PDF Summary:Poor Economics, by Abhijit V. Banerjee and Esther Duflo
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1-Page PDF Summary of Poor Economics
Millions of people throughout the world live on less than 99 cents a day. MIT professors Esther Duflo and Abhijit Banerjee won the Nobel Prize in Economic Sciences for their efforts to study the causes of such poverty—Poor Economics demonstrates their unique approach.
They analyze poverty by asking small, pointed questions about specific aspects of the lives of the poor. Their goal is to develop a detailed picture of how the poor live and how policy interventions affect their lives so that policymakers can better design interventions that help them. Since publishing Poor Economics in 2011, their approach has come to dominate the field.
In our guide, we’ll see what the authors discover when they closely examine the lives of the world’s poorest people. Along the way, we’ll note critiques of their approach and share relevant updates on the current status of global poverty.
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How Do Poor Parents Plan Their Family Size?
Based on their research, Duflo and Banerjee found that poor mothers often suffer disadvantages if they have children too early in life or if they have more children than they can afford. If they have children before they finish school, mothers tend to get less education during their lifetimes, and if they have more children than they can afford, mothers sacrifice their own nutritional and health needs to ensure those children are cared for. Mothers with less education and poorer health in turn have a harder time escaping poverty.
(Shortform note: Girls who receive more education are more likely to delay pregnancy and earn a higher income later in life. Experts find that for every year a girl in a developing nation is in school, her first pregnancy is delayed by six to 10 months. Also, for every year of secondary education a girl completes, her income grows by 15 to 25%. Statistics like this suggest that enabling girls to stay in school is a powerful way to reduce poverty.)
Given these facts, Duflo and Banerjee wanted to determine how the poor make decisions about their fertility. They found that two factors affect these decisions:
Disempowered Women Can’t Make Independent Decisions
Poor women are often disempowered, which renders them less able to make independent decisions about their fertility. Specifically, poor girls are often less educated than boys and have fewer employment opportunities. They thus frequently see motherhood as the only way to achieve economic security: After all, the father may support them. According to Duflo and Banerjee, this encourages girls to engage in risky sexual behavior even before they’ve finished school, which leads to early pregnancies.
Evidence suggests that when empowered and allowed to decide for themselves, poor women prefer to have fewer children than when their decision is influenced by their husbands. Women who were given unaccompanied access to family planning services reported fewer unwanted pregnancies than those who accessed those same services with their husbands, claim the authors.
(Shortform note: Since the publication of Poor Economics, more studies have confirmed the authors’ findings that when women are empowered to make their own decisions, they choose to have smaller families. A recent policy intervention in Uganda found that providing teen girls with vocational training and information on reproduction and marriage led to lower rates of teen pregnancy and early marriage four years after the intervention. They further expressed a desire to marry and have children at a later age than did their peers and were nearly 50% more likely to be generating independent income, suggesting a causal link between financial independence and the decision to have fewer—and later—children.)
Parents View Children as a Form of Economic Security
Duflo and Banerjee also argue that in countries lacking institutional support such as retirement funds and health insurance, parents rely on adult children for care. For example, in places where fertility rates are forced down, savings rates go up, indicating that parents view children as a form of savings, so that when they have fewer children, they purposefully put aside more savings for the future because they assume they’ll have fewer children supporting them in old age. This was seen, the authors say, when the Chinese government initiated a program of family planning: As average family size decreased, savings rates gradually increased.
If policymakers want to improve the lot of women and parents and help them make good fertility decisions, they need to address the above two factors, assert Duflo and Banerjee.
(Shortform note: Although Duflo and Banerjee argue that when parents have fewer children, they’re more motivated to save money, they don’t address the possibility that increased savings in smaller families might be a result of children simply being expensive, so that when parents have fewer kids, they consequently have more money to set aside for the future. Researchers found that the average cost of raising a child to age 18 in China was nearly seven times a family’s average annual income. The authors don’t explore whether larger savings are caused by smaller families or are merely correlated with them.)
Small Questions About Markets and Institutions That Affect the Poor
According to the authors, the private lives of the poor are influenced by market and institutional forces. In this section, we’ll explore the factors that shape these forces, and we’ll discuss how they affect the poor.
Why Do Financial Services Not Help the Poor?
