on April 14, 2014
I’ve spent the past seven years working for Intuit, the company behind such successful consumer software products as TurboTax, QuickBooks, Quicken and Mint.com. A fundamental principle to our product management approach is the “follow-me-home.” That is, we literally shadow our potential customers – usually small business owners and American taxpayers and budgeters – to observe how they behave and why they make the decisions they do. The intent is to learn by observing, rather than surveying or relying on research reports. This widely acclaimed book by two young MIT economists, Abhijit Banerjee and Esther Duflo, takes the Intuit “follow-me-home” approach to the fight against global poverty. While Jeffrey Sachs is declaring the macro-decisions required to end global poverty literally within years and critics like William Easterly are asserting that such claims smack of utopian social engineering, the authors of “Poor Economics: A Radical Rethinking of the Way to Fight Global Poverty,” take a more customer-back approach to making a dent in the problem. They ask a few fundamental questions: “Are there ways for the poor to improve their lives, and what is preventing them from being able to do these things?”
In Part I: “Private Lives,” Banerjee and Duflo take a close look at the lives of the poor from the ground level. Rather than conjuring up solutions from above, the authors first investigate actual behavior of those who are targeted with massive foreign aid packages. The world of development economics assumes that the poor are “trapped” and need our help to escape. They are hungry, lack access to healthcare, and family planning. Is that true? Moreover, there are two basic schools of thought in development economics, which the authors refer to as “wallahs,” from the Hindi word. Those, like Sachs, are “supply wallahs, who envision supply side solutions. That is, if you build schools and supply teachers, more children will go to school and overall education levels will improve. The other approach, the “demand wallahs,” is best exemplified by Easterly, who argues that only demand driven changes will make a difference. In other words, unless and until you change how locals see the value of education there is no point in building schools and hiring teachers.
First, are there really a billion hungry people in the world? Is there a nutritional poverty trap? No, there isn’t, the authors say. A close review of the lives of the poor show that even those living on less than $0.99 a day spend only half of that on food. And if they happen to get more money, they almost always spend it on “empty calories” – sweats and delicacies – not more food.
Is there a “health trap” affecting the poor, as Sachs argues? No, not really either, they claim. The poor actually spend a relatively significant sum on health care, but mainly on expensive cures rather than cheap prevention, mainly due to lack of information, “weak beliefs” and procrastination, according to the authors.
Is there an “education gap” that explains why certain countries can’t seem to find growth? Sort of, they say, but it’s artificial and created by the locals themselves. Parents believe that only advanced education (high school and higher) pays dividends (the authors claim that each extra year of education boosts earning potential, even early elementary education) and both parents and teachers subscribe to an “up or out” mentality where only the most talented students are encouraged to stay in school and receive family support.
Do large families contribute to poverty? Could better access to birth control alleviate the problem? Banerjee and Duflo claim that poor families having 10 children can be rational from their perspective. In all likelihood only 1 or 2 of their children will prove “worthwhile” – succeed in school, get a “good job” (more on that below), and take care of them in old age. Much like the other areas, there is little evidence that “supply” of family planning matters. “Demand” for such services is what really matters. Until poor families alter their views on the value of large families, no amount of intervention will matter. The same goes for valuing preventative healthcare and education, according to the authors. They clearly want to come across as neutrals in the Sachs vs. Easterly debate, but the weight of their evidence piles up heavily on the “demand wallah” side.
In Part II: “Institutions”, the authors review the argument that the poor are hampered by the lack of critical institutions such as access to financing, savings accounts, insurance. “For the poor, every year feels like being in the middle of a colossal financial crisis,” they write, mainly because they lack many safety nets and support institutions.
