Poor Economics

by Abhijit Banerjee

  The bigger point is that a little bit of hope and some reassurance and comfort can be a powerful incentive. It is easy for those of us who have enough, living a secure life, structured by goals that we can reasonably confidently aspire to achieve (that new sofa, the 50-inch flat screen, that second car) and institutions designed to help us get there (savings accounts, pension programs, home-equity loans) to assume, like the Victorians, that motivation and discipline are intrinsic. As a result, there are always worries about being overindulgent to the slothful poor. Our contention is that for the most part, the problem is the opposite: It is too hard to stay motivated when everything you want looks impossibly far away. Moving the goalposts closer may be just what the poor need to start running toward them.

  9

  Reluctant Entrepreneurs

  A businessman sitting next to us on a plane many years ago described how, when he returned to India in the mid-1970s after completing his MBA in the United States, his uncle had taken him out for a lesson in true entrepreneurship. It was early one morning when he and his uncle headed for the Bombay (as Mumbai was then called) Stock Exchange. But instead of going into the modern tower that houses the exchange, his uncle wanted him to observe four women who were sitting on the sidewalk, facing the road in front of the exchange. The aspiring businessman and his uncle stood for a few moments watching them. The women mostly did nothing. But occasionally, when the traffic stopped, they would get up, scrape something off the road, and put it in plastic carrier bags next to them, before returning to their seats. After this happened several times, the uncle asked him if he understood their business model. He confessed to be baffled. So the uncle had to explain: Every morning before dawn the women went to the beach, where they collected wet sea sand. They then laid it evenly on the street before the real traffic began. When the cars started driving over the sand, the heat from their wheels dried it. All they had to do then was occasionally to scrape off the top layer of sand, now dry. By nine or ten, they had a quantity of dry sand, which they brought back to the slum to sell in small packets made from discarded newspapers: The local women used the dry sand to scrub their dishes. This, the uncle reckoned, was true entrepreneurship: If you have very little, use your ingenuity to create something out of nothing.

  Women from slums who manage to make a living, quite literally, from the wheels of Bombay’s commerce epitomize the incredible spirit of innovation and entrepreneurship the poor often display. This book could easily be filled with stories of creativity and resilience among owners of small-scale enterprises. Such images have been a powerful motivation for the recent microfinance and “social business” movement, which starts from the premise that the poor are natural-born entrepreneurs, and we can eradicate poverty by giving them the right environment and a little bit of help getting started. In the words of John Hatch, the CEO of FINCA, one of the largest microfinance institutions in the world: “Give poor communities the opportunities, and get out of the way.”

  Yet there are some perhaps surprising instances when, after you have gotten out of the way, the poor do not seem so ready to roll. Since 2007, we have been working with Al Amana, one of Morocco’s largest MFIs, to evaluate the impact of access to microcredit in rural communities that had previously been completely excluded from formal financial sources. After about two years, it became evident that Al Amana was not getting as many clients in the villages as had been anticipated. Despite the lack of alternatives, less than one in six eligible families was interested in a loan. To try to understand why, we went with some Al Amana staff to interview a few families in a village called Hafret Ben Tayeb, where no one had borrowed. We were received by Allal Ben Sedan, the father of three sons and two daughters, all adults. He had four cows, one donkey, and eighty olive trees. One of his sons worked in the army; another tended to the animals; the third was mostly idle (his main activity was harvesting snails when they were in season). We asked Ben Sedan whether he would want to take a loan to buy some more cows, which his idle son could take care of. He explained that his field was too small—if he bought more cows they would have nowhere to graze. Before leaving, we asked him if there was anything else he could do with a loan. He replied, “No, nothing. We have enough. We have cows, we sell them, we sell the olives. That is enough for our family.”

  A few days later, we met Fouad Abdelmoumni, the founder (and then CEO) of Al Amana, a man of great warmth and intelligence, who in a previous life as an activist had spent years in jail as a political prisoner and was entirely devoted to improving the lives of the poor. We discussed the surprisingly low demand for microcredit. In particular, we went back to the story of Ben Sedan, who was convinced that he had no use for more money. Fouad drew up a clearly feasible business plan for him. He could take a loan, build a stable, and buy four young cows. They would not need to graze in a field: They could be fed in the stable. Within eight months, he could sell the cows for a hefty profit. Fouad was persuaded that if someone explained this to him, Ben Sedan would see the wisdom of this plan and take out a loan.

  We were struck by the contrast between Fouad’s enthusiasm and Ben Sedan’s insistence that his family did not need anything. Yet Ben Sedan was not at all resigned to remaining poor: He was very proud of his son, who had been trained as a nurse and worked as a paramedic in the army. His son, he thought, had a real chance at a better life. So was Fouad right that Ben Sedan just needed to be led to a business plan? Or was Ben Sedan, who, after all, had been in the business of raising cows for most of his adult life, telling us something important?

  Muhammad Yunus, founder of the world-famous Grameen Bank, often describes the poor as natural entrepreneurs. Combined with the late business guru C. K. Prahalad’s exhortation to businessmen to focus more on what he called the “bottom of the pyramid,”1 the idea of the entrepreneurial poor is helping to secure a space within the overall anti-poverty policy discourse where big business and high finance feel comfortable getting involved. The traditional strategies of public action are being supplemented by private actions, often taken by some of the leaders of the corporate world (for example, Pierre Omidyar of eBay), directed at helping the poor realize their true potential as entrepreneurs.

  The basic premise of Yunus’s view of the world, shared by many in the microfinance movement, is that everyone has a shot at being a successful entrepreneur. More specifically, there are two distