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Theorizing Behavior within Informal Economies

Economic theories lead to certain predictions about human behavior, but conditions in the real world often put additional constraints on behavior.

For example, farmers who live at or near subsistence level may not invest in new technology that will improve their productivity. Why don't they spend a little extra money on seeds that are likely to significantly increase their harvests? This might seem irrational.

According to Melanie Morten (Economics), poor farmers are risk-averse because if their crops fail, they stand to lose everything and starve. They have no cushion of safety to fall back on in the event of drought or flood, and therefore stick with the seeds that they know. Giving farmers some form of insurance might be a way to encourage them to take up new technologies, so that if the new crops fail they are still able to survive.

Melanie Morten, migrant workers

Melanie Morten in India

Melanie studies informal economies in developing countries, using both large-scale surveys and randomized trials. She formulates testable hypotheses based on economic theory and, after analyzing the resulting data, proposes practical applications. She spoke about two of her research projects, one dealing with the effects of migration on informal insurance and another on the use of text messaging to improve repayment of micro-financed loans.

Melanie started the microfinance text-messaging project when she was working in Manila over the summer of 2008 for Innovations for Poverty Action, a research NGO founded by Yale Professor Dean Karlan. Microfinance enables individuals who do not have access to conventional banking services to borrow and lend small amounts of money. Ideally this access helps people lift themselves out of poverty. “Does microfinance work? We don't yet have firm evidence,” she said.

Typical loans averaged $400 in Melanie's sample population. The borrowers had a very low default rate (roughly three percent), but nearly one-third repaid their loans late. Working with Karlan and Jonathan Zinman of Dartmouth, she set about testing the hypothesis that if borrowers received text message reminders about when their payments were due, they would pay in a more timely fashion. Moreover, she proposed that messages personalized with the account officer's name would have a greater impact than impersonal messages. A variety of text messages were sent to borrowers, and indeed, the personalized version reduced late payments by five percent.

Her dissertation project, advised by Chris Udry, Mark Rosenzweig, and Aleh Tsyvinski, explores what happens to informal systems of insurance when people move from farming villages into cities.

“Informal insurance occurs when relatives or neighbors provide loans and transfers to other relatives and neighbors when they experience negative shocks such as crop failure or sickness,” she says, thus smoothing out income shocks and mitigating risks. In a good year, a farmer helps his struggling neighbor; in a bad year, his neighbor helps him. But if the farmer's son goes to the city for work, the farmer could become less reliant on his neighbor for an infusion of cash, destroying the reciprocal relationship and leaving his neighbor without a safety net.

“Using 30 years of household level data from villages in India, I am looking at what happens to this informal insurance as people in the village begin to migrate,” she explains. Does the traditional, informal insurance system break down, or is it strengthened by the money the migrant sends home, which could potentially provide resources to the whole community?

Her project uses a dataset collected in six villages in southern India over the course of 30 years by the International Crop Research Institute for the Semi-Arid Tropics (ICRISAT). Melanie needed to undertake qualitative research to supplement that data, and she found the local ICRISAT survey enumerators “immensely helpful in setting up the interviews I needed to do to understand the environment.” She spoke with farmers, traders, migrants, and moneylenders. In addition, ICRISAT social scientists helped her understand the overall social and economic changes that had occurred in the region during the decades of the survey.

“I am interested in migration because it is an increasing phenomenon – both internal migration and international migration – but also because it creates a very large change to the structure of communities. I want to understand what the effect is on both the people who choose to migrate and those who don't migrate, but who are linked to people who do.”

Melanie’s approach combines theory and data analysis. She explains, “Economic theory suggests how to interpret data. It provides hypotheses and also suggests what kind of empirical analysis to undertake. Theory helps to provide structure and understanding for the patterns in the data. When would we expect migration to improve informal risk sharing, and when would we expect it to break down?” Melanie will spend the next year-and-a-half analyzing the data and writing up her findings. “My theoretical predictions are that this will depend on how the income that migrants get changes relative to the income opportunities that they have at home. Using the long dataset of 30 years, I can then look at this specific hypothesis.”