27,080 So a lot of these people, for example, they don't want to go 967 00:57:27,080 --> 00:57:31,310 to the city and become a full time worker in the city. 968 00:57:31,310 --> 00:57:31,700 Why? 969 00:57:31,700 --> 00:57:33,600 Because they think they'll lose their job. 970 00:57:33,600 --> 00:57:37,120 And when they lose their job, if they still have the farm at 971 00:57:37,120 --> 00:57:40,080 home, they can come back to the farm and get 972 00:57:40,080 --> 00:57:42,500 a living from that. 973 00:57:42,500 --> 00:57:45,250 But if that means that your job in the city 974 00:57:45,250 --> 00:57:47,840 is a temporary job. 975 00:57:47,840 --> 00:57:52,860 If I'm hiring someone temporary, I have no incentive 976 00:57:52,860 --> 00:57:56,030 to give that person any skills. 977 00:57:56,030 --> 00:57:58,750 I know he's going to be gone in a month. 978 00:57:58,750 --> 00:58:00,930 So nobody gets start any skills. 979 00:58:00,930 --> 00:58:01,230 Why? 980 00:58:01,230 --> 00:58:03,030 Because they're all temporary laborers. 981 00:58:03,030 --> 00:58:04,500 But why are they temporary laborers? 982 00:58:04,500 --> 00:58:09,810 Because they don't want to put all their money into this one 983 00:58:09,810 --> 00:58:13,180 basket, all the eggs into this one basket because they think 984 00:58:13,180 --> 00:58:17,320 that suppose I lose that job, what's going to happen? 985 00:58:17,320 --> 00:58:19,610 I might as will keep my foot in farming. 986 00:58:19,610 --> 00:58:21,130 And so they keep their foot in farming. 987 00:58:21,130 --> 00:58:24,610 They keep their foot in the city. 988 00:58:24,610 --> 00:58:27,370 They keep their foot in farming sugar cane. 989 00:58:27,370 --> 00:58:31,870 They keep their foot in farming wheat. 990 00:58:31,870 --> 00:58:33,570 They do many, many different things. 991 00:58:33,570 --> 00:58:35,710 That means they don't get good at anything, and they don't 992 00:58:35,710 --> 00:58:37,503 take advantage of what they're good at. 993 00:58:43,880 --> 00:58:49,950 So one other thing you could do is 994 00:58:49,950 --> 00:58:53,220 actually offer insurance. 995 00:58:53,220 --> 00:58:57,000 To all of these strategies the logical 996 00:58:57,000 --> 00:58:58,250 alternative is insurance. 997 00:59:01,060 --> 00:59:04,280 What is insurance? 998 00:59:04,280 --> 00:59:06,050 What would be weather insurance? 999 00:59:12,660 --> 00:59:15,380 What's an insurance? 1000 00:59:15,380 --> 00:59:15,970 Yeah? 1001 00:59:15,970 --> 00:59:18,703 AUDIENCE: The idea for the insurance is to gather up a 1002 00:59:18,703 --> 00:59:21,685 large group of people with different specific exposures 1003 00:59:21,685 --> 00:59:25,080 to a certain risk and then to pool that risk. 1004 00:59:25,080 --> 00:59:28,306 So you pay marginally in the event that something happens, 1005 00:59:28,306 --> 00:59:28,940 and then you get a reimbursement. 1006 00:59:28,940 --> 00:59:30,125 PROFESSOR: What does the contract look like? 1007 00:59:30,125 --> 00:59:31,400 I am asking a simple question. 1008 00:59:31,400 --> 00:59:32,386 You're right. 1009 00:59:32,386 --> 00:59:34,358 AUDIENCE: You pay an annual premium. 1010 00:59:34,358 --> 00:59:37,810 And then if something happens, you get reimbursed for it. 1011 00:59:37,810 --> 00:59:38,470 PROFESSOR: Right. 1012 00:59:38,470 --> 00:59:44,680 So if the weather is really bad, you give me $1,000, and I 1013 00:59:44,680 --> 00:59:48,285 pay $50 in a normal year or something. 1014 00:59:50,810 --> 00:59:52,262 You want to say something? 1015 00:59:52,262 --> 00:59:54,246 AUDIENCE: I mean, another alternative to private 1016 00:59:54,246 --> 00:59:55,734 insurance would be to have some form 1017 00:59:55,734 --> 00:59:57,222 of government insurance. 