Bryan Caplan  

Thumbs Up for Portfolios of the Poor

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I really liked Portfolios of the Poor: How the World's Poor Live on $2 A Day.  Westerners tend to think of the world's bottom billion as charity cases. The harsh and amazing reality, though, is that they largely stand on their own two feet.  The ultra-poor not only feed, house, and clothe themselves; they raise children and work hard to give them a better life.  Portfolios shows us how they do it, relying heavily on financial diaries kept by villagers and slum dwellers in South Africa, India, and Bangladesh.

The main lessons:

1. The income of the ultra-poor is not only low, but highly variable.  They rarely have regular jobs in a "sweatshop."  Instead, they desperately cobble together income from many different sources.  Many days they earn nothing at all.

2. No one, no matter how poor, lives "hand to mouth."  Even the poorest people save money, make investments, and plan ahead.

3. The poor also borrow a lot of money.  Who would lend to them?  For the most part, other poor people - family, savings clubs, small-time loan-sharks.  The rates are astronomical - 20% per month is pretty common.

4. Even the poorest people spend a lot of money on things other than food.  One of their main reasons for saving and borrowing is to pay for relatively lavish weddings and funerals.

When reading this book, I had two conflicting reactions. 

One was optimistic: "Isn't it great to see all the clever strategies the world's poor use to better their lives?"  It's inspiring - and humbling - to learn that people in dire straits see themselves as protagonists - not victims.

My other reaction, though, was frustration.  Yes, the world's poor are striving to better their lot.  But what they really need isn't small-scale entrepreneurship and micro-credit.   It's employment in the formal sector, and access to international credit markets.  What they need, in short, is globalization.  Either they need to come to us, or our institutions need to go to them.

Think about it this way: Who has a comparative advantage in running a business?  In lending money?  An important part of the answer, in both cases, is "relatively rich people."  They're the ones who can gamble and lose without going hungry.  Why then are so many of the world's poor self-employed?  And why do they primarily borrow money from each other?  Because they're isolated from the broader economy.  They deal with each other because no one else is around.

Part of the reason for their isolation is admittedly transactions costs.  It would be awfully difficult for me to start a business in rural Bangladesh; I don't know anyone who lives there, much less anyone I trust.  But a lot of the isolation of the world's poor is driven by regulation.  Poor countries have policies that discourage both formal sector employment and international investment.  The result: While the world's poorest make a heroic effort to get by, their very best often isn't good enough to save them and their children from hunger, sickness, and worse.

P.S. Coming soon - the most quotable passages from Portfolios of the Poor.



TRACKBACKS (1 to date)
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The author at Sepia Mutiny in a related article titled Life on $2 a Day writes:
    Slate’s Explainer series had an article last week that attempted to get to the bottom of the following question (a version of which some of you may have also wondered about in the past): Recent news reports about the Congress Party’s electi... [Tracked on June 3, 2009 12:14 AM]
COMMENTS (21 to date)
hacs writes:

I know that they see themselves neither as victims nor as protagonists, but something among those extremes, as survivors.
From a literary standpoint, it is alike a Severino in "The Death and Life of a Severino", translated by Elizabeth Bishop.

Prakhar Goel writes:

Dear Bryan,

Your comment on transaction costs set off a thought I had some time ago.

Consider a person living on $2 a day. If such a person wants to get a loan to make an investment, he/she has only two options. Either they pay an insanely high interest rate (they don't have a credit history) or they put up collateral. However, high interest rates are never nice and all the collateral that these people have is in human capital. However, current laws do not allow people to put up human capital as collateral. This would be a significant barrier for any person without tangible assets or a decent credit history.

