Migration Choice under Risk and Liquidity Constraints

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Migration Choice under Risk and Liquidity Constraints Marieke Kleemans 1 University of California, Berkeley November 2014 JOB MARKET PAPER Abstract This paper develops and tests a migration choice model
Migration Choice under Risk and Liquidity Constraints Marieke Kleemans 1 University of California, Berkeley November 2014 JOB MARKET PAPER Abstract This paper develops and tests a migration choice model that incorporates two prominent migration strategies used by households facing risk and liquidity constraints. On the one hand, migration can be used as an ex-post risk-coping strategy after sudden negative income shocks. On the other hand, migration can be seen an as investment, but liquidity constraints may prevent households from paying up-front migration costs, in which case positive income shocks may increase migration. These diverging migratory responses to shocks are modeled within a dynamic migration choice framework that I test using a 20-year panel of internal migration decisions by 38,914 individuals in Indonesia. I document evidence that migration increases after contemporaneous negative income shocks as well as after an accumulation of preceding positive shocks. Consistent with the model, I find that migration after negative shocks is more often characterized by temporary moves to rural destinations and is more likely to be used by those with low levels of wealth, while investment migration is more likely to involve urban destinations, occur over longer distances, and be longer in duration. Structural estimation of the model reveals that migration costs are higher for those with lower levels of wealth and education, and suggests that the two migration strategies act as substitutes, meaning that those who migrate to cope with a negative shock are less likely to invest in migration. I use the structural estimates to simulate policy experiments of providing credit and subsidizing migration, and I explore the impact of increased weather shock intensity in order to better understand the possible impact of climate change on migration. Keywords: Internal Migration, Risk-Coping, Liquidity Constraints, Dynamic Choice JEL Classification: D14, D91, J61, O12, R23 1 Department of Agricultural and Resource Economics, U.C. Berkeley, I am sincerely thankful to my advisors, Jeremy Magruder, Edward Miguel and Alain de Janvry, for their guidance and support. This paper has greatly benefited from comments by Michael Anderson, Sam Bazzi, David Card, Michael Clemens, Fred Finan, Meredith Fowlie, Svenn Jensen, Zhimin Li, Ethan Ligon, Yongdong Liu, Aprajit Mahajan, Melanie Morten and Elisabeth Sadoulet, as well as seminar participants at NEUDC at Boston University, University of San Francisco, U.C. Berkeley, GARESC at U.C. Davis and the 2014 Nordic Conference in Development Economics. I gratefully acknowledge financial support from the AXA Research Fund. All errors are my own. 1 1 Introduction Approximately 230 million individuals in the world are currently characterized as international migrants, and another 763 million as internal migrants, moving within the borders of their country (Bell and Muhidin, 2013). This migration is partially motivated by large income differences between countries, as well as between areas within a country, for example rural and urban areas. In Indonesia, the focus of this study, those living in urban areas earn on average 60 percent more than those living in rural areas and this number accounts for differences in prices and employment between rural and urban areas. While a wide range of reasons may explain the choice to migrate, two primary rationales are often highlighted in a developing country context as reasons to migrate and, more broadly, as roles that migration can play in the process of economic development. On the one hand, migration can be used to cope with negative income shocks. If a household is hit by a negative shock, for example an agricultural shock due to drought, the household may decide to send a household member elsewhere to earn additional income. This migration strategy can be seen as an alternative to other ex-post risk-coping strategies, such as reducing savings, selling assets, increasing labor supply locally and decreasing consumption. Alternatively, migration can be used as an investment strategy with the goal of increasing and diversifying future expected income and benefiting from higher wages elsewhere, for example in urban areas. However, as with any investment, this often requires large up-front costs. If a household is liquidity-constrained, it may not be able to make this investment, even if it would be profitable. Therefore, in the presence of liquidity constraints, an increase of wealth for example due to one or more positive income shocks may relax liquidity constraints and so increase migration. While both migration strategies are closely related, they have opposite predictions in terms of the migratory response to shocks. When moving in order to cope with negative shocks, a strategy I will refer to as survival migration, migration increases after negative contemporaneous income shocks. Alternatively, if individuals are liquidity-constrained, migration may increase after (an accumulation of) positive income shocks that help relax liquidity constraints that prevented migration initially. I will refer to this strategy as investment migration. 2 Both migration strategies are widely observed and documented empirically but described as separate phenomena and in different papers. The survival rationale of migration is described for example in Kleemans and Magruder (2014) and Morten (2013), who find that sudden negative rainfall shocks induce people to migrate internally. 