THE VULNERABILITY OF HOUSEHOLDS TO POVERTY IN PERU, 2004-2014 Javier Herrera Zúñiga1 Angelo Cozzubo Chaparro2 Abstract In the last decade the Peru has gone through a period of rapid economic growth, accompanied by a dramatic reduction of the poverty by 37 percentage points. However, the observed economic slowdown in the past four years have led to wonder if that growth has allowed to consolidate a middle class finally freed from the risk of falling back into poverty or if, on the contrary, those households who left poverty would return to it in an even less favorable macroeconomic context. Our study aims to fill a gap in the empirical literature concerning the household’s vulnerability to poverty in Peru using a dynamic approach. The concept of vulnerability is defined as the risk or ex ante probability for a household to move from a situation of not poor in the initial period to poor in the next period. Following the methodological proposal of Dang & Lanjouw (2014), we estimate a vulnerability index, analyze its determinants and build vulnerability lines which, in complement with the poverty lines, allow us to break down the population into three groups and analyze its evolution in time: poor, vulnerable and non-vulnerable households. The ENAHO household panel data was used considering jointly all 9 biannual panels over the 2004-2014 period, which allowed us to rely on more than 50,000 observations on poverty transitions. Our results are robust to various specifications and cut points, and show that, the vulnerable population have been increasing in this period of rapid growth and poverty reduction reaching levels greater than 30% of total households in 2014. Contrarily to other studies which stress the role of adverse shocks, we find that the households’ vulnerability is mainly due to structural factors, linked to household’s labor characteristics but also to specific exogenous shocks, as well as the macroeconomic growth fluctuations. Individual dissaving strategies and having health insurance contribute to reduce vulnerability to poverty. JEL classification: I32, D31 Keywords: vulnerability, poverty dynamics, adverse shocks, panel data, Peru 1 Institut de Recherche pour le Développement, Pontificia Universidad Católica del Perú (PUCP), Departamento de Economía. [email protected] 2 Pontificia Universidad Católica del Perú (PUCP), Departamento de Economía. Instituto de Estudios Peruanos (IEP). [email protected] 1 THE VULNERABILITY OF HOUSEHOLDS TO POVERTY IN PERU, 2004-2014 1. The Importance of Considering the Vulnerability of Households Poverty rates in Peru has declined significantly during the last decade of strong macroeconomic growth, resulting in more than half of households ceasing to be poor. However, with the slowdown in the growth rates, from 9.1% in the peak of the cycle in 2008 to 2.3% in 2014, the decline in poverty has been much lower and the outlook for 2015 is not encouraging. The deterioration of the general economic context, particularly in activities geared towards the internal market, could imply an increase in the vulnerable population besides a larger number of poor households that were previously out of poverty but belonging to the group of vulnerable households. Several reasons justify the interest in studying the vulnerability to poverty. In the first place, we can consider it as an intrinsic dimension of well-being, as manifested by the very poor households that were interviewed in the study of the Voices of the Poor (Narayan 2000). Uncertainty about having the minimum resources to eat, heal, dress, etc. is considered by the population as an essential component of their poverty condition. Vulnerability induces many households to behave in ways that can reduce risks and mitigate their consequences. These strategies often have an immediate cost in terms of missed opportunities as well as long-term costs, trapping households in a situation of persistent poverty that could be transmitted between generations. In second place, it is fundamental to distinguish the poor and the households that, while being out of poverty, are vulnerable to falling since it makes it possible to observe a population group that escapes the targeting from a perspective of static monetary poverty. It is so that vulnerable population may even present different characteristics than the poor and the non-vulnerable population, making it necessary to implement specific policies. In third place, paying attention to the vulnerability of households highlights the difference between ex ante poverty interventions and ex post poverty alleviation policies. In this sense, it will not be enough to attend households that already suffer a poverty condition, since the design of preventive interventions for those households at greater risk of experiencing a future deprivation becomes crucial in a context of economic deceleration, such as the one through which Peru is going through nowadays. In this way, the study of vulnerability in the Peruvian context raises a series of crucial questions for the design and implementation of policies in the following years: To what extent has poverty reduction enabled households to have a sustainable exit out of poverty? Were the households that emerged from poverty are part now of the vulnerable population or did they exit permanently without risk of falling back into poverty? To what extent are non-poor households susceptible to fall into poverty as a result of an adverse shock? To what extent do social protection mechanisms have a role in reducing the risk of poverty? Does health coverage reduces vulnerability? In this paper, we will present an estimation of vulnerability lines, analogous to the poverty ones, which enable us to decompose the non-poor population into households that are 1 vulnerable to poverty and those that are not vulnerable. Our approach adopts a definition of vulnerability as the ex-ante risk of an unfavorable transition to poverty. We estimate vulnerability indexes and vulnerability lines based on panel data from the National Household Survey (ENAHO) produced by the National Institute of Statistics (INEI). We present the evolution of the vulnerable households and their corresponding share within the total population and discuss the determinants of the vulnerability of households. Our results show that the vulnerability of households to poverty is "structural", related mainly to the characteristics of the labor market insertion, which produces high income instability; the demographic structure of the household; the level of education and ethnicity condition; and the geographical environment that defines productive opportunities and reflects the State density. Adverse shocks, which have traditionally been considered as the distinguishing factor of vulnerable households, only have a significant impact in the case of major shocks, such as natural catastrophes, or when they occur cumulatively. The document is divided into five additional sections to this introduction. The second section discusses the concept and measurement of vulnerability and reviews the empirical literature on the subject. In the third section, we present the data and the empirical strategy used for the vulnerability lines estimation. The fourth section show and discuss the results obtained; while in the fifth, several analyzes of sensitivity and robustness of our results are presented. Finally, the sixth section concludes. 2. Concept and Measurement of Vulnerability The conceptualization of vulnerability has had a long discussion coming from several approaches and with different nuances both in its definition and in the way in which it should be measured and operationalized in the empirical research. First, it is crucial to differentiate the concept of vulnerability, in its broadest sense, from the poverty one. As Chaudhuri (2003) mentions, vulnerability and poverty can be understood as two sides of the same coin. Poverty is an ex post welfare situation or realization which reflects a state of deprivation, lack of resources or lack of capabilities. Vulnerability, on the other hand, is an ex ante measure of well-being whose main intention is not to reflect the present welfare but rather an uncertain state in the future. In this sense, we can argue that poverty is the ex post realization of a stochastic variable; while vulnerability will be the expectation on that variable in relation to a threshold previously defined (Christiaensen & Subbarao, 2005). Thus, poverty can be observed for a specific moment while vulnerability is shown as a dynamic and uncertain phenomenon because it represents the possibility (risk) of ending in a state of deprivation in a future period of the life cycle of the household. In this way, a household will become vulnerable when it is especially susceptible to losses due to negative shocks, caused by a long exposure to risks, weak internal conditions or by bad risks management (World Bank 2013). Hoddinott & Quisumbing (2003) point out that the first step in understanding vulnerability consists in relating the source of the risks faced by economic unity, resource holding, and risk management techniques applied. In the core of their conceptual framework, the authors present three key components of the household: adjustments, which describe the 2 context in which a household reproduces and develops; assets, understood in its broadest sense as income-generating resources; and activities, which refers to the distribution of these resources in income-generating activities conditioned by the