Sharing Risk to Avoid Tragedy : Informal Insurance and Irrigation in Village Economies

Motivated by co-operational patterns of farmer societies in developing countries, I present a model of joint interaction between risk sharing against idiosyncratic shocks and co-operation over public investments reducing aggregate risk in presence of limited commitment constraints. The model is applied to the case of farmers in rural India co-operating over informal insurance and irrigation provision. Firstly, I demonstrate theoretically that if access to the benefits of such public investments can be regulated by villagers, the two institutions reinforce each other. However, if benefits of these investments are non-excludable, as is e.g. the case with provision by central authorities, they may harm risk sharing. Using two waves of the ICRISAT panel data set, I provide empirical evidence supporting the mechanism. Finally, I calibrate the model in order to conduct a number of counterfactual experiments quantifying significant reinforcing effects between the two institutions and welfare losses due to sub-optimal irrigation ownership and management practices followed in India