1018 00:59:57,222 --> 01:00:00,297 So I was thinking when you were talking about this that 1019 01:00:00,297 --> 01:00:02,678 are a lot of historically sort of much more seemingly 1020 01:00:02,678 --> 01:00:06,398 primitive societies who did a better job of sort of dealing 1021 01:00:06,398 --> 01:00:09,622 with these issues, like, say, like, the Incas or even, like, 1022 01:00:09,622 --> 01:00:11,606 the Mycenaeans or something. 1023 01:00:11,606 --> 01:00:15,670 And what seems to be different is that they had kind of 1024 01:00:15,670 --> 01:00:17,633 somewhat strong functioning central states that 1025 01:00:17,633 --> 01:00:18,575 redistributed across. 1026 01:00:18,575 --> 01:00:21,872 People like the Incas didn't even have money or sort of 1027 01:00:21,872 --> 01:00:24,510 markets in the modern sense that we've talked about, yet 1028 01:00:24,510 --> 01:00:27,930 they had this sort of sophisticated system of 1029 01:00:27,930 --> 01:00:32,571 redistribution and, like, collection of agricultural 1030 01:00:32,571 --> 01:00:35,710 products to, I guess, feed the military but 1031 01:00:35,710 --> 01:00:36,440 also to smooth risk. 1032 01:00:36,440 --> 01:00:36,760 PROFESSOR: Yes. 1033 01:00:36,760 --> 01:00:38,550 So we'll talk a little bit about that in the end, which 1034 01:00:38,550 --> 01:00:41,560 is you're talking about, I think, something very 1035 01:00:41,560 --> 01:00:47,540 important which is what would public policy look like here? 1036 01:00:47,540 --> 01:00:50,495 You would want some way to insure people. 1037 01:00:54,400 --> 01:00:57,250 But right now I'm asking a narrow question. 1038 01:01:00,980 --> 01:01:06,380 If I was facing risk and there was an insurance market, I 1039 01:01:06,380 --> 01:01:07,960 could buy insurance, right? 1040 01:01:07,960 --> 01:01:10,000 If I'm worried about risk and I'm doing all kinds of 1041 01:01:10,000 --> 01:01:14,400 inefficient things to avoid risk, I could deal with it by 1042 01:01:14,400 --> 01:01:18,400 just saying, look, you know, I'm going to buy insurance on 1043 01:01:18,400 --> 01:01:18,720 the weather. 1044 01:01:18,720 --> 01:01:22,630 And when the weather's bad, I'm going to get money. 1045 01:01:22,630 --> 01:01:30,860 So here's a weather insurance product in Ghana. 1046 01:01:30,860 --> 01:01:36,040 This was offered at different prices to different people. 1047 01:01:36,040 --> 01:01:39,490 And the striking fact here is when you offer at a price of 1048 01:01:39,490 --> 01:01:43,380 zero, people are willing to take it, not entirely 1049 01:01:43,380 --> 01:01:45,270 surprisingly. 1050 01:01:45,270 --> 01:01:54,560 However, as the price goes up to an actually fair price-- 1051 01:01:54,560 --> 01:01:57,150 what is an actually fair price, if I can 1052 01:01:57,150 --> 01:01:58,271 say the word correctly? 1053 01:01:58,271 --> 01:01:59,213 Yeah? 1054 01:01:59,213 --> 01:02:01,568 AUDIENCE: It's the amount it actually costs, like, 1055 01:02:01,568 --> 01:02:05,336 aggregate to get to an expected value of zero. 1056 01:02:05,336 --> 01:02:05,820 PROFESSOR: Right. 1057 01:02:05,820 --> 01:02:09,940 So the amount I pay you in expectation is equal to the 1058 01:02:09,940 --> 01:02:11,610 amount you pay. 1059 01:02:11,610 --> 01:02:14,330 That's actually fair price. 1060 01:02:14,330 --> 01:02:16,420 You can see that some people buy above the 1061 01:02:16,420 --> 01:02:17,860 actually fair price. 1062 01:02:17,860 --> 01:02:20,444 Why is that? 1063 01:02:20,444 --> 01:02:22,390 AUDIENCE: [INAUDIBLE]. 1064 01:02:22,390 --> 01:02:22,880 PROFESSOR: Sorry? 1065 01:02:22,880 --> 01:02:24,200 AUDIENCE: [INAUDIBLE]. 1066 01:02:24,200 --> 01:02:25,600 PROFESSOR: Because they're risk adverse. 1067 01:02:25,600 --> 01:02:28,520 So you're really willing to pay the market. 1068 01:02:28,520 --> 01:02:31,610 Economic theory would say you should be willing to pay more 1069 01:02:31,610 --> 01:02:33,310 than the actually fair price. 1070 01:02:33,310 --> 01:02:33,560 Why? 1071 01:02:33,560 --> 01:02:37,890 Because the actually fair price says on average you 1072 01:02:37,890 --> 01:02:39,750 break even. 1073 01:02:39,750 --> 01:02:41,440 But risk hurts you a lot. 1074 01:02:41,440 --> 01:02:43,750 So you don't want to break even on average. 