Wealthy people benefit from financial services, such as comprehensive insurance and easy-to-access credit, assert Duflo and Banerjee. Despite the fact that the poor also need these services, businesses rarely provide them.
Insurance Companies Offer the Poor Few Options
Duflo and Banerjee argue that the poor have a strong need for insurance because they’re exposed to more and greater risk than the wealthy: Their jobs (often in agriculture or casual labor) are unstable, they’re more vulnerable to disease, and they endure violence more often. Living on a knife’s edge of financial security, the slightest setback can be catastrophic for the poor.
(Shortform note: This factor—the lack of security in the lives of the poor—is known as low socioeconomic resilience, and it’s one reason why the poor are disproportionately affected by natural disasters or extreme weather events. Because the poor don't have the funds to easily replace assets lost in a disaster, they’re less resilient to such losses.)
However, insurance companies are reluctant to insure the poor because they find it unprofitable, write Duflo and Banerjee. The same general challenges insurers always face are amplified in the case of the poor: fraudulent claims, the tendency of the insured to take risks or run up costly medical bills, difficulty collecting payments, and so on. Insurers therefore offer limited options to the poor that tend to only cover catastrophic events. Duflo and Banerjee find that the poor don’t use even these limited options, for two main reasons:
1. They don’t trust the insurers. Insurance is based on paying for something you don’t yet need. This is a dynamic built entirely on trust—if the poor don’t know the insurers, it’s hard to grant them that trust.
(Shortform note: Experts agree that trust is one of the key factors that affect getting insurance to the poor. They suggest that one of the best ways to establish trust is through the demonstration effect: Make all insurance payouts public and easy for others to see and understand.)
2. It’s hard to plan for the future. This is the same issue keeping the poor from using preventive measures in healthcare, write Duflo and Banerjee. It’s hard for anyone to contemplate the future, let alone a catastrophic future, and it’s especially difficult for the poor to do so under the unrelenting pressure of a hardscrabble life.
(Shortform note: Researchers find that poverty causes short-term thinking. Scarcity, they say, changes what people pay attention to and causes them to focus more on short-term benefits than long-term costs. For the poor, then, the benefit of avoiding a payment in the present can loom larger than a potential future catastrophe.)
According to Duflo and Banerjee, the poor devise ways to minimize risk and informally insure one another—for instance by giving money to family and friends who fall on hard times or by borrowing from local (exploitative) moneylenders to pay unexpected health expenses—but these workarounds don’t provide the security formal insurance can, and they often lead to more debt.
(Shortform note: Nearly a quarter of all households in low-income countries borrow money to cover unexpected expenses. Interest rates on these loans vary considerably depending on who provides them, but researchers have found money lenders charging rates as high as 96% per year. Poor borrowers in these situations rarely escape their debt and often end up borrowing more money to pay off previous debts.)
So, development economists need to work on expanding insurance for the poor and improving their general circumstances to help them manage the risks they face in life, argue Duflo and Banerjee.
The Poor Have Limited Access to Credit and Loans
Banks are unwilling to give the poor access to loans and credit because doing so is unprofitable—it’s expensive to verify creditworthiness, and there’s always the possibility of default, explain Duflo and Banerjee. To cover their expenses and justify the risk of lending to the poor, banks only offer them lending options with extremely high interest rates. These are hard for the poor to pay back, so they rarely seek out a loan or a line of credit from a bank.
(Shortform note: Researchers estimate that about three quarters of the world's poorest people don’t use banks.The chief reasons for this are travel distance, bureaucratic barriers, and high costs.)
Because of this, innovators have developed a new kind of institution to lend to the poor, write Duflo and Banerjee: the microfinance institution (MFI). MFIs lend small sums of money at affordable interest rates to those who don’t otherwise have access to formal credit. Economists have praised these institutions for using innovative strategies to accomplish this profitably, and many policymakers have assumed that MFIs have solved the problem of getting credit to the poor. However, Duflo and Banerjee don’t believe MFIs have been as beneficial to the poor as their reputations suggest.
The authors observe that two core strategies MFIs use to lend to the poor actually end up discouraging them from using MFI loans to significantly improve their lives:
1. MFIs lend a sum of money to a group of borrowers who are all mutually accountable for repaying that sum. If a group member defaults or misses a payment on their equal portion of the sum, the other members have to make up the difference, explain Duflo and Banerjee. This is good for MFIs because the borrowers do the work of vetting each other and collectively ensure that the loan gets repaid. The trouble is, many poor people are unwilling to enter into this kind of an agreement if they don’t know the other people in the group well and can’t be sure everyone’s going to repay their debts on time—it puts them at risk of having to take on other people’s debts as well as their own.
