Three essays on the production and investment decisions of households living in rural India

In order to end poverty by 2030, the declared goal of the United Nations, a better understanding is needed which policies help poor households to escape poverty and how to end its inter-generational transmission. Since the Millennium Declaration in September 2000, and the adoption of the Millennium Development Goals (MDGs), the delivery of basic social services, such as education, health, water supply and sanitation, has become the central focus of international development assistance. However, the provision of basic social services is not necessarily sufficient to lead to an accumulation of human and productive capital, which would allow households to escape poverty and interrupt its inter-generational transmission. To understand why people are poor, we need to understand what productive decisions poor households take, and to identify what constraints households face in their attempt to accumulate human, as well as, productive capital. A better understanding of such constraints could guide policies that have a long-term impact on poverty reduction and on development. A number of factor could explain why poor households operate at unprofitable levels and why they are constrained in their investment decisions. Empirical evidence points to different explanations: cost of learning and access to information, insufficient education, risk, credit constraints, non-convex production technologies, and behavioral patterns that are inconsistent with standard neoclassical models. Currently, one of the major challenges in formulating policies that foster productive investments among the poor, seems to be to disentangle the effects of scale, credit constraints, and the lack of insurance mechanisms. This thesis seeks to shed further light on the relative role of these three constraints. In the context of rural India, it analyzes what production and investment decisions households take and how important risk and credit constraints as well as scale effects are in these decisions. Finally, it evaluates potential policy tools that could support households in overcoming these constraints. Today, 33% of the world's poor live in India, the vast majority of them (80.5%) in rural areas. The economic structure of rural India is still dominated by agricultural production, and consequently, this thesis concentrates on agricultural production decisions and employment in agriculture. In particular, this thesis addresses three questions in three individual papers: First, are farm households constrained in their crop choices by agricultural production risk and to which extent can India's public works program support households in overcoming this constraint? Second, how profitable is cattle farming in rural India at different levels of investment and which barriers do households face in reaching optimal investment levels? And third, can risk in agricultural wages explain limited investment in girls' education in the presence of intra-household substitution in household chores? The first paper focuses on crop choice of farm households. It reassesses the stylized fact that households have to trade-off between returns and risk in their crop choice in the context of Andhra Pradesh, a state in the south of India. It then explores the effect of India's flagship anti-poverty program, the National Rural Employment Guarantee Scheme (NREGS) on households' crop choice using a representative panel data set. The NREGS guarantees each household living in rural India up to a hundred days of employment per year, at state minimum wages. The paper shows theoretically, and empirically, that the introduction of the NREGS reduces households' uncertainty about future income streams because it provides reliable employment opportunities in rural areas independently of weather shocks and crop failure. With access to the NREGS, households can compensate income losses emanating from shocks to agricultural production. Households with access to the NREGS can therefore shift their production towards riskier but also more profitable crops. These shifts in agricultural production have the potential to considerably raise the incomes of smallholder farmers. The paper concludes that employment guarantees can, similarly to crop insurance, help households in managing agricultural productions risks. It also argues that accounting for the effects of the NREGS on crop choice and profits from agricultural production affects the cost-benefit analysis of such a program considerably. The second paper concentrates on the profitability of farming cattle in Andhra Pradesh. The paper also uses a representative panel dataset, and examines average and marginal returns to cattle at different levels of cattle investment. It finds average returns in the order of -8% at the mean of cattle value. These returns vary across the cattle value distribution between negative 53% (in the lowest quintile) and positive 2% (in the highest). While marginal returns are positive on average, they also vary considerably with cattle value and breed. The paper shows that average and marginal returns are considerably higher for modern variety cows, i.e. European breeds and their crossbreeds, than for traditional varieties of cows or for buffaloes. It also shows that cattle farming becomes most profitable at minimum herd sizes of five animals, due to decreasing average labor costs with increasing herd sizes. The results of this paper suggest that cattle farming is associated with sizable non-convexities in the production technology and that substantial economies of scale, as well as high upfront expenses of acquiring and feeding high-productivity animals, might trap poorer households in low-productivity asset levels. The fact that wealthier households and households with lower costs to access veterinary services are more likely to overcome these barriers, supports this idea. The second paper concludes that cattle farming might well generate positive returns for households in rural India, but that most households seem to operate at unprofitable levels. This could also explain the apparent paradox between widespread support of cattle farming through agricultural policy interventions and negative returns to cattle, as stressed in recent works. It argues that policy interventions that target productive assets will only be beneficial if transfers are high enough to allow households to overcome these entry barriers. The third paper concentrates on the effect of risk on the productive decisions of households, and analyzes the effect of wage risk in agricultural employment on women's labor supply and time allocated to home production. It seeks to understand the extent to which risk raises labor supply of women to levels that can become harmful for other members of the household. The hypothesis is that in the presence of intra-household substitution effects -- for instance in the performance of household chores -- increased female labor supply might have negative effects on the time allocation of girls. If women have less time available for home production and childcare, and such activities can only be foregone at high cost, they might be forced to take older girls out of school or to cut down on the time these girls study at home in order for them to fill in for these tasks. The paper uses cross-sectional data on the time allocation of different household members and predicts wage risk at the village level as a function of the historical rainfall distribution and a village's share of land that is under irrigation. The results show that wage risk affects the time allocation of women, increasing their labor supply and reducing the time they allocate to home production. Wage risk also increases the time girls spend on household chores and reduces their time in school. Because the observed effect of wage risk on girls' time allocated to household chores corresponds very closely to the effect observed for women, it seems plausible to attribute it to intra-household substitution effects. The observed effect of risk on girls' school time, however, is greater than the observed effect of risk on the home-production time of girls. This can be due to two reasons: First, in the presence of intra-household substitution effects, shocks in wages will not only increase female labor supply but also girls' time on household chores. And the model predicts that risk-averse households invest less in education when future school time becomes uncertain, because future school time affects the returns to current schooling. Second, if school attendance is indivisible, then girls might be forced to drop out of school temporarily or even permanently. The paper then simulates the effect of the NREGS on the time-allocation decisions of working women and school-age girls. The results suggest that the NREGS could increase the time working women spend on household duties, because it reduces uncertainty regarding future earnings, and alleviates the need to accumulate savings. Thereby, the NREGS would reduce the pressure on girls to perform household tasks and allow them to increase the time they spend in school or studying by 6 minutes daily. Wit these findings, this thesis contributes to a better understanding of the choices poor households in rural India face in their day-to-day decision making, and offers insights into what policies could support households in escaping poverty, and interrupt its inter-generational transmission.