Risk Attitudes and the

‘Vicious Circle of Poverty’

PAUL MOSLEY and ARJAN VERSCHOOR

The article reconsiders the view that the poor are trapped into poverty as
a result of their risk aversion, precluding the level of investment needed to
lift them out of poverty. The starting point is the experimental methods of
Binswanger who found no significant association between risk aversion
and low income. Using experimental data from Uganda, Ethiopia and
India the article confirms these early findings, and provides estimates of
the correlation between the variables involved in the ‘vicious circle of
poverty’. The paper concludes that there is generally little relationship
between risk aversion and an income measure of poverty, but a strong
relationship between the latter and asset levels and returns.

Cet article reconsidère l’idée que les pauvres sont enferrés dans la
pauvreté du fait de leur aversion au risque, qui empêche la constitution de
l’investissement nécessaire pour les sortir de cette situation. Le point
de départ de l’analyse repose sur les méthodes expérimentales de
Binswanger, qui a mis en évidence l’absence de corrélation significative
entre l’aversion au risque et les bas revenus. A partir de données
expérimentales sur l’Ouganda, l’Ethiopie et l’Inde, l’article confirme ces
résultats initiaux, et fournit des estimations sur le degré de corrélation
entre les variables impliquées dans le hcercle vicieux de la pauvretéi.
L’article conclut qu’il y a généralement peu de rapport entre l’aversion
au risque et une mesure de la pauvreté à partir du revenu, mais en
revanche une relation étroite entre cette dernière et le niveau et la
rentabilité des actifs détenus.

I. INTRODUCTION AND EARLY LITERATURE

An intuitive explanation of the intractability of poverty in the face of policies to

reduce it consists in the argument of the ‘vicious circle of poverty’: poor people’s

Paul Mosley is Professor of Economics at the University of Sheffield, UK, and Arjan Verschoor
is Lecturer in Development Studies at the University of East Anglia, UK. The authors gratefully
acknowledge the support of the Department for International Development under their research
programme on ‘Risk, Incentives and Policies for Pro-poor Growth’ (R7614/7615/7617).

The European Journal of Development Research, Vol.17, No.1, March 2005, pp.59–88
ISSN 0957-8811 print/ISSN 1743-9728 online
DOI: 10.1080/09578810500066548 q 2005 Taylor & Francis Group Ltd
60 THE EUROPEAN JOURNAL OF DEVELOPMENT RESEARCH

attempts to escape from poverty are frustrated by the fact that they are poor. The
idea of the vicious circle of poverty takes many forms, since the attribute of poverty
which makes escape difficult may be poor health, lack of skill, lack of self-
confidence or support mechanisms, remoteness from markets and institutions,
social exclusion, lack of physical assets or borrowing power, or combinations of
the above. But one key element in many versions of the spiral, in any country or
environment, is risk aversion: if very poor people are risk averse, they will be
unwilling to invest in the acquisition of modern technology because that involves
taking risks, and thus they will remain poor, with processes of capital investment
and innovation being confined to those people who are economically secure and in
possession of sufficient defence against risk to be willing to invest and innovate.
This has obvious distributional implications [Weeks, 1972]: if the poor do not
invest and the rich do, gains in enterprise income will be restricted to the rich, with
the implication of growing inequality over time. Thus, if we are to understand the
dynamics of poverty, we need to understand attitudes to risk, how they are
distributed between individuals and if possible what influences, policy and other,
have a bearing on those attitudes. In order to throw light on these matters, this paper
presents new data on attitudes to risk from three developing countries, and in the
light of those data asks what evidence there is of chronic poverty being caused by a
vicious circle in which risk attitudes are key. In a brief concluding section we
examine what the implications of such a vicious circle might be.
The general idea of the vicious circle of poverty comprised a standard element
in explanations of poverty and underdevelopment in the 1950s and 1960s
(notably in the shape of Gunnar Myrdal’s [1964] ‘principle of circular and
cumulative causation’),1 receded from sight in the next two decades in the face of
a certain amount of rubbishing by economists of the right,2 but then resurfaced
late in the 1990s as a part of the new literature seeking to explain mechanisms of
impoverishment and poverty persistence. Notable within this new literature is the
recent World Development Report on poverty, which proposes a ‘vicious circle’
focused less on the risk attitudes of the poor than on their behaviour, in particular
their restricted ability to manage or cope with risk:
Extreme poverty deprives people of almost all means of managing risk by
themselves. With few or no assets, self-insurance is impossible. With poor
health and bad nutrition, working more or sending more household
members to work is difficult. And with high default risks, group insurance
mechanisms are often closed off. When a shock occurs, they must obtain
immediate increases in income or cut spending, but in so doing they incur a
high long-term cost by jeopardising their economic and human
development prospects. These are the situations that lead to child labour
and malnourishment, with lasting damage to children, and the breakdown
of families. [World Bank, 2000:146]