1075 01:02:43,750 --> 01:02:47,980 You're willing to pay extra money to get rid of the bad 1076 01:02:47,980 --> 01:02:49,380 things that happen when-- 1077 01:02:52,530 --> 01:02:56,375 risk hurts you more than just-- 1078 01:02:59,040 --> 01:03:02,430 it's not just that sometimes you get more, 1079 01:03:02,430 --> 01:03:03,960 sometimes you get less. 1080 01:03:03,960 --> 01:03:06,460 The fact that sometimes you get less is worrying you, is 1081 01:03:06,460 --> 01:03:09,340 making you do bad things that are inefficient. 1082 01:03:09,340 --> 01:03:11,840 So you should be willing to pay more than the actually 1083 01:03:11,840 --> 01:03:15,185 fair price to get insurance because that's the whole idea 1084 01:03:15,185 --> 01:03:17,730 of insurance. 1085 01:03:17,730 --> 01:03:23,930 Car insurance is almost hugely not fair if you look at the 1086 01:03:23,930 --> 01:03:25,550 car insurance we have the US. 1087 01:03:25,550 --> 01:03:26,630 Why do we have that? 1088 01:03:26,630 --> 01:03:30,560 Because we want to be covered against the possibility that 1089 01:03:30,560 --> 01:03:32,020 sometimes people will sue us for a 1090 01:03:32,020 --> 01:03:35,070 million dollars in damages. 1091 01:03:35,070 --> 01:03:39,530 And so we are willing to pay a lot more than what's fair. 1092 01:03:39,530 --> 01:03:42,520 So these people, they're not willing to pay. 1093 01:03:42,520 --> 01:03:45,050 At the fair price, 30% willing to take it. 1094 01:03:47,570 --> 01:03:51,660 And you have to really go down to about the price of one, 1095 01:03:51,660 --> 01:03:55,480 that's 1/9 of the fair price, to get people to take it. 1096 01:03:55,480 --> 01:03:58,030 So people don't seem to want insurance. 1097 01:03:58,030 --> 01:04:01,110 So if everything I said so far was true, why 1098 01:04:01,110 --> 01:04:04,200 don't they want insurance? 1099 01:04:04,200 --> 01:04:06,610 I said they did all these inefficient things 1100 01:04:06,610 --> 01:04:08,040 to deal with risk. 1101 01:04:08,040 --> 01:04:10,160 Isn't that immediately telling us that 1102 01:04:10,160 --> 01:04:11,410 they should want insurance? 1103 01:04:15,430 --> 01:04:15,810 Yes? 1104 01:04:15,810 --> 01:04:17,060 No? 1105 01:04:26,850 --> 01:04:32,380 And, in fact, when they take insurance, good things happen. 1106 01:04:32,380 --> 01:04:42,990 So this picture, what it shows, this is spending on-- 1107 01:04:42,990 --> 01:04:45,700 total chemical spending is an odd title. 1108 01:04:45,700 --> 01:04:48,110 I didn't put it there. 1109 01:04:48,110 --> 01:04:50,970 But it's total spending on chemical fertilizer. 1110 01:04:50,970 --> 01:04:53,560 So how much fertilizer do you buy? 1111 01:04:53,560 --> 01:04:59,520 Well, when you get insurance, you buy about, you know, a 1112 01:04:59,520 --> 01:05:01,850 little bit more than in control. 1113 01:05:01,850 --> 01:05:03,750 So some people were offered insurance. 1114 01:05:03,750 --> 01:05:05,000 Some people were offered credit. 1115 01:05:05,000 --> 01:05:06,730 Some people were offered both. 1116 01:05:06,730 --> 01:05:12,810 And you see the sum gains in investment. 1117 01:05:12,810 --> 01:05:14,810 People under invest when they get-- 1118 01:05:19,260 --> 01:05:22,230 so relative to getting just the loan, 1119 01:05:22,230 --> 01:05:23,640 insurance really helps. 1120 01:05:23,640 --> 01:05:28,130 So when you get a loan, you don't want the loan if it 1121 01:05:28,130 --> 01:05:31,210 doesn't come with insurance because you worry that you 1122 01:05:31,210 --> 01:05:32,510 can't repay the loan. 1123 01:05:32,510 --> 01:05:34,100 So you don't actually gain much. 1124 01:05:34,100 --> 01:05:36,430 So if you're offered the loan, you gain nothing. 1125 01:05:36,430 --> 01:05:40,580 But when you're offered loan and insurance then your 1126 01:05:40,580 --> 01:05:43,370 investment goes up by about almost 50%. 