1 Evidence of the investment strategy is documented by Bryan, Chowdury and Mobarak (2014) and by Bazzi (2014), who find that beneficial migration is prevented by liquidity constraints and that overcoming these constraints by subsidizing migration or through positive income shocks increases out-migration. The difference between Kleemans and Magruder (2014) on the one hand and Bazzi (2014) on the other hand seems puzzling as both papers study the Indonesian context but find opposite responses to rainfall shocks. However, the discrepancy may be understood by recognizing that different types of migration are observed: Kleemans and Magruder (2014) focus on internal, short-distance migration, while Bazzi (2014) studies international migration that requires large up-front migration costs, making liquidity constraints more likely to be binding. This paper provides a unified framework of migration choice that incorporates both survival and investment rationales for migration. I develop a migration choice model that encompasses both migration strategies and that improves on previous migration models by allowing for multiple moves over time, between multiple locations, and by incorporating wealth as an important determinant of migration choice. This model is dynamic in nature, to allow for people to plan future migrations and save up for migration over time to overcome liquidity constraints. It builds on the dynamic savings model by Deaton (1991), in which people have a certain amount of wealth and, after receiving a stochastic wage draw in each time period, must decide how much to save in order to smooth consumption and maximize utility over time. I extend this to become a migration choice model by including the current location as an additional state variable and migration choice as an additional control variable. The basic intuition can be explained by a simple three-location model in which a household can decide to migrate away from its home location to either a nearby rural area at a low migration cost, but where wages are only slightly higher than at home, or to a further-away urban area with higher costs and higher wages. 1 Other papers that empirically observe increased migration after negative income shocks include Mueller, Gray and Kosec (2014), De Weerdt and Hirvonen (2013) and Boustan, Fishback and Kantor (2010). 3 In each period, the household observes a wage draw at its current location from a known distribution. If the household receives a bad wage draw and does not have sufficient savings built up, they may prefer to move to another location to receive a different wage. To avoid high migration costs, the household would likely prefer to move to a nearby rural location just to get another wage draw. I explicitly model a disutility of being away from the home location, which predicts that survival migration will be short in terms of distance as well as duration. On the other hand, households may try to save up for migration as an investment to benefit from higher wages in a further-away city. If they are liquidity-constrained, then an accumulation of positive shocks may push them over the barrier, after which they are able to cover migration costs. The model therefore predicts that this type of migration is more likely to occur over longer periods of time. I solve the dynamic migration choice model numerically and test the predictions of this model using a rich dataset of internal migrants in Indonesia. As part of the Indonesia Family Life Survey, all migration moves of 38,914 individuals were recorded over a 20-year period. Individuals were carefully tracked as they changed location, allowing me to study all migration decisions that individuals made, even if they are of short duration and over short distances. After showing that rainfall shocks are good proxies for income shocks, and that a sequence of positive rainfall years helps households accumulate wealth, I study the migration response to rainfall shocks. In line with the model, I find that migration increases both after contemporaneous negative rainfall shocks and after an accumulation of previous positive shocks. Also in agreement with the model, I find that survival migration is more likely to be temporary, have a rural destination, and be used by those with low levels of wealth. Investment migration, on the other hand, is more likely to occur over longer distances and to urban areas, and is longer in duration. I then structurally estimate the model using maximum likelihood estimation in a mixed logit framework in order to retrieve individual migration cost parameters. The average migration costs of going to nearby rural area locations, which are used mostly for survival migration, are approximately equal to 25 percent of annual income. Investing in migration to a more distant, urban area is about 4 times as costly, slightly more than average annual income. Examining heterogeneous effects reveals that migration is about 30 percent more costly for those with lower levels of wealth and 4 education, and approximately 50 percent less costly for younger individuals. Studying the benefits of migration in terms of increased consumption and wages, I find that both migration strategies have positive returns to the mover. However, the magnitude of these benefits depends strongly on the migration rationale: those who migrated to cope with negative income shocks benefit to a lesser extent than those who invested in migration. Predicted consumption increases by 8 percent after survival migration and by 35 percent after investment migration; comparable numbers for wage increases are 8 and 46 percent for survival and investment migration, respectively. Comparing individuals with various degrees of prior migration experience moreover suggests that the two migration strategies act as substitutes, meaning that those who migrate to cope with a negative shock are less likely to invest in migration. Taken together, these findings may have important policy implications. Those with lower levels of wealth and education pay higher migration costs while earning less. In addition, they are more likely to engage in the type of migration that yields lower returns, which reduces the opportunity to invest in migration to the extent that the two strategies act as substitutes. This may have important distributional implications and resonates with a recent debate on the existence of geographical poverty traps. Jalan and Ravallion (2002) introduced this term, defining it as a situation in which the characteristics of a household s area of residence are such that the household s consumption cannot rise over time, while an otherwise identical household that lives in a better-endowed area would enjoy a rising standard of living. In a recent paper, Kraay and McKenzie (2014) survey the empirical evidence on poverty traps. While finding sparse evidence in support of poverty traps in general, they argue that geographical poverty traps form an exception, stating that the evidence most consistent with poverty traps comes from poor households in remote rural regions. While not specifically testing for the existence of poverty traps, I find that liquidity constraints prevent profitable migration (as also shown by Bryan, Chowdhury, and Mobarak (2014) and Bazzi (2014)) that poor individuals face higher migration costs and engage in less profitable migration, which may subsequently limit their chances of investing in migration. A policy instrument that may mitigate these distributional challenges and promote profitable migration is the provision of credit. In my model environment, where part of the population faces liquidity and credit constraints, I examine a policy experiment of providing credit at various interest 5 rates. I find that, on the one hand, credit reduces the need for survival migration, as it provides an alternative ex-post risk-coping strategy by allowing individuals to borrow in order to finance consumption. On the other hand, credit increases the use of investment migration by allowing individuals to borrow the up-front cost of migrating, thereby confirming that liquidity constraints initially prevented migration with positive expected returns. This paper advances our understanding of what drives people to migrate, a question that has engaged development economists for decades (e.g. for early references: Lewis, 1954 and Harris and Todaro, 1970). Still, existing income differences between countries and areas within a country, combined with evidence of profitable returns to migration, have led people to wonder why more people do not migrate. 