Some, like Nobel Peace Prize winner Muhammad Yunus, claim that microcredit financing institutions (MFI) hold the key to solving the riddle of global poverty. Banerjee and Duflo agree that the benefits of microcredit are significant, (“In our minds, microcredit has earned its rightful place as ‘one’ of the key instruments in the fight against poverty”), but it is far from being a panacea (“…we are kidding ourselves if we think they can pave the way for a mass exit from poverty”). The fact that only a fifth of eligible businesses in areas where MFIs are present leverage microcredit while the rest use local moneylenders offering extortionist rates needs to be explained. There are a couple of ways to look at it, really. For example, the amount available for loans is quite limited and the terms of repayment are rather inflexible. The informal network of money lenders provide several benefits that MFIs don’t. The lending is often based on personal relationships; the loan amounts can be larger; and the repayment schedule can be modified as needed. For many poor these benefits outweigh the extortionist rates the money lenders charge.
Perhaps even more important, is the developing world home to a billion entrepreneurs waiting to grow their businesses if only they had the access to capital and other resources required? Hardly, the authors say. Rather, most “poor entrepreneurs” are entrepreneurs only because they can’t find any other work. Most of these enterprises are small retail shops that are undifferentiated and lack any real growth potential. “Perhaps the many businesses of the poor are less a testimony to their entrepreneurial spirit than a symptom of the dramatic failure of the economies in which they live to provide them with something better,” the authors write. The type of investment needed for genuine growth requires heavy upfront capital with delayed return, precisely the type of investment that microcredit does not support. “Taken together, this evidence makes us seriously doubt the idea that the average small business owner is a natural “entrepreneur,” in the way we generally understand the term, meaning someone whose business has the potential to grow and who is able to take risks, work hard, and keep trying to make it happen even in the face of multiple hardships.”
What about access to saving accounts? The authors write how many of the world’s poor build their house brick-by-brick; whenever they come into some extra cash, they immediately buy some building supplies and add to the home, which may decade over a decade to complete. Why? Because the poor have no access to savings accounts and the authors suggest that there is no viable private market for it.
Finally, Banerjee and Duflo rejects the pessimistic arguments made in “Why Nations Fail: The Origins of Power, Prosperity, and Poverty” by Daron Acemoglu and James Robinson that INSTITUTIONS (that is, democracy, free speech, free markets, or lack thereof) in poor countries tend to be lacking and therefore arrest development and promote negative influences, like corruptions. The Banerjee and Duflo claim that changes for the better are possible, but only from the margins and from the bottom up. They maintain that even modest changes can have significant political repercussions, such as the threat of public audit. Yes, they conclude, INSTITUTIONS are critical and difficult to change, but they are not necessary and sufficient in and of themselves. Even well-intentioned programs have bad results due to lazy thinking at the policy stage. The important thing to remember is that “Details matter. Institutions are no exception.”
In the closing chapter, “In Place of a Sweeping Conclusion,” Banerjee and Duflo write about five lessons from their research; although they stress that there are no silver bullets. First, the poor lack information; there’s evidence that simple information presented effectively can make a big difference. Second, the poor bear too much personal responsibility for critical decisions; we can make it easier for them to chlorinate their water, inoculate their children, save their money, and so on. Third, the conditions for some markets serving the poor are simply not there; we likely must give away or subsidize critical goods and services (e.g. bed nets, insurance, savings accounts). Fourth, many poor countries have poor political institutions, but they are not therefore doomed to failure; it is possible to design smarter policy without charging the existing social and political structures. Fifth, limited or unrealistic expectations become self-fulfilling prophecies; it is possible to change expectations by tackling the “Three I’s”: ignorance, ideology, inertia.
In sum, “Poor Economics” offers a valuable and embarrassingly novel perspective – the perspective of the poor themselves, who have been the target of $2.3 trillion in foreign aid investment since World War II. They leave the reader with this thoughtful concluding statement: “If we resist the kind of lazy, formulaic thinking that reduces every problem to the same set of general principles; if we listen to poor people themselves and force ourselves to understand the logic of their choices; if we accept the possibility of error and subject every idea, including the most apparently commonsensical ones, to rigorous empirical testing, then we will be able not only to construct a toolbox of effective policies but also to better understand why the poor live the way they do. Armed with the patient understanding we can identify the poverty traps where they really are and know which tool we need to give the poor to help them get out of those.”
Or, to put it more succinctly, “Attend to the details, understand how people decide, and be willing to experiment.”