The Economics of Poverty

Money and how to make it, spend it and save it are decisions faced by everyone in the world. Yet, for the world’s poorest people, the very challenging financial and economic circumstances they face is a constant source of stress and worry as they try to make enough to survive and to bring themselves and their family out of poverty. These very issues are addressed insightfully in two pieces – “The Economic Lives of the Poor” (Banerjee and Duflo, The Journal of Economic Perspectives; 2007) and “Portfolios of the Poor: How the World’s Poor Live on $2 a Day” (Collins, Morduch, Rutherford, and Ruthven; 2009), which were recently discussed in a CTED student discussion group meeting.

To think about the financial economic situations that face the world’s poor – those living on $2 or less a day – is to see the options and choices about how to spend, save and make money shrink immensely. Banerjee and Duflo based the data in their article on a series of publicly available surveys in a variety of countries and found several trends and tendencies across much of the worlds poor.

Who are these people who survive on $2 or less a day? Banerjee and Duflo note that many of these families are exceptionally large – on average around seven or eight members. In a majority of countries that they looked at, the high numbers they found in these families arises from extended families all living in the same household – mainly to share fixed costs. The young outnumber the older family members about six to one whereas in the United States, the ratio is one to one.

In regards to how the poor make their money, there are several interesting factors to be discussed. In many countries, the poor do not just have one occupation – instead they have many jobs. Banerjee and Duflo mention the women in Guntur, India, who sell dosas in the morning and then embellish plain saris and sell them door to door in the afternoon. In another part of India, they found that in an average household with three adults, there are seven professions being practiced.  The key aspect that these findings reveal is that the majority of the world’s poor do not have the level of specialization in one profession to develop their own business or to earn higher wages, often due to a lack of education and by switching between the professions often.

Risk-spreading is clearly one reason why the poor, who might find risk especially hard to bear, tend not to be too specialized in any one occupation. They work part time outside agriculture to reduce their exposure to farming risk, and keep a foot in agriculture to avoid being too dependent on their nonagricultural jobs. Another reason for a second job is to occupy what would otherwise be wasted time… finding some work outside agriculture is a way for them to make productive use of their time when the land is unusable…A final, more compelling reason for multiple jobs is that the poor cannot raise the capital they would need to run a business that would occupy them fully…most businesses operate with very little assets and little working capital.

As we can see, there are several factors that limit the ways in which the world’s poor make money.

But what about spending and saving money? What are the biggest expenses for this group and how, if possible, are they able to save their earnings. Banerjee and Duflo found that for many of the worlds poor in the surveys that they looked at, food is the largest expense for these rural and urban families averaging about 56-76% of their $1/day earnings. It’s not surprising then, that inflation of food prices hits these people very hard. Entertainment is often the next largest expense, with families in some parts of India spending 10% of their budget on festivals. Many don’t have access to the more modern forms of entertainment such as movies and television, so this does not figure greatly into budgets for most of the world’s poor. In terms of assets, the most common possession across countries is land – even if it is just a small plot of land that their houses are built upon. Very often, however, these people lack formal titles to their land, which in turn makes it impossible to use their land as a collateral for loans. Many of these households own very few goods that Banerjee and Duflo term “productive” – items that might be beneficial to or develop their small businesses, such as bicycles, phones, sewing machine, etc. Very little gets spent on education, which is often caused by a lack of infrastructure and investment in quality teachers, and is yet another factor that limits the ability to find a job that pays more.

As the poor have very few physical goods, we should also look at the more abstract savings and insurance goods that they might purchase. The majority of healthcare costs are paid out of pocket – formal insurance is not a common purchase for many households (though, Banerjee and Duflo point out that about half of the extremely poor have insurance in Mexico). Far more common is informal insurance through social networks.

When the poor fall under economic distress, their “insurance” often means eating less or taking their children out of school.

Obviously, there are very few options available to the extreme poor in cases of hardship or sickness. Portfolios of the Poor cites the example of Feizal in Uttar Pradesh, India, who broke his leg in a bicycle accident and went to a traditional doctor to save money. His leg never healed and he ended up going to a modern hospital for treatment, which he had to pay out of pocket and lost wages for the time he missed work as a result of delaying effective treatment. Had Feizal paid small insurance payments throughout the year he might have avoided the large losses he incurred.

If money is needed, there is the option of loans, but often these loans are very hard to obtain for those without assets to secure the loan or have very expensive interest rates making it hard to pay the loan back. Banerjee and Duflo found, though, that in Udaipur, India, about two in three people had a loan – either from a relative, a money lender, a shopkeeper or a bank or other formal source. The majority of loans taken out by the world’s extreme poor tend to be from these informal sources, which are oftentimes the only loan sources available to the poor both geographically and in terms of willingness to lend to them, though at a high cost.

Loans are most frequently the predominant catalyst for savings for the world’s extreme poor. Banerjee and Duflo note, “one reason why many of the poor respond so well to microcredit is not necessarily because it offers them credit, but because once you take a loan and buy something with it, you have a disciplined way to save-namely, by paying down the loan.” For most of the world’s poor, the biggest challenge to saving is the lack of a safe and secure place to stash their earnings. In some countries, people form savings clubs or self-help groups, in which members encourages others to save. “Portfolios of the Poor” offers the story of Thembi in South Africa who paid for her brother’s funeral, which traditionally is very important and most individuals end up paying the equivalent of seven months’ salary. Thembi had a type of funeral insurance but it was not enough to pay for her brother’s funeral so she was forced to take out loans from family members and a formal loan with the funeral savings club. It ended up taking Thembi the rest of the year to pay back the formal loan but she was still unable to pay back family and friends. The options available in her situation were few, but with her informal networks and limited funds she was able to cope but wiped out her safety net.

In conclusion, the limited access to markets for loans, savings and insurances has wide implications for the economic lives of people in underdeveloped regions around the world.  Since they tend to have little to no access to capital and therefore lack the ability to invest in infrastructure to start their own businesses, they are forced to diversify and shield themselves from risk.  That is, people living on $2 or less a day have to take on several jobs and cannot specialize, which further keeps them from advancing economically.

Yet, with the introduction of a few simple technologies, the status quo does not necessarily need to persist.  For instance with the increasing availability of mobile phones in developing regions have come opportunities that change this calculation. The unbanked population now has access to mobile money (MPesa in Kenya, CAME in Mexico, etc.), farmers can gather information on market prices (Esoko in Ghana) or can insure themselves against droughts and excess rain (for instance Kilimo Salama in Kenya).  These are but a few examples that promise to change the economic lives of people in underdeveloped regions.


About CTED

CTED, as part of the New York University Abu Dhabi Research Grant, is a multidisciplinary research lab that focuses on combining economic principles, technological advances, and human-centric design to create innovative solutions for the problems experienced in emerging regions.
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