1127 01:05:43,370 --> 01:05:46,520 So you really invest a lot more in fertilizer when you 1128 01:05:46,520 --> 01:05:49,340 get insurance and credit together relative to getting 1129 01:05:49,340 --> 01:05:51,940 just credit. 1130 01:05:51,940 --> 01:05:54,840 So that says that that affects your income. 1131 01:05:54,840 --> 01:05:58,030 This says that this affects your welfare. 1132 01:05:58,030 --> 01:06:02,810 When you get insurance and credit, you are actually about 1133 01:06:02,810 --> 01:06:06,610 half as likely to have somebody in your 1134 01:06:06,610 --> 01:06:09,570 family miss a meal. 1135 01:06:09,570 --> 01:06:11,280 That's an extreme form of risk. 1136 01:06:11,280 --> 01:06:14,320 You're just starving because you don't have money. 1137 01:06:14,320 --> 01:06:16,455 That halves when you offer insurance. 1138 01:06:16,455 --> 01:06:18,930 So insurance is very good for these people, whether or not 1139 01:06:18,930 --> 01:06:21,410 they want it. 1140 01:06:21,410 --> 01:06:23,440 Insurance seems to be increasing output 1141 01:06:23,440 --> 01:06:27,400 and reducing risk. 1142 01:06:27,400 --> 01:06:27,876 AUDIENCE: Wait. 1143 01:06:27,876 --> 01:06:28,828 Can you go back to that slide? 1144 01:06:28,828 --> 01:06:29,304 PROFESSOR: Yeah. 1145 01:06:29,304 --> 01:06:30,256 AUDIENCE: I don't understand. 1146 01:06:30,256 --> 01:06:33,270 So the both is if they get insurance and the loan? 1147 01:06:33,270 --> 01:06:36,168 [? PROFESSOR: Bought ?] and credit. 1148 01:06:36,168 --> 01:06:38,824 AUDIENCE: And so then the percentage of people missing 1149 01:06:38,824 --> 01:06:41,000 meals of that goes down dramatically? 1150 01:06:41,000 --> 01:06:41,590 PROFESSOR: Dramatically, yeah. 1151 01:06:41,590 --> 01:06:44,680 AUDIENCE: But what is it that if they have just insurance or 1152 01:06:44,680 --> 01:06:47,710 just capital, it looks like it increases over the control? 1153 01:06:47,710 --> 01:06:49,230 PROFESSOR: It doesn't really increase. 1154 01:06:49,230 --> 01:06:55,015 Like, as you can see, you need both for it to work. 1155 01:07:05,440 --> 01:07:07,710 So why aren't they insured? 1156 01:07:07,710 --> 01:07:10,380 And there are two versions of this question. 1157 01:07:10,380 --> 01:07:13,430 One is why aren't they buying insurance in the market? 1158 01:07:13,430 --> 01:07:15,230 And the other is why aren't they buying-- 1159 01:07:15,230 --> 01:07:18,770 if they don't buy insurance, they can still do something 1160 01:07:18,770 --> 01:07:25,060 else, which is one way to get insurance is for all of us to 1161 01:07:25,060 --> 01:07:26,730 just pool together. 1162 01:07:26,730 --> 01:07:28,180 The government doesn't have to do anything. 1163 01:07:28,180 --> 01:07:29,610 The market doesn't have to do anything. 1164 01:07:29,610 --> 01:07:30,790 We all live in the same village. 1165 01:07:30,790 --> 01:07:35,630 We can all get together, and we can all adopt the rule 1166 01:07:35,630 --> 01:07:42,200 which says that if any of us loses 50% of their income, 1167 01:07:42,200 --> 01:07:46,940 we'll all pay them 1% of our income. 1168 01:07:46,940 --> 01:07:50,310 We could adopt that rule, right? 1169 01:07:50,310 --> 01:07:55,020 And that would insure everybody because there's, 1170 01:07:55,020 --> 01:07:56,870 like, 50 of us in this room. 1171 01:08:01,470 --> 01:08:05,635 If I lose 50% of income, all of you give me 1% of your 1172 01:08:05,635 --> 01:08:08,100 incomes and I'm OK. 1173 01:08:08,100 --> 01:08:11,150 So you can ensure me. 1174 01:08:11,150 --> 01:08:12,080 We don't need a market to do it. 1175 01:08:12,080 --> 01:08:15,440 We can just do it at the community level. 1176 01:08:15,440 --> 01:08:16,100 AUDIENCE: [INAUDIBLE] 1177 01:08:16,100 --> 01:08:19,350 limitation of that is the fact that you're diversifying 1178 01:08:19,350 --> 01:08:23,110 across a larger geographical area or presumable, like, a 1179 01:08:23,110 --> 01:08:23,970 bad weather condition. 