My proposal (and please don't crucify me for this immediately) is to bring back a limited form of indentured servitude. In effect, we give people the right to form legally binding contracts where they give up, for a limited period of time, their right to freely form contracts and own property (so the profits of their labor accrue to the person who they formed the contract with). In return, during this period, we can naturally require that they be provided nutrition, etc. (and this can be part of the contract). Effectively, during the period of indentured servitude, the initiating contract will be the only active one. The people under these contracts become the legal equivalent of children. This can then serve as collateral. As it is, with rates as high as you mentioned (20%/mo.) there is little difference. A person under that interest rate either pays up or gets lorded over for the loan. At least this way, the system is formalized and the worst excesses can be prevented. This will also allow lenders (or rather, competition will force lenders) to reduce interest rates to more manageable levels.

I would also note that this system was widespread in the early (I.e. 1600-1700) British Empire. In fact, it was one of the major ways that settlers came to the US. Their patrons would pay for their passage across the Atlantic and in return, the people would work exclusively for their patrons for the next seven years. Afterwards, they were free to start over and work for themselves. It seemed to have worked out pretty well for them.

ajb writes:

The point that Prakhar misses is that elementary contracts don't function well for the vast majority in most countries. Hence, indentured servitude isn't needed so much as well-functioning Western style markets complete with reasonably reliable courts and some degree of competition and political accountability. Moreover, it should be easy and credible for someone to make and KEEP a buck by finding a way to hire the poor. In most countries these conditions are all but impossible for economic and political reasons especially given corruption, protectionism, oligopoly, and populist demagoguery destroying credible commitment needed to build up a functioning market for the poor. Indeed this is the argument for imperial colonialism that Niall Ferguson made. In a real sense, only self-serving imperialists were able to impose a semblance of Western institutions in many poor countries, often badly, and without regard to fair treatment of the local populace.

Adam writes:

Surprise, people around the world barter, truck, and trade. Will they be better off with our institutions--GM, the Fed, Citibank, AIG, and ACORN? I doubt it.

Prakhar Goel writes:

@ajb

Obviously a well functioning judicial system is necessary for indentured servitude is to exist in an acceptable manner.

Without basic requirements like a non-intrusive government and rule of law, nothing can really lift people out of poverty.

However, once the courts arrive complete with the easy rules for making and keeping money, we still have the problem of people with no capital. Here is where we can jump-start the process.

Kurbla writes:

I think poor countries can benefit the most from direct aid in form of free education, food, medical help. Emigration robs poor countries of their active population, and especially of the most talented, most educated people - and leaves elderly and less talented, less educated people at home. It is exactly opposite of what is needed. People are more important than money.

Investment can be beneficial as well, although it is not that important as direct aid. I do not think that economic globalization is needed for investment. But, I think that economic globalization can expose poor countries to huge negative externalities.


Jayson Virissimo writes:

"Emigration robs poor countries of their active population, and especially of the most talented, most educated people - and leaves elderly and less talented, less educated people at home. It is exactly opposite of what is needed. People are more important than money." -Kurbla

You cannot be robbed of something you do not own. Poor people do not own other poor people simply because they happen to live nearby. No one has the right to prevent their neighbors from moving away and therefore, should not be able to use the force of law to prevent them from doing so. To do so is to assert that you have a higher claim over another person they they have over themselves.

Zac Gochenour writes:

@Jayson, unfortunately, people make such assertions constantly and see absolutely nothing wrong with it.

@Prakhar, if the idea is to allow indentured servitude but change nothing else, I doubt things would change much for the very poor. Like you hinted, whether you are deep in 20%/month loans or an indentured servant is pretty much a wash. Like Bryan said, the poor don't need microcredit, they need globalization.

If the idea is to open borders and allow the very poor to become indentured servants so they can afford to immigrate to the first world, I say their lot will be improved but they probably won't need to sign such a contract. The main thing preventing the poor from working for American firms or getting better loans isn't airfare.