(Shortform note: In the time since the publication of Poor Economics, the microfinance industry has grown considerably, and group-lending is no longer the only way MFIs lend to the poor. Studies have shown, in fact, that when MFIs offer individual loans, they attract more new borrowers. This indicates that potential borrowers are indeed, as Duflo and Banerjee suggest, reluctant to join a group to get a loan.)
2. MFIs don’t offer flexibility in how their loans are repaid. They impose a strict repayment schedule, typically demanding that regular payments are made by the borrowing group on a weekly basis, write Duflo and Banerjee. This, again, is good for the MFI, but discourages the poor from borrowing money if they feel unsure about when they can start paying it back. For instance, if a laborer is injured, she may be unable to get back to work and earn money for a long time. Duflo and Banerjee say it also discourages people from taking larger loans that would bring more benefits but would take longer to repay—for example, someone might want to buy a cart to sell fruit, but can only afford to borrow enough money to rent the cart for the day to make the weekly payments.
(Shortform note: MFIs have become notorious for their inflexible repayment structures. Borrowers are often subjected to public shaming and humiliation for missing payments or defaulting and suffer severe psychological stress.)
For these reasons, the authors find that the poor often avoid using MFIs to cover important expenses. Instead, they prefer to borrow from family and friends because of the flexibility they have in repaying those loans. Given this lending landscape, the poor have difficulty borrowing enough money to make significant changes in their lives. So, there’s still work to be done in figuring out how to get the poor enough credit to improve their lot.
Updated Information on Microfinance
Since Duflo and Banerjee published Poor Economics in 2011, the microfinance industry has continued to receive significant investments from government aid agencies, commercial banks, nonprofits, and investment firms. However, recent studies of the industry confirm Banerjee and Duflo’s view that MFIs don’t improve the lives of the poor as much as its advocates may have hoped.
The original intention of the microfinance model was to increase the poor’s access to credit. However, in many locations, the industry has now become characterized by predatory lending practices that severely impact the well-being of borrowers. In Sri Lanka, for instance, around 200 women who owed money to an MFI committed suicide within a three year period because of their debts. In other areas of the world, it’s common for borrowers to lose their homes to MFIs or be wanted by the police for owing even small sums of money to these institutions.
Even where MFIs are treating borrowers better, they’ve still made little progress in improving the lives of the poor beyond the short term. A recent study found that, while microfinance loans helped improve a poor household’s conditions in the short term—by increasing income and improving health—they had no statistically significant long-term effects.
The Poor Rarely Save for the Future
Duflo and Banerjee find that, even on their meager incomes, the poor don’t save as much money as they could. The evidence suggests this is true whether the poor have access to formal savings accounts or not. The two main reasons the authors find for this inability to save are:
1. Setting aside money requires self-control and decisiveness—the poor struggle with this because of their stressful lives. Stress, the authors point out, damages our ability to make decisions and exercise self-control. Because the poor always live under significant stress—they endure a lot of risk and barely have enough resources to cover daily needs—their brains can’t easily control impulses and plan for the long-term.
(Shortform note: Studies confirm the authors’ point about poverty’s effect on self-control. Researchers suggest that giving the poor money or other assets improves their ability to regulate their decisions and save for the future.)
2. Setting aside money requires feeling hopeful about the future, but the poor often feel hopeless because the possibility of a better future seems unrealistic. Too often, the authors find, the poor’s best efforts to save for the future are negated by unexpected health expenses, crop losses, or other disasters. As a result, the poor rarely believe they’ll reach any goal they hope to save for.
(Shortform note: Hope has been demonstrated to increase savings rates. Hope enables people to focus on the future, making it easier for them to take actions now that will improve that future.)
These reasons are primarily internal and psychological, but the authors see them as nonetheless relevant to explaining why the poor don’t set aside enough money to ensure more financial stability in the future. Policymakers need to account for this if they hope to increase savings rates among the poor.
