Poor Economics, Summary and Review: Part 2

 

Chapter 4: Population Control

Do large families cause poverty?

Another common theory is that families which have more kids are poorer, the idea that if there are many children, each child gets less resources (quantity/quality tradeoff). But is this really true? Or is there just a correlation? Are families poor because they are large, or large because they are poor? As it turns out, no causal link has actually been shown between the two. In 1977, half of the 141 villages in Matlab, Bangladesh were selected to receive intensive family planning. These regions had about 1.2 fewer children than the other villages. However, by 1996, there was no significant difference in the height, weight, school enrollment or years of education in both regions! I think this should be taken with a grain of salt for the reason that it's probably heavily dependent on the region and whether it has enough resources, enough jobs, and how strong government programs are. Wait but if the same resources have to be shared with more people, some of them have to have less right? So if the children don't get less, who does? Mothers. The mother’s health is negatively affected my frequent, closely spaced pregnancies, and they are less likely to have as much education and work in the formal sector.

So what forms of population control work?

Does birth control work?

Birth control policies such as increasing access to contraceptives, or increasing their demand by educating teenagers are a common policy to reduce teenage pregnancies. However, there already is a lot of supply, people know they should get contraceptives, and they’re not that expensive, so what’s going on? Actually, having sex seems to be a pretty calculated decision for girls who think getting a child wouldn’t necessarily be that bad, as the father would also need to take care and the girl would have some role and significance in the family. I’m slightly skeptical the extent to which this is true, given that people usually underestimate risks, or perhaps that pop cultures generally shows unprotected sex/does not show the use contraceptives, but this adds very useful nuance, and leads to an important lesson: it’s very important to understand the level of knowledge and the reasoning of the poor to properly implement a certain policy.

However, teen pregnancies are probably bad for health and girl education. So what works? Girls going to school makes it less appealing for them to have a child. But it’s really important to consider other factors. More important than contraceptives, social and economic factors often pressure women to have children.

Economic Pressure on Having Children

The reason families have many children is they see them as a future investment to care of them during retirement. This provides crucial context as to why having fewer children does not mean more investment per child, because the parents are more likely to save if they have less children! I don't fully buy that this saving is so high that investment per child stays roughly the same for large and small families, but it does partially explain why there's no (or less) causal linkage between large families and worse off children.

Additionally, many don’t want girl children as they will marry out of the family, leading to horrible instances of sex selective abortions, neglect of girls (not treating diseases), and even mother’s not breastfeeding girls, because breastfeeding acts as a contraceptive, preventing the mother from getting pregnant to have a boy child.

Social Factors

There are many family dynamics at work as well, meaning work in the family is not allocated in the most economically efficient way. Some social pressures are good, such as social enforcement mechanisms to take care of children, while some cause harm, by limiting women’s ability to work.

So what are effective solutions?

Now that we have understood that the fundamental reason families have children is a sort of safety net for retirement, the solution becomes evident: Give social security to the elderly! This also benefits girls, since there are no longer as many costs to having a girl child and children are seen less of as investments.

Part II: Institutions

The next part of this book, deals more with the institutions surrounding poverty, such as the political system, banks and businesses.

Chapter 5: Risk and Insurance

Poor people are always taking on a ton of risk - activities like farming are incredibly risky - there are changing weather patterns, price always fluctuates. This prevents them from taking on risky endeavors that pay off long term eg: using new fertilizer.

Given this background, the concept of insurance feels fairly promising! Give the poor a safety net, and allow them to take risky bets that pay off — only, there are many problems. Firstly, adverse selections means those who are most at risk of bad things happening to them are most likely to get insurance, meaning insurance companies suffer losses and have to raise premiums. The only way to get around this is to make insurance mandatory, which is problematic as many of the poor don’t want insurance as they don’t trust they’ll get paid back. Secondly, fraud means it’s really hard to tell if people’s claims are true or false, leading to things like overmedicating if their insurance covers it, so insurance can only be used for things out of people’s control like medical emergencies, or the level of rain.