1180 01:08:23,970 --> 01:08:24,970 PROFESSOR: Absolutely. 1181 01:08:24,970 --> 01:08:27,300 But we should at least do that. 1182 01:08:27,300 --> 01:08:31,550 The fact is that people seem to have limited insurance even 1183 01:08:31,550 --> 01:08:32,972 from their friends. 1184 01:08:32,972 --> 01:08:35,097 AUDIENCE: But couldn't that potentially open you up to 1185 01:08:35,097 --> 01:08:37,149 huge exposure as an individual? 1186 01:08:37,149 --> 01:08:38,399 PROFESSOR: Why? 1187 01:08:40,120 --> 01:08:42,720 AUDIENCE: I mean, I guess if everybody gets equally then 1188 01:08:42,720 --> 01:08:45,092 even if you have a really bad year-- but if everybody has a 1189 01:08:45,092 --> 01:08:46,590 bad year then you wouldn't require it. 1190 01:08:46,590 --> 01:08:49,359 PROFESSOR: You can adopt a rule which basically says 1191 01:08:49,359 --> 01:08:54,399 let's take an average income of everybody and then those 1192 01:08:54,399 --> 01:08:58,000 who get more than average in that given year give a little 1193 01:08:58,000 --> 01:08:59,770 bit to the ones who get less than average. 1194 01:08:59,770 --> 01:09:01,950 You can always do that. 1195 01:09:01,950 --> 01:09:03,920 So in substance it's a puzzle. 1196 01:09:03,920 --> 01:09:05,210 Why don't they buy it from the market? 1197 01:09:05,210 --> 01:09:09,574 Why don't they buy it from each other? 1198 01:09:09,574 --> 01:09:14,689 And there's been a lot of hype in this area. 1199 01:09:14,689 --> 01:09:17,569 Like, Forbes Magazine had this issue where they said the 1200 01:09:17,569 --> 01:09:23,080 "insurance for the poor is an unpenetrated natural market." 1201 01:09:23,080 --> 01:09:26,590 And a lot of microfinance institutions have been talking 1202 01:09:26,590 --> 01:09:30,529 about the next microcredit revolution is micro insurance. 1203 01:09:30,529 --> 01:09:33,029 So they're going to provide insurance to people. 1204 01:09:33,029 --> 01:09:36,069 But in fact we don't see very much insurance being supplied 1205 01:09:36,069 --> 01:09:37,374 or demanded. 1206 01:09:37,374 --> 01:09:43,069 Now, insurance is difficult for a variety of reasons. 1207 01:09:43,069 --> 01:09:44,815 Does anybody know what moral hazard is? 1208 01:09:48,968 --> 01:09:49,449 AUDIENCE: Yeah. 1209 01:09:49,449 --> 01:09:53,841 Moral hazard is just the concept that-- 1210 01:09:53,841 --> 01:09:55,829 I guess it could be best 1211 01:09:55,829 --> 01:09:58,314 illustrated through the example. 1212 01:09:58,314 --> 01:10:00,550 There was a huge [INAUDIBLE] about moral hazard about 1213 01:10:00,550 --> 01:10:03,182 bailing out the banks because it could encourage banking 1214 01:10:03,182 --> 01:10:06,014 institutions in the future to act more recklessly because 1215 01:10:06,014 --> 01:10:07,550 there's this implicit guarantee it could backstop 1216 01:10:07,550 --> 01:10:09,250 because it happened once before. 1217 01:10:09,250 --> 01:10:09,675 PROFESSOR: Right. 1218 01:10:09,675 --> 01:10:12,130 So one problem with insurance-- 1219 01:10:12,130 --> 01:10:14,950 but this doesn't explain why people don't want it. 1220 01:10:14,950 --> 01:10:19,580 It just explains why it could be expensive. 1221 01:10:19,580 --> 01:10:22,660 You know, if I offer insurance to you and I say that I'll 1222 01:10:22,660 --> 01:10:26,870 take care of you whenever your income falls, your incentive 1223 01:10:26,870 --> 01:10:28,910 to stay home goes up a lot. 1224 01:10:28,910 --> 01:10:30,650 That's moral hazard. 1225 01:10:30,650 --> 01:10:31,900 What's adverse selection? 1226 01:10:35,264 --> 01:10:40,190 AUDIENCE: You're only drawing those with high risk. 1227 01:10:40,190 --> 01:10:41,100 PROFESSOR: Yeah. 1228 01:10:41,100 --> 01:10:45,800 The other worry is that you tend to draw in the people. 