(Shortform note: Affecting the way the poor think about savings may be as simple as giving them a lockbox. A recent study of poor small-business owners in Malawi demonstrated that poor entrepreneurs given lockboxes saved more money than those who weren’t given any. In addition, those with lockboxes ended up spending more money on school-related expenses, giving gifts, lending money to friends and family, and giving credit to their customers. The study suggests that even simple, affordable interventions can make a difference in the savings and spending habits of the poor.)
Why Do They Run Businesses?
According to the authors, many poor people run their own businesses. Most work in agriculture as fruit vendors or farmers, for instance. Many westerners see this as evidence of a natural entrepreneurial spirit, but Banerjee and Duflo disagree. They’ve found that the poor generally run businesses only because they have no other options: The job market has failed them.
In their research, Duflo and Banerjee noticed that the businesses of the poor are typically small and unprofitable, even though they have a high marginal return. This means that it would take little money to grow their businesses. Despite the high marginal returns, the poor generally choose not to invest in their businesses.
As the authors see it, this seems to be because the poor don’t want to run a business—they don’t want to be entrepreneurs. Instead, in all the countries Duflo and Banerjee examined, the poor almost universally aspire for their children to get the only kind of stable job they know of: a government job. The small businesses they run are just a means of getting by until that happens.
So, instead of celebrating the supposed entrepreneurial spirit of the world’s poor, development economists need to figure out better ways to get the poor stable jobs, assert Duflo and Banerjee.
The Labor Market in the Developing World
Analysis of the labor market in the developing world confirms that a lack of stable jobs is the predominant reason for the high rates of entrepreneurship among the poor. Studies have found that between one half and two-thirds of self-employment in the developing world is due to having no other options.
The reasons for this are complex, but one consistent factor is that wage employment in the developing world largely consists of informal jobs. These jobs entail no contractual agreement between a worker and employer and tend to have low, inconsistent wages. Moreover, most of these jobs in developing countries are in subsistence agriculture—an inherently unstable and low-paying sector. In the face of this instability, the poor simply work for themselves in order to make something when they otherwise couldn’t.
There’s some indication that the job market doesn’t improve significantly as economies grow. Instead, in places such as South Asia and Africa, informal rural farming jobs often give way to informal urban jobs—as street vendors or casual construction laborers, for instance.
Increasing formal employment opportunities is an important task of development economists. Two strategies that have shown promise are:
Improving roads and other infrastructure. Such improvements can make it easier for companies to establish factories in poor towns and cities—these are among the most stable kinds of formal jobs.
Streamlining business regulations. When governments make it easier for businesses to register and open, more formal employment opportunities result.
Four Key Lessons About Improving the Lives of the Poor
Banerjee and Duflo set out to examine the lives of the poor as they actually are. They see several key lessons emerging from this study. In this section we’ll share four of those lessons, as well as the authors’ suggestions for addressing them.
The Poor Need More Information
When it comes to personal or economic decisions, the poor often simply don’t have enough information to make good choices, believe Duflo and Banerjee. To get more information to the poor, it should be delivered in enjoyable formats, such as through song or a funny advertisement, and it should be delivered by sources the poor find credible, like the press or local, trusted people.
(Shortform note: A recent study shows that, in trying to get information to the poor, policymakers should carefully consider the message, the medium, and the messenger. Duflo and a team of researchers conducted a randomized controlled trial in India and the United States to determine the effectiveness of using social media to deliver information directly to the poor. They found that messaging delivered via Facebook worked best when it was presented in simple terms by a celebrity—not by an official appointed as an expert.)
The Poor Need Easier Choices
Wealthy people living in wealthy countries have many difficult decisions made for them, which benefits them because they then don’t have the opportunity to make poor decisions, claim Duflo and Banerjee. Their water is purified, their healthcare providers are highly trained and closely regulated, their foods are fortified with key nutrients and regulated to ensure they’re safe, their assets are protected, they have money set aside for the future through Social Security or other financial institutions, and so on.
The poor have none of these things, write the authors. They have to purify their own water, figure out ways to save for the future outside of typical financial institutions, make complicated decisions about their healthcare, and more. Such decisions are difficult for anyone to make, but especially for the poor, who feel the constant pressure of a lack of resources, information, and basic economic security.