Asif Dowla writes:

This idea that there are tremendous barriers to start a business in poor countries is overstated. This is true for formal sector businesses. But starting an informal business face little regularity restrictions. One of the authors of the book, Jonathan Morduch pointed out that it would be very difficult for a member of microfinance institution in NY city to start selling food in the street corner without permission from the City, Health Department and who knows what other institution. Whereas in poor countries you find tones of food vendor and they are the top clients of MFIs.

Kurbla writes:
    Jayson:

    "You cannot be robbed of something you do not own. Poor people do not own other poor people simply because they happen to live nearby."

True, people do not own other people, especially not because they happen to live nearby. But, if they are members of the same community, then they have elaborated system of rights and duties - and duties frequently include reduction of the freedom of movement.

But, I didn't said that emigration should be prevented. In almost all cases, it shouldn't. I think, that in almost all cases immigration from poor countries should be prevented, and it is completely different issue.

For example, if EU allows immigration of best surgeons from Gabon, and as result mortality in Gabon increases, that is, in my opinion, the responsibility of EU.

James writes:

Kurbla,

I never thought I'd encounter anyone willing to openly admit to favoring the use of force to prevent the world's poor from peacefully seeking their own betterment.

Jayson Virissimo writes:

"For example, if EU allows immigration of best surgeons from Gabon, and as result mortality in Gabon increases, that is, in my opinion, the responsibility of EU." -Kurbla

And if they refuse to continue to offer their services? Are you prepared to force people to work for the "greater good"? This seems an awful lot like slavery...

Kurbla writes:
    James: I never thought I'd encounter anyone willing to openly admit to favoring the use of force to prevent the world's poor from peacefully seeking their own betterment.

Uh ... it is like I said I do not like Harleys, and you concluded that I do not like bikes. Too general. This formulation doesn't reflect my thoughts.

    Jayson: And if they refuse to continue to offer their services? Are you prepared to force people to work for the "greater good"? This seems an awful lot like slavery...

Not allowing immigration is not the same thing as forced work. These are very different issues. But if you want, my position is very mainstream; forced work should be avoided, but in some cases, it is lesser of two evils. On the other side, my opinion on immigration is that it is almost always harmful for poor countries.


Ivan writes:

Proponents of indured slavery and opponents of immigration,

Nobody wants to emigrate from Hong Kong, Taiwan, Singapore or South Korea to USA and EU. So, if West should anything to do for poor,it is to help them to become as much as possible similar to Hong Kong, Singapore and Korea. And I very much doubt that could be achieved by governmental foreign aid. If it were possible, Africa would be paradise until now.

Let's grow up - poor will become reach once they adopt free market capitalism, rule of law and globalization (as plenty of examples in Asia confirm). Period. Everything else is snake oil.

Prakhar Goel writes:

@Kurbla

Nice thought but reality disagrees. People and organizations, large and small, have been giving Africa aid for ages. It just gets funneled into the pockets of the corrupt governments. This problem is so bad that many prominent people who study African poverty have asked international organizations to _stop_ aid.

@Zac

Indentured servitude if enacted in a framework of working courts and rule of law would enable a lot more than micro-financing. Thats the entire point. A person's human capital, even that of a dirt poor one, is probably at least on the order of magnitude of hundreds if not thousands of dollars. This much capital can give these people a real chance to lift themselves out of poverty immediately.

Secondly, have you seen the airfare for coming to the US? For countries abroad, the one usually paying the airfare is a corporate entity. Then once a person lands in the US, US immigration laws make it nearly impossible to switch jobs without being deported but that person can still be fired (at which point, they will be given airfare back and told to go home). Its not that much different from a watered down version of indentured servitude.* There is a reason for this. Namely, if a company pays somebody's passage into the US, they need some guarantee that that person will stay on with that company until said company can recoup the travel costs. For truly poor countries, I can pretty much guarantee that individuals will not have the funds to travel to the US unless they are in one of the bordering countries. If this is done on a truly mass scale, the current system (of largely unenforceable) non-compete clauses and soft incentives would not work as well as a well-defined system of indentured servitude.