1229 01:10:45,800 --> 01:10:51,630 So if I offer people the option of, you know, whenever 1230 01:10:51,630 --> 01:10:54,100 your income falls, I'll take care of you. 1231 01:10:54,100 --> 01:10:57,710 I might only get the people who they know their income is 1232 01:10:57,710 --> 01:11:00,400 going to fall come and join that scheme. 1233 01:11:00,400 --> 01:11:01,410 That's adverse selection. 1234 01:11:01,410 --> 01:11:02,760 So we have both of those. 1235 01:11:02,760 --> 01:11:06,890 And there's outright fraud because people might claim 1236 01:11:06,890 --> 01:11:08,770 their income has fallen but in fact their 1237 01:11:08,770 --> 01:11:11,470 income hasn't fallen. 1238 01:11:11,470 --> 01:11:12,480 How do I measure that? 1239 01:11:12,480 --> 01:11:17,620 So it's expensive to deliver. 1240 01:11:17,620 --> 01:11:19,130 That's a given. 1241 01:11:19,130 --> 01:11:22,980 But nevertheless, the reason why-- 1242 01:11:22,980 --> 01:11:26,600 but you would imagine that at least some forms of insurance 1243 01:11:26,600 --> 01:11:27,600 should exist. 1244 01:11:27,600 --> 01:11:30,020 One is catastrophic health insurance. 1245 01:11:30,020 --> 01:11:33,720 Like, you were in a traffic accident. 1246 01:11:33,720 --> 01:11:36,990 Nobody gets into a traffic accident on purpose, very 1247 01:11:36,990 --> 01:11:39,460 little moral hazard. 1248 01:11:39,460 --> 01:11:42,190 Why isn't there insurance for that at least? 1249 01:11:42,190 --> 01:11:46,100 Another one is weather insurance. 1250 01:11:46,100 --> 01:11:47,750 I don't control the weather. 1251 01:11:47,750 --> 01:11:51,400 So there's no moral hazard or adverse selection. 1252 01:11:51,400 --> 01:11:52,560 I don't control the weather. 1253 01:11:52,560 --> 01:11:54,540 The weather is what it is. 1254 01:11:54,540 --> 01:11:59,680 So if you say that, why don't we get lots of market for 1255 01:11:59,680 --> 01:12:01,940 rainfall insurance? 1256 01:12:01,940 --> 01:12:10,540 When the rainfall is below some cut off, I pay you money 1257 01:12:10,540 --> 01:12:11,790 otherwise you pay me money. 1258 01:12:14,690 --> 01:12:17,790 So we would at least expect to see these kinds of insurances. 1259 01:12:17,790 --> 01:12:20,130 It's difficult to have, like, more complex insurance. 1260 01:12:20,130 --> 01:12:21,940 Maybe there's some fraud or something. 1261 01:12:21,940 --> 01:12:23,990 But this kind of insurance, why don't we see more 1262 01:12:23,990 --> 01:12:25,240 of it in the world? 1263 01:12:37,100 --> 01:12:40,650 So this is a sort of where we're beginning to understand. 1264 01:12:40,650 --> 01:12:44,350 So there was this huge hype, like, five years ago, 1265 01:12:44,350 --> 01:12:48,120 everybody in the world was talking about how the next 1266 01:12:48,120 --> 01:12:50,210 revolution in micro insurance. 1267 01:12:50,210 --> 01:12:52,980 And then that revolution kind of never happened. 1268 01:12:52,980 --> 01:12:57,540 In fact, it was kind of, if you like-- 1269 01:12:57,540 --> 01:12:59,650 we worked with a micro finance 1270 01:12:59,650 --> 01:13:01,350 organization to offer insurance. 1271 01:13:03,930 --> 01:13:07,540 And after about a year, they basically said, look, you 1272 01:13:07,540 --> 01:13:09,230 guys, we can't do this. 1273 01:13:09,230 --> 01:13:11,950 We're losing clients every day because they were forcing 1274 01:13:11,950 --> 01:13:13,740 their clients to buy insurance. 1275 01:13:13,740 --> 01:13:17,830 The way you avoid adverse selection is by forcing 1276 01:13:17,830 --> 01:13:19,100 people to buy it. 1277 01:13:19,100 --> 01:13:22,560 You don't want people to have choice otherwise only the sick 1278 01:13:22,560 --> 01:13:24,280 people will buy health insurance. 1279 01:13:24,280 --> 01:13:25,440 They're forcing all their clients 1280 01:13:25,440 --> 01:13:26,690 to buy health insurance. 1281 01:13:26,690 --> 01:13:30,370 As a result, all their clients were deserting them. 1282 01:13:30,370 --> 01:13:32,670 So they basically canceled the program. 1283 01:13:32,670 --> 01:13:35,840 So nobody seems to want insurance. 