Income Diversification and Poverty Income Diversification and Poverty

Chapter 2. Background on the Northern Uplands region
income. At the national level, this is equivalent to structural transformation, defined as the long-term
decline in the percentage contribution of agriculture sector to gross domestic product (GDP) and
employment in growing economies. For example, the contribution of agriculture to GDP in Vietnam
has declined from 35.3 percent in 1991 to 24.1 percent in 1995 and 19.9 percent in 2000 (GSO, 1997;
Ministry of Agriculture and Rural Development, 2002).
Alternatively, agricultural diversification can be defined as the shift from crop production to
livestock, fisheries, and forestry activities. Similarly, crop diversification refers more narrowly on
shifts in the composition of crops grown. In contrast to non-farm diversification, crop diversification
(defined in terms of the number of crops) is often greatest among poor subsistence farmers in rainfed
agriculture. The reasons for this pattern are discussed below.
2.1.2 Determinants of diversification
Given the well-known gains associated with specialization, why do rural households in
developing countries adopt multiple income-generating activities At least six factors can be
identified:
• First, multiple income sources can be a strategy to reduce risk. If each source of income
fluctuates from year to year due to weather or other factors and the variations in income
are not positively correlated across sources, then a household with multiple income
sources will experience less income variability than a specialized household. Risk
management may help explain crop diversification because some crops (such as cassava)
are more drought tolerant 1 than others. In addition, risk management helps explain
diversification from crop production into non-farm activities such as wage labor and nonfarm
enterprises. When diversification is motivated by risk management, the household
generally has to sacrifice in terms of average income. Thus, we expect diversification to
occur when income sources are highly variable and when households are particularly risk
averse. This is consistent with empirical research that shows that poor rural households
practicing rain-fed agriculture in low-potential areas are more likely to have diverse
income sources than richer households in areas with greater agro-ecological potential.
• The second motivation for diversification is that there may be positive externalities
between different activities so that total income from combining two activities is greater
than if the household specialized in either one. For example, livestock production
provides animal traction and manure which increase the productivity of crop production.
Alternatively, crop production and agricultural processing may be more efficient when
carried out by the same household if it reduces transportation costs.
• Third, multiple income sources may be useful as an adaptation to missing or poorlyfunctioning
markets. For example, if a household has plot of land that is too small to fully
occupy family labor, one option would be to rent or purchase additional land. But if land
markets do not exist, then the household may be forced to use its “surplus” labor in nonfarm
enterprises or wage labor even if the return is lower. Alternatively, if credit markets
do not operate efficiently and a household has a cash constraint, it may use non-farm
activities to earn cash to pay for agricultural inputs.
1 On the other hand, Quiroz and Valdez (1995) argue that crop diversification is unlikely to reduce
income risk because the yields of different crops are closely correlated since they are both affected by weather.
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