# **1. Introduction**

The occupational and sectoral choices of the millions of rural households in developing countries are important determinants of economic growth. In the context of traditional growth models where a rural economy is identified with activities solely in the agricultural sector, sectoral diversification is synonymous with rural to urban migration. However, the view that rural economies are purely agricultural has recently been questioned. Reardon et al. (2006) review survey evidence from a large number of developing economies and show that on average rural nonfarm income constitutes about 40 percent of household incomes. In Bangladesh, the share of nonfarm household income grew from 42 percent in 1987 to 54 percent by 2000 (Reardon et al 2006, Hossain, 2004).

Two types of factors, pull and push, induce households to diversify between farm and nonfarm activities. The pull factors include increasing demand, higher wage rates, and higher returns from nonfarm activities. High returns allow households to accumulate capital and invest in farm and nonfarm activities with high returns. This type of diversification requires access to credit, as well as physical, human and social capital and leads to higher growth.

Higher growth could also be achieved by focusing on a single occupation or sector. In this case household members can increase productivity and growth by learning from each other’s experience. For example, two members of a household, say a father and his son, jointly decide on which sector to enter in order to maximize household welfare. If the son enters the same sector as the father, he will be able to pick up the necessary skills faster as he learns from his father’s experience (Menon and Subramanian, 2008). However, lack of access to credit and capital, and the presence of idiosyncratic and uninsured risks may push rural households away from focusing on a specific sector into diversified activities, thus compromising growth.

In rural areas, one important push factor is year to year variability in rainfall and associated farm-income variability. Households may engage in nonfarm activities with low risks even if they have low returns. In areas with poor agro-climatic conditions, risky agriculture, and no insurance markets, nonfarm activities allow households to cope with severe downturns in agricultural productivity (Reardon et al., 2006; Ellis, 2004). Households pushed to diversify their activities may thus have lower returns and experience lower consumption growth in comparison to households that diversify due to pull factors. At the household level, diversification due to push factors may result in more income security but at the cost of a lower level of welfare and overall growth.<sup>1</sup> The increased variability in rainfall that is usually associated with climate change<sup>2</sup> , implies that the prevailing risk mitigation strategies developed after years of exposure and experience with the prior climate regime may become less and less effective. Thus it is imperative to establish empirically whether 1 Households may also self-insure against weather risks by “saving for the rainy day.” However, savings for selfinsurance as opposed to investment in productive capital also hinders growth.

2 Climate can be thought of as the expected distribution of weather. In this study we will focus on one aspect of climate variability, i. e. rainfall variability at the local and regional level. Rainfall variability is expected to increase in a warming world. Climate change is projected to increase the number of extreme temperature and rainfall events, and hence climate variability is expected to show an upward trend.

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