Over the weekend, I finished reading Poor Economics: A Radical Re-Thinking of the Way to Fight Global Poverty.
If I had to boil it down to one sentence, here’s my take: things are usually not what they seem.
Yes, rather mundane conclusion, especially since we’re talking about the aggregation of years of painstaking economics research on what works – and doesn’t – in development work. But authors Banerjee and Duflo manage to make accessible their work – a tough task for most economists – so I figured my takeaway should be accessible also.
I particularly enjoyed chapter 9, which discusses micro credit. I am a big proponent of micro credit, the practice of giving small loans to poor people who otherwise have no access to formal financial tools. A classic example of why micro credit is needed is the vendor who borrows 100 rupees in the morning to purchase stock, only to repay the moneylender 101 at the end of the day. One rupee – about $0.02 USD – interest? Not bad, right?
If you do the math, the basic APR on that loan – if it goes unpaid – is 365% per year. Now what do you think?
That’s the reality of life for most low-income vendors – they can’t access bank finance so they have to borrow from friends and family and when that’s not possible, from the local moneylender. That is, until micro credit got started. Now, microfinance institutions will make small loans to those same vendors, except they’ll charge anywhere from 24% up to 90% APR. Expensive? Absolutely. Better than the moneylender? Absolutely.
OK, so microfinance makes sense. And there are more than 200 million microfinance clients around the world. But does it help bring people out of poverty? Banerjee and Duflo have run the numbers, and the short answer is: well, not always. Not even that often.
Huh? Here’s what the authors have to say:
Are there really a billion barefoot entrepreneurs, as the leaders of MFIs and the socially-minded business gurus seem to believe? Or is it just an optical illusion, stemming from a confusion about what we call an “entrepreneur”? There are more than a billion people who run their own farm or business, but most of them do this because they have no other options. Microcredit and other ways to help tiny businesses have an important role to play in the lives of the poor, because these tiny businesses will remain, perhaps for the foreseeable future, the only way many of the poor can manage to survive. But we are kidding ourselves if we think that these businesses can pave the way for a mass exit from poverty.
– The businesses of the poor tend to have few if any employees and very limited assets.
– The businesses run by the poor are also generally unprofitable, which may well explain why giving them a loan to start a new business does not lead to a drastic improvement in their welfare.
– Many business suffer from the “empty shelf” problem: a space a created for a shop, but no inventory fills the shelves. Even a small investment in more inventory will have large marginal returns, but once the shelves are full, the business has no further scope to grow.
– Despite initial large returns to small investments, many small businesses hit at point at which a substantial capital investment is needed in order to continue growing. However, few people are willing to give such large loans to the poor.
– Because of this trap, the poor may not invest as much (both money but also emotions and intellectual energy) into their businesses because they know that their business will always remain too small to make real money.
– (In fact) Creating good jobs could go a long way in increasing the stability of the lives of the poor, which will, in turn give the poor the opportunity and the urge to invest in their children and save more.
This is just one chapter. Read the whole book…it challenges a lot of assumptions and is a really welcome addition to the discussion. I’m already reading Karlan and Appel’s More Than Good Intentions as well, and will report back when I finish…