Duflo and Banerjee suggest that a practical way to alleviate this pressure is to make these decisions easier for the poor. One way to do this is by ensuring default options are good. If tasty cereals are fortified and made readily available, it’ll be easier for the poor to get critical micronutrients into their diet. Referring to Richard Thaler and Cass Sunstein’s book, Nudge, Banerjee and Duflo propose a second way to make good decisions easier for the poor: Nudge them toward the right choices. For example, savings accounts could be structured to encourage deposits and discourage withdrawals.
Studies Cited in Support of Nudges Can’t Be Reproduced
Duflo and Banerjee suggest that nudges are an effective way to get the poor to make better choices. Nudges have been proposed in the field of behavioral science as an effective way to lead people to unconsciously make better choices.
Nudge Theory is founded on the idea that we make decisions on the basis of rules of thumb and biases that we don’t account for. By presenting choices in ways that exploit these unconscious biases (in other words, by nudging), policymakers can improve people’s lives without restricting their freedom.
The entire field of behavioral science has come under scrutiny since the publication of Duflo and Banerjee’s book, however. Researchers found that a majority of the results of studies in the behavioral sciences can’t be reproduced. When the results of a study can’t be reproduced, it undermines the credibility of its conclusions. Nudge theory was one of the areas of behavioral science most undermined by this replication crisis.
Perhaps, then, the decisions of the poor are not as likely to be improved by nudges as Duflo and Banerjee suggest. While this undermines some of their advice for dealing with the factors affecting poverty, it doesn’t undermine the authors’ analysis of those factors.
The Poor Need Innovators and Governments to Build Better Financial Services
Duflo and Banerjee argue that governments, charitable organizations, and private financial groups can and should develop innovative financial services for the poor. Where electronic money transfers have become available, for instance, the poor have more access to funding. Though microcredit financing has its limitations, it has made credit more available to even the poorest people.
In certain situations, the authors believe governments should step in with subsidies or other financial incentives to help provide adequate services to the poor. This applies in cases where free market forces don’t support the development of services the poor need. Health insurance options for the poor, for example, tend to cover only catastrophic events and not preventive care. Duflo and Banerjee argue that in cases like this, the benefits of offering free goods and services—such as bleach or routine check-ups—often outweigh the costs.
Financial Inclusion Since the Publication of Poor Economics
Financial inclusion is the availability and accessibility of financial services. Recent research has confirmed that increasing financial inclusion significantly reduces poverty rates and income inequality.
In the time since the publication of Poor Economics, digital financial services have become more available—1.2 billion adults worldwide gained access to these services between 2011 and 2017. With access to digital technology, people can transition from solely relying on cash transactions to relying on other kinds of financial services.
Increasing financial inclusion requires a concerted effort of numerous specialists and regulators to ensure that access is broad and equitable.
The Poor Need Improved Expectations
Expectations can become self-fulfilling, write Duflo and Banerjee. Accordingly, when parents, teachers, politicians, or the poor themselves expect failure, they get failure. However, policymakers can take measures to change expectations. For instance, when women were given leadership roles in rural India both men and women began to see women as potential leaders.
Affecting the Perception of Women as Leaders in Rural India
Banerjee and Duflo are referring to a quota system, established in 1993 in India, that mandated that a third of village council leader positions be reserved for women. Village councils are responsible for many issues related to local infrastructure and program implementation. Researchers studying the effects of this program on the public perception of women as leaders found that, while individuals still preferred leaders of the same gender (men preferred men, for instance), more individuals recognized women as effective leaders, and more individuals voted for women in open elections. Thus, the program indicated that changing expectations may at times simply be a matter of changing policies.
Duflo and Banerjee argue that giving things away for free can help improve people’s expectations for their own lives. In their view, a change in circumstances for the better tends to give people hope for the future. Renewed hope can change the way people think about the present, which initiates a virtuous cycle.
Giving Things for Free Improves the Lives of the Poor
One program testing the effectiveness of giving things away for free showed significant improvements in the lives of the poor. This Graduation program was implemented in seven countries and included the following components:
The gift of a free productive asset, such as a cow.
Free technical training to manage that asset.
Regular gifts of cash or food support for a few months to a year.
Free access to a savings account.
Free coaching and regular home visits for accountability.
Free health and life-skills training.
The results of the Graduation program were clear: Those who received these free things increased their consumption, saved more money, and were healthier and happier even a year after the program ended. What’s more, the long-term financial benefits of the program were one to four times greater than the upfront costs.
Programs like this suggest that giving things away for free can have a lasting positive impact on the well-being of the poor.
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