In practice, insurance is really hard to do in a for-profit market sense. There is clearly need for the government to be involved. If private insurance markets are to arise, they will likely require subsidies by the government to reduce premiums, at least until the poor get a sense of how insurance works and are willing to get it even without the subsidy.

Chapter 6: Lending

How does lending work with the poor?

Banks don’t lend to the poor for several reasons:

1. The poor have no collateral in case of defaults
2. If the poor default, it’s hard for overburdened courts to get back their money
3. If banks do get back money, this can cause a lot of pressure on the poor, and banks don’t want to be associated with “farmer suicides.”
4. They can’t enforce loans using force or coercion.

That’s why the poor often turn to local moneylenders who can monitor the debts and ensure they get paid back. Because the poor have no collateral, moneylenders charge really high interest rates - around 40-200% annually.

Wait but why is this interest so high?

Shouldn’t competitive pressures be driving them down? The interest is high because administrative costs are high! Moneylenders have to constantly make sure the poor don’t evade repayments, and doing so requires money, requiring higher interest rates. This leads to an interesting phenomena where the poor are more likely to borrow from those with the power to hurt them such as the mob, because they have greatest enforcement capacity and thus charge the lowest interest rates!

I think it's really crucial to understand banks and moneylenders not as sharks that want to prey off the poor, but as profit incentivized actors, which charge high interests for the simple reason that they have high costs. This helps understand problems with more nuance and develop better solution (eg: what if you could reduce the costs of banks and moneylenders?).

Here’s where microfinance steps in:

Through strict weekly repayments, an organized system of groups and strict loan officers, microfinance organizations ensure they’ll be paid back, which allows for much lower interest!

So is this the miracle cure to poverty?

Well, studies definitely show positive impacts - households are more likely to have bicycles and make long term purchases. However, it’s not like everyone had started a business, there were no large changes in women empowerment.

What are drawbacks of microfinance?

1. There’s a lack of flexibility — have to pay every single week, microfinance is quite risk averse, meaning even in places like Hyderabad where there’s large access to microfinance, people still borrow a lot from moneylenders.
2. It’s hard to spend on long term investments like college, large businesses since the money needs to be paid back every week.
3. The government sometimes has high hostility to microfinance institutions (MFIs). In Andhra Pradesh, they accused MFIs of causing farmer suicides and cracked down and arrested many MFIs. There are genuine concerns about the coercive nature of microfinance loans — MFI agents are often aggressive in offering the loans, and extremely strict in their repayment, more so than moneylenders. This may cause increased suicides (although the causation of these two is very unclear), insistence that the poor sell their assets to pay off loans, and debt traps. Although such instances are definitely not specific to microfinance, and arguably worse with moneylenders, it’s clear that the incentives and motivations of MFIs are very important to take into account.
4. Fast growth has caused careless lending, such as the sub-prime mortgage crisis in the 2008 financial crisis.

Unfortunately, many of these drawbacks seem really difficult to avoid. The whole point of microfinance is decreasing costs by reducing defaults and being strict on repayment, which allows them to charge lower interest rates. If people were given more flexibility, more would default, meaning default might be seen as acceptable to many, causing costs to hugely increase, requiring higher interest rates and… we’re back where we started.

For more information, see: https://www.cgdev.org/blog/backgrounder-indias-microfinance-crisis

So if not microfinance, how can large businesses be financed?

The bottom line is it’s hard. India has 40% of lending to “priority sector” including SMEs, agriculture and microfinance, but banks are complaining this is expensive and risky. It’s also hard to judge what are “worthwhile investments” because banks are so large - if you punish loan officers for default, they only give loans to the safest, guaranteed projects.

Conclusion

Microfinance is definitely good and one of the many tools to fight poverty - has reached so many people. However, it is clearly not the miracle solution, and countries still have to figure out how to finance medium enterprises.