1284 01:13:35,840 --> 01:13:41,090 Now, I don't think people have fully understood 1285 01:13:41,090 --> 01:13:42,330 what's going on there. 1286 01:13:42,330 --> 01:13:43,670 I certainly don't. 1287 01:13:43,670 --> 01:13:46,040 I mean, I think part of it is people 1288 01:13:46,040 --> 01:13:47,690 don't understand insurance. 1289 01:13:47,690 --> 01:13:52,420 So part of the problem is that people think, well, 1290 01:13:52,420 --> 01:13:53,810 I'm giving you money. 1291 01:13:53,810 --> 01:14:00,050 And if I don't use this service, you should give me 1292 01:14:00,050 --> 01:14:00,780 the money back. 1293 01:14:00,780 --> 01:14:05,260 So the idea that I'm giving you something-- 1294 01:14:05,260 --> 01:14:09,470 see, for most of us, the bizarre thing about insurance 1295 01:14:09,470 --> 01:14:12,010 is it's a product that you really don't 1296 01:14:12,010 --> 01:14:14,640 want to use, right? 1297 01:14:14,640 --> 01:14:15,930 Insurance is one thing. 1298 01:14:15,930 --> 01:14:18,670 But you want to buy it but not use it. 1299 01:14:18,670 --> 01:14:21,230 I'm happy when I don't get sick and, therefore, I'm 1300 01:14:21,230 --> 01:14:24,980 really happy when I paid for it and I didn't get anything. 1301 01:14:24,980 --> 01:14:27,980 Psychologically, it's an odd product in that sense. 1302 01:14:27,980 --> 01:14:30,110 It's a product that you're happiest when 1303 01:14:30,110 --> 01:14:31,660 you don't use it. 1304 01:14:31,660 --> 01:14:32,890 So that's one problem clearly. 1305 01:14:32,890 --> 01:14:33,930 It's a bizarre product. 1306 01:14:33,930 --> 01:14:37,030 It's one unique kind of product. 1307 01:14:37,030 --> 01:14:41,090 Usually we're happy when we get what we paid for. 1308 01:14:41,090 --> 01:14:45,020 Here, you're happy when you don't get what you paid for. 1309 01:14:45,020 --> 01:14:46,700 And that makes it difficult. 1310 01:14:46,700 --> 01:14:50,060 Second thing, I think, is they don't trust 1311 01:14:50,060 --> 01:14:52,240 the insurance company. 1312 01:14:52,240 --> 01:14:56,130 And there's some evidence that when the insurance company has 1313 01:14:56,130 --> 01:14:59,950 come through an NGO which people know and like, they're 1314 01:14:59,950 --> 01:15:01,910 more willing to buy it. 1315 01:15:01,910 --> 01:15:06,600 So there's some trust element there. 1316 01:15:06,600 --> 01:15:07,440 But I think there's something else 1317 01:15:07,440 --> 01:15:11,340 that I think is difficult. 1318 01:15:11,340 --> 01:15:16,635 So think of catastrophic health insurance. 1319 01:15:27,750 --> 01:15:30,090 And if I was offering catastrophic health insurance, 1320 01:15:30,090 --> 01:15:32,580 our theory was very simple. 1321 01:15:32,580 --> 01:15:34,215 Nobody gets a heart attack on purpose. 1322 01:15:37,320 --> 01:15:38,790 Nobody gets cancer on purpose. 1323 01:15:38,790 --> 01:15:40,680 So let's just insure those things. 1324 01:15:44,180 --> 01:15:45,570 That was OK. 1325 01:15:45,570 --> 01:15:47,300 The theory seemed to work. 1326 01:15:47,300 --> 01:15:52,150 The problem is people also die from other things. 1327 01:15:52,150 --> 01:16:04,810 Like, the stomach hurts and then they probably got an 1328 01:16:04,810 --> 01:16:06,486 infection and died. 1329 01:16:06,486 --> 01:16:09,600 That's not covered by the insurance because, you know, 1330 01:16:09,600 --> 01:16:13,330 in general it's only particular 1331 01:16:13,330 --> 01:16:15,030 conditions that are covered. 1332 01:16:15,030 --> 01:16:18,890 People don't understand why one thing that is covered and 1333 01:16:18,890 --> 01:16:20,380 another thing isn't. 1334 01:16:20,380 --> 01:16:22,880 And if you explain that, well, there's more moral hazard in 1335 01:16:22,880 --> 01:16:26,720 this one than that one then that's too hard to explain. 1336 01:16:26,720 --> 01:16:31,170 So, basically, insurance products, out of the necessity 1337 01:16:31,170 --> 01:16:34,100 of protecting the insurance organization from adverse 1338 01:16:34,100 --> 01:16:36,620 selection and moral hazard, tend to be incomplete. 