2 Moreover, empirical evidence shows that those who migrate for longer distances and duration tend to benefit to a larger extent, which has made people wonder why these migration patterns are not observed more frequently (e.g. Banerjee and Duflo, 2007 and Munshi and Rosenzweig, 2005). By bringing together two often-cited and empirically observed migration strategies, this paper contributes to the understanding of why people migrate, where they migrate to, and how long they stay at their destination. In an environment in which people face risk and liquidity constraints, I model these two strategies within a dynamic migration choice framework. The dynamics of the model allow for updating of preferred migration strategies in each period, making the model flexible by incorporating moves between various locations as well as multiple moves over time. As such, the model incorporates commonly observed migration patterns such as return migration and circular migration, which are not easily explained in models where people migrate merely in search of the best employment opportunity or models in which migration is treated as a one-shot decision. The importance of including multiple moves and a choice between multiple locations was also recognized by Kennan and Walker (2011), who develop a detailed dynamic model of optimal migration that explains migration choice based on expected income differentials in their data. There are considerable differences between their model and the model presented in this paper, primarily that Kennan and Walker (2011) consider a model in which wealth does not affect 2 This question has been examined in the international context for example by Clemens, Montenegro, and Pritchett (2008) and McKenzie, Gibson, and Stillman (2010), and in the context of internal migration for example by Bryan, Chowdhury, and Mobarak (2014) and Beegle, De Weerdt and Dercon (2011). 6 migration decisions. As such, individuals can borrow and lend without restriction to finance the cost of migration. This assumption may be warranted for their target group young white males with a high school education in the United States but has much less validity in the context of rural Indonesia. The model in this paper is therefore presented as an alternative model of migration choice applicable to developing country contexts in which wealth and liquidity constraints profoundly limit migration and destination choices. The findings in this paper also have implications for the expected future impacts of climate change on migration. Weather patterns are expected to change due to global warming, and rainfall shocks will likely increase in intensity. This may adversely impact those living rural areas, for whom weather shocks are a major source of income variation. While there is still considerable uncertainty about the impact of climate change on migration, this paper addresses a piece of the puzzle by studying how individual migration choices respond to weather shocks. I run a counterfactual experiment to examine the predicted change in migration patterns and welfare in response to increased intensity of weather shocks. I find that more extreme weather shocks increase the need to engage in survival migration as an ex-post risk-coping strategy while simultaneously limiting the opportunity to save up for profitable investment migration. This leads to a predicted reduction in overall welfare and disproportionately affects those at the bottom of the wealth distribution. This paper is structured as follows: First, I will present the dynamic migration choice model in Section 2. The data and empirical strategy are described in Section 3, and Section 4 provides reduced-form results. Section 5 introduces the structural estimation of the model, after which Section 6 presents the structural results. Various policy and counterfactual experiments are considered in Section 7, and Section 8 concludes. 2 Dynamic Migration Choice Model This section develops a model incorporating both the survival and investment rationales for migration. This approach improves on previous models by allowing for multiple migration choices over time and between multiple locations, and incorporating wealth as an important determinant of migration choice. The model is dynamic in nature, to allow people to save up for migration and to 7 acknowledge the forward-looking nature of migration choice. It extends the dynamic savings model from Deaton (1991) by adding location as an additional state and control variable. In Deaton s savings model, individuals are not permitted to borrow to finance consumption. The model has one state variable, wealth, and one control variable, consumption. In each period, the decision maker receives an income draw from a known distribution and chooses how much to consume and how much to save for the next period in order to maximize utility. As such, savings serve as a precautionary motive to smooth consumption and maximize lifetime utility. Recently, Bryan, Chowdury and Mobarak (2014) developed a migration model that also builds on Deaton (1991) by incorporating liquidity constraints. In their model, migration is risky while individuals find out whether or not they are good at migrating. If they are not, they lose the cost of migrating; for those close to subsistence, this will lead to underinvestment in migration in order to avoid the cost of failed migration. As such, their model incorporates liquidity constraints that may be relaxed by a migration incentive, which they randomly distribute in villages in rural Bangladesh. Indeed, the 8.50 US dollar incentive induces 22 percent of households to send a migrant. While they find empirical evidence in support of their model, the large magnitude of their effects is not fully accounted for. As is common in migration choice
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