Poor Economics
A Radical Rethinking of the Way to Fight Global Poverty
By: Abhijit V. Banerjee & Esther Duflo
[Note - This is part two of this book review, please also be sure to read Part I - Private Lives here]
Summary - Most of us have views on the causes and solutions to poverty. These views, on the cause side, often range from laziness and poor life choices to government oppression and lack of opportunities. As for solutions, many see progress lying in the hands of large government programs that break poverty traps or in setting up better capitalistic mechanisms to increase opportunities and demand for services and labor. Finally, many are apathetic and don't believe and real solutions are possible. In Poor Economics, the authors take a data informed perspective to see what the research says about these issues and how people actually respond to various programs and interventions offered to them.
PART 2 - INSTITUTIONS
Chapter 6 - Barefoot Hedge-Fund Managers
"Risk is a central fact of life for the poor." They face significant amounts of risk as a regular part of life. What strategies do they employ to mitigate their risk? What interventions can we employ to support their efforts?
There are many hazards of being poor and very little margin when bad breaks occur. A high fraction of the poor run small businesses or farms, what happens in years and seasons of drought? What happens for day laborers when they are not able to find permanent work? What happens when sickness or disease interrupts the ability to work? One bad break can have permanent consequences. Interestingly, there may be psychological forces at work as well. Facing risk makes us worry and stressed which leads to depression which decreased focus and production.
Many of the world's poor act like hedge-fund managers (though obviously not with financial instruments) trying to diversify risk in their lives. They often partake in multiple occupations; if one is not producing, they can shift to another (though, this is typically less efficient). If they own farm plots they will hold multiple plots in different parts of the village; if blight or infestation occur in one area, perhaps another will be spared. Another strategy employed is a very conservative approach to risk management in their business(es). Even if they believe another technology or approach to have more potential return, they may avoid it simply because of the initial cost or potential risk in the venture. Families will tend to marry their daughters other villages close to them to maintain relationships but also provide opportunity for different weather patterns.
Another strategy that has benefits is a concept of social insurance. It's the idea of villagers helping each other out. If one family is having a bad time, other villagers support them, being very mindful that the next time it could be them. The research shows that this approach does have some value, though typically limited. Communities often help when a bad harvest hits, or the loss of a job, but typically when a health-shock occurs, a family is left to deal with it themselves. A key limiter in this approach is trust. What if you slack off? What if you don't return the help?
What about formal insurance? Hundreds of millions have been invested in an attempt to develop insurance options for the poor, but there are significant challenges. Regulation is difficult (kickbacks, fraud, overuse, etc.) Another is adverse selection and the challenge of getting stuck with the high-risk types. But, perhaps there are certain types of insurance that could mitigate some of these issues: weather insurance, catastrophic health events (though selection would still be an issue), etc. Yet the reality is that a lot of those who are poor simply don't want insurance and the demand is low? Why?
There are numerous reasons why there is low demand for insurance. Sometimes governments step in (or there is a perception that they will), or that the poor don't understand insurance products (evidence suggests they do), perhaps credibility in and trust for the insurer. Certainly the challenge of time plays into it, the idea of giving you money today in case I need it in the future when I really need it now is a significant factor. The authors' conclusion is that governments should step in, paying part of the premium for the poor and there is evidence that this can and has worked.
Chapter 7 - The Men from Kabul and the Eunuchs of India: The (Not so) Simple Economics of Lending to the Poor
Like anyone, the poor need access to loans and capital. The questions are: how do many obtain loans today, what are the opportunities and what are the challenges? Because banks are typically unwilling to engage with the poor, moneylenders fill the demand. The challenge is that they typically charge very steep levels of interest that exploit the poor and create traps for them.
Banks typically are not interested because the margins and returns simply do not justify their investment. The amount of work required for loans of $5-$100 simply don't make sense for them. Loans are based on trust and the likelihood that a loan will be repaid. In mature markets, significant amounts of information is available on those seeking loans (credit scores, financial portfolios, etc.). For the poor, this is not the case. Part of the reason moneylenders charge such high interest is because they are collecting personal data based on relationships and knowledge of neighborhoods and individuals and taking the higher risk of default.
In the mid-1970's the Grameen Bank in Bangladesh developed the concept of micro-credit which today reaches roughly 150 to 200 million borrowers. Today, there are many MFIs (micro-finance institutions). Trust and information are still key components, but they take a unique approach. The typical MFI contract involves loans to a group of borrowers who are liable for each other's loans and hence have a reason to try to make sure that the others repay. Many often meet on a regular basis in small groups to collect payments, share ideas and encourage one another. In this, the power of community and shame plays a strong motivational role. So does it work? Yes, evidence suggests that it does help, though is not a "silver bullet" to radical transformation as some hope or suggest. It is helpful for entrepreneurs and in some other situations but not all, so it is "one of they key instruments in the fight against poverty." Yet, the demand isn't as high as one might envision, why? Several hypothesis are offered: perhaps some are reluctant to join groups with others they don't know well, this requires trust; perhaps the conservative nature of the groups is not appealing to those that want to take greater risks; perhaps the structure of weekly repayments starting immediately does not work for those who need more time to nurture their investments into returns. Their is also a void between very small ventures (MFI) and large ventures (banks or large investors). While micro-investing has served many well, there is still the opportunity for further development and growth of these instruments; from accepting greater levels of risk to supporting larger projects and businesses.