1339 01:16:36,620 --> 01:16:38,480 They cover only a few conditions. 1340 01:16:38,480 --> 01:16:40,010 People don't understand those conditions. 1341 01:16:40,010 --> 01:16:42,570 So there was this big fight with this [INAUDIBLE] 1342 01:16:42,570 --> 01:16:44,220 we worked with. 1343 01:16:44,220 --> 01:16:46,650 They got into this big fight with a group of women who were 1344 01:16:46,650 --> 01:16:51,270 very upset because one of their friend's husband died. 1345 01:16:51,270 --> 01:16:52,700 He died at home. 1346 01:16:52,700 --> 01:16:54,260 He suddenly got sick and died. 1347 01:16:58,030 --> 01:17:01,380 When he got sick, she went to the local doctor. 1348 01:17:01,380 --> 01:17:05,440 And the local doctor recommended a whole bunch of 1349 01:17:05,440 --> 01:17:08,970 medication, expensive medication which was useless 1350 01:17:08,970 --> 01:17:11,710 because the doctor, I think, was bad. 1351 01:17:11,710 --> 01:17:13,500 The insurance company said this was 1352 01:17:13,500 --> 01:17:15,420 not a covered condition. 1353 01:17:15,420 --> 01:17:21,860 We can't pay for it because it was not covered in fact. 1354 01:17:21,860 --> 01:17:24,100 The insurance company in this particular case said we will 1355 01:17:24,100 --> 01:17:27,600 only cover conditions that require hospitalization, and 1356 01:17:27,600 --> 01:17:30,170 we'll only pay if you have been hospitalized. 1357 01:17:30,170 --> 01:17:32,360 That's a very good way to check whether people are 1358 01:17:32,360 --> 01:17:34,560 making up conditions or not. 1359 01:17:34,560 --> 01:17:37,700 So they had imposed this hospitalization condition, 1360 01:17:37,700 --> 01:17:39,170 which was to protect them. 1361 01:17:39,170 --> 01:17:42,680 But then these people said, look, her husband died. 1362 01:17:42,680 --> 01:17:44,070 How could it be worse? 1363 01:17:44,070 --> 01:17:45,060 You have to pay. 1364 01:17:45,060 --> 01:17:46,090 So it was a big fight. 1365 01:17:46,090 --> 01:17:47,880 The insurance company refused to pay. 1366 01:17:47,880 --> 01:17:51,900 As a result, all of them quit [INAUDIBLE]. 1367 01:17:51,900 --> 01:17:55,620 So just the nature of the product is difficult. 1368 01:17:55,620 --> 01:18:00,490 That's one final psychological element which I think is also 1369 01:18:00,490 --> 01:18:04,860 difficult, which is catastrophic insurance is 1370 01:18:04,860 --> 01:18:07,535 particularly a product that makes you-- 1371 01:18:07,535 --> 01:18:10,260 you value it when you think about your own death or 1372 01:18:10,260 --> 01:18:12,680 something or something really bad. 1373 01:18:12,680 --> 01:18:15,020 People don't like thinking about those things. 1374 01:18:15,020 --> 01:18:18,160 So it's very hard to get people to be rational about 1375 01:18:18,160 --> 01:18:21,290 buying a product that involves contemplating really awful 1376 01:18:21,290 --> 01:18:22,820 things happening to you. 1377 01:18:22,820 --> 01:18:27,890 So a lot of people are both, I think, maybe they are a little 1378 01:18:27,890 --> 01:18:32,230 bit superstitious about it. 1379 01:18:32,230 --> 01:18:35,930 So they don't really like taking on this risk, thinking 1380 01:18:35,930 --> 01:18:38,190 about these states of awful things happening. 1381 01:18:38,190 --> 01:18:41,180 So if you're going to insure us to insure awful things like 1382 01:18:41,180 --> 01:18:44,030 when the crop completely dries up, that's not what people 1383 01:18:44,030 --> 01:18:45,420 want to think about. 1384 01:18:45,420 --> 01:18:47,100 So that's another reason why. 1385 01:18:47,100 --> 01:18:49,900 But in general, we don't fully understand why people aren't 1386 01:18:49,900 --> 01:18:50,920 buying these products. 1387 01:18:50,920 --> 01:18:54,160 But they aren't buying them. 1388 01:18:54,160 --> 01:18:57,750 So if there's no question, I'll stop here. 1389 01:18:57,750 --> 01:18:59,000 [INAUDIBLE].