@Ivan

Making these countries more like Singapore and HK would definitely help. But we still have the problem of these people having no capital. Indentured servitude (or slavery, whatever you want to call it but note that servitude as discussed here is voluntary) is a technique for jump-starting the process.

* I have had some indirect experience of this and it works well.

Frazier writes:

I understand the benefits of a larger market and more choices to choose from when tackling the super-poor and their options for loans and employment. However, I have to wonder if giving them more options to be taken advantage of, or to make poor choices is really what they need.

For globalization to answer some of these questions, the new participants would need to know as much as possible about their new options to make sound decisions that move them forward.
I can only recall the millions of people in the united states that are considered middle class yet they are drowning in debt. What type of education and regulation would be necessary to increase the positive effects of more credit?

I also apply similar skepticism to indentured servitude. It helped many people make the initial voyage across the Atlantic to the 'new world' but quickly became a way for one class to dominate another.

And finally
@Kurbla: You have a point. Braindrain, to a certain extent is quite a common disadvantage to free movement of the most talented and educated as you said. That's why many countries offer free education to citizens who are willing to pledge a certain amount of documented time working within the country that educated them.

But even so, one cannot fault those people for leaving. If they do not choose to stay and contribute to their respective communities, you cannot force them to stay imho.

Kiva Guy writes:

There is already a tool to micro finance without knowing the poor people personally or waiting for more globalization.

http://www.kiva.org

Your loans are paid back and then you can re-loan the amount. I have been using it for 2 years with great satisfaction.

C. writes:

"Indentured servitude if enacted in a framework of working courts and rule of law would enable a lot more than micro-financing."

This exists; it's called the Gulf States. See for instance, here.


You say "in a framework of working courts and the rule of law." There is an inherent inequality of power between master and servant. This inequality of power is deeply exacerbated in situations where the servant is moving to a place where they are a stranger, and may not know the language and customs, not have relatives or friends to act as an outside resource. They are then completely dependent upon their master. Think practically: I'm so poor I'm willing to sell my body and labor for a period of years. What happens if my master beats me? Do I go to the cops? Do I even know where the police station is? Do I speak the language well enough to express my complaint? Would I trust the police to take my side? What if I complain and I get booted out to the street, in a foreign country, with no money to take me back home? And no job, and therefore no valid visa, and am subject to arrest and deportation?

Perhaps you think I am unfairly picking on the Gulf States, or that these countries are not prime examples of the rule of law which you think would be necessary for this to work. To which I would say: John Nash Pickle. That case happened in Oklahoma. It was sorted out, eventually. But it took months for it to be uncovered, and years to be sorted out, in a country whose laws are quite clear that this is entirely illegal.

You seem to me to be saying, "in a world where the servants couldn't be horribly abused, indentured servitude might be a good thing." Well, this ain't that world. There's bastards in every country, and the imbalance of power between master and servant creates a very, very great scope in which bastards can operate.

Colin K writes:

@Kiva Guy:

Does Kiva allow you to take a profit on your loans, or just reinvest it in more charity?

BobinDenver writes:

Colin K et al.,
I was disappointed to find out that Kiva does not allow you to make a profit. You only get to reinvest the principal. I suspect that a consolation is they are keeping interest rates to a minimum. Think of the interest you forgo as a subsidy to the program allowing better competition with the local money lender.

Still a very worthwhile program. Don't let the perfect be the enemy of the good.

If you'd like to turn a profit consider the MicroPlace.com model.

Bryan,
On your recommendation I've purchased Portfolios of the Poor and am looking forward to a good read. Thanks for the suggestion.

Bob

David Jinkins writes:

Arriving a bit late at this party...

During travels through rural China and Turkey, I always thought the most surprising aspect of very poor people's lives was how vulnerable they felt (and were) to minor bad luck. If I get sick, I stay home for a few days. If a very poor person gets sick, the effects of the medicine necessary and lost time can last for months or years.

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