Chapter 8 - Saving Brick by Brick
The sight of unfinished homes is very common in developing communities around the world? Why is this? The answer is relatively simple, this is how many save. When they have small amounts of resources, they "save" them by buying bricks to build their future home.
An important, almost side note, is that many of the classical, Victorian perceptions of the poor simply are not valid. For example, they viewed the poor as impatient and unable to think far ahead, which an innate inclination towards shortsighted behavior, as carefree or simply incompetent. The reality is that these perceptions are false.
Although very few poor have access or make use of savings accounts (again banks are reluctant due to the administrative costs vs. returns), they find many ingenious was to save. An example is forming savings "clubs" with other savers where they meet regularly, each deposit a set amount and then on a rotating basis, one member gets the entire amount. Others are known to hide money for small emergencies. Others, as noted, "save" by slowly building homes.
So would the poor utilize banks if they had access? Initial studies showed low utilization rates because a) high costs to start the accounts b) high costs to withdraw funds c) the expense/inconvenience to go to banks and access funds. Kenya has mitigated some of these challenges through a program called M-Pesa where phones are used to store and transfer funds. You purchase credits at a local vendor and then store, collect, or send them via cell phones.
Yet, even with greater access and lower costs to banking would and do the poor utilize them? It is noted that human psychology is a real challenge. The human brain processes the present and the future very differently. We seem to have a vision of how we should act in the future that is often inconsistent with the way we act today and actually will act in the future. We hope that our future self will be more patient than our present self and don't account for future wants and needs. Those that realize this, often find inventive ways to protect their current selves from themselves. Yet for most, the viscous cycle remains, goals tend to be very far away, they know there will be lots of temptations along the way and therefore struggle to save. Saving is a discipline and a challenging muscle to develop. How can we give incentive to the poor to develop this muscle? No clear answers were provided.
Chapter 9 - Reluctant Entrepreneurs
Are we all entrepreneurs? The micro-finance and "social business" movement starts from the premise that the poor are natural-born entrepreneurs. We can eradicate poverty by giving them the right environment and a little bit of help to get started. Is this true? and to what extent?
BRAC, a large MFI in Bangladesh tested these ideas. They ran RCT (random control trials) with the "poorest of the poor", those that even traditional MFIs would exclude and had control groups with no interventions. "The difference is impressive," compared to the control groups, total monthly spending is up 10% and "outlook on life seems to have changed." Given the chance, it seems that even people who have been hit by extreme hardship were able to take chair of their lives and start their exit out of extreme poverty.
But there are challenges, namely that these businesses are tiny and, for the most part, making very little money. In their 18 country data set, the average monthly profit was $115 USD PPP. Marginal returns are high (% return on investment) while overall returns (total profit) are low. Such is the paradox, these people are energetic and resourceful and make a lot out of very little. The challenge is that their returns are very small, their businesses are undifferentiated from those around them and they have no chance to earn a reasonable living.
Why is this? Is it simply a lack of capital or are there other factors? It seems there are a number of other factors. One of them is the actual potential of the business, for many, growth potential tapers off very quickly due to saturated markets, limited opportunities for economies of scale and efficiencies, etc. As noted previously, MFIs are not structure to scale and incentivize low risk and management skills are necessary for scaling. Bottom line, scaling is simply too hard and that the average business owner is not a natural "entrepreneur" in our traditional sense. Certainly there are some, but there is not necessarily a disproportionate percentage simply due to situation and environment. Many are small business owners simply because they have limited options, whether they actually enjoy running the business or not.
So if there are not millions of natural entrepreneurs that we need to invest in, what are the hopes and dreams of the poor? It consistently turns out that it is stable jobs (ideally government jobs). There is a desire for stability and stability seems to have significant impacts. For example, one study in Mexico showed that children from mothers with stable jobs (even in factories with poor conditions and low wages, but stable) were significantly taller than those without such opportunities. Moreover, even though the income difference wasn't that great, it appears that the sense of stability had other very positive effects.
Not surprisingly, stable jobs are most prevalent in large cities but what may be surprising is that permanent migration is fairly rare? Why? Living conditions are poor in urban areas and therefore men (typically) will go and work for a few weeks at a time and return but this type of work is not stable enough to help families get over the hump. To solve these types of challenges raise the issues to a political and policy level, the focus of the next chapter.
Chapter 10 - Policies, Politics
Even the most well-intended and well-thought-out policies may not have an impact if they are not implemented properly. We are all well aware of the failings of governments; so what do you do? Some would argue that you focus not on the policies themselves but the political process, solve that then work on policies, otherwise you are wasting energy and effort. Others would argue a more indirect route of largely by-passing governments and providing more aide directly to the poor with targeted aims.
Corruption and dereliction of duty create massive inefficiencies. Often, these bad institutions have incentives for their leaders to keep them "bad" for personal gain. While not impossible to break, the challenges are real and large. Can you work from the outside in? Could you co-opt cities within a country (e.g. Hong Kong) and develop healthy policies and practices and multiply these efforts until you hit a tipping point? Doubtful, but interesting nonetheless.
Ultimately, the chapter runs long on ideas and hypothesis but very little evidence or data.