Chapter 7: Saving

The poor clearly have very good reason to save - for emergencies so families don’t have to go without meals or for long term investments in education. The poor also clearly care a lot about preventing future risks, so do they save, and if so, where?

The poor don’t save in banks for a few reasons:

1. Banks have a minimum amount of money to start an account because small accounts have relatively high administrative costs due to paperwork, regulations, etc.
2. There are high fees to withdraw money
3. Withdrawing money is inconvenient and hard - you have to travel to centers

Because of this, the poor find other, ingenious ways to save. They have community funds in which they deposit money and give to local lenders, or groups collectively club in money to put in a bank. People are sometimes part of many of these groups. These are a lot more flexible and have lower fees, but are costly due to the complicated arrangement, and the poor would likely be better if they actually started a bank account, as studies show women who start bank accounts save more than women who don’t.

There is potential for a “micro-saving” revolution in which instead of highly paid bank employees, local shopkeepers can take and manage deposits. Technology can also play a role, with can make withdrawing money electronically much more convenient than going to a bank.

The Psychology of Saving

It seems, through saving on simple purchases and buying cheap things like fertilizer, through the power of compound interest, the poor can save a dramatic amount of money! So why don’t they? Fertilizer can increase revenue by 70%. However, even when these benefits are demonstrated by giving fertilizer for free to farmers, the vast majority still go back to not using it. Why is this? Interestingly, it’s because saving to buy fertilizer is really really hard. There are always more proximate things to spend the money, that all seem necessary, such as feeding a guest, and it’s hard to say no. To get around this, the Saving and Fertilizer Initiative (SAFI) was started to give farmers an opportunity to purchase fertilizer at the start of the harvest when they have money to do so, meaning they have to precommit on buying fertilizer and don’t have to do the psychologically difficult thing of saving. This program increased the fraction of farmers who used fertilizer by an astonishing 50%, more than a 50% reduction in the price of fertilizer!! Furthermore, there’s a big inconvenience of tracking when fertilizer comes into the market. This means that psychologically, this tiny bottleneck of keeping track of fertilizer delivery was holding them back from gains in productivity.

Explaining this Psychology

This can be explained by the phenomena of “time inconsistency” in which we plan to spend money responsibly in the future, but in the short term, consume temptation goods such as alcohol, or sugar in tea (temptation goods are goods which are immediately appealing, but aren’t something we actively anticipate to enjoy). An important clarification is required: something like a TV probably isn’t a temptation good, because the poor plan on it in advance, meaning they clearly anticipate the benefits! Many of the “emergencies” the poor face are a kind of temptation issue, as it’s easier to spend money in the moment than suspend the issue. The poor in fact have this self awareness — slum dwellers regularly say they want to cut back spending on tea, snacks and alcohol. This leads to another function of saving: The poor save to psychologically protect themselves from impulsive, short term purchases! However, programs involving the poor precommiting to save money on some purchase often didn’t worked as they were hesitant to put money into “locked” boxes that could only be used for eg: preventative healthcare. This means awareness of problems alone is not enough to overcome this problem.

Self control is particularly hard for the poor, as goods the poor might want such as a refrigerator are quite expensive and seem so far away. These decisions are often automatically made for the rich, through things like mandatory pension plans, and easy access to banks, which are inaccessible o the poor.

So as you might expect, microcredit probably increases consumption on temptation and consumer goods right? But in fact the opposite occurs! Consumption on tea, snacks, and alcohol reduces after microcredit. This may be because, according to Padmaja Reddy, founder of MFI Spandana, thinking about long term goals and getting used to making short-term sacrifices are the first steps towards liberation from one of the most frustrating aspects of poverty. A little bit of hope, some reassurance, and making targets seem less elusive and impossible can go a long long way in better decision making ability and investing towards the future.

 Part 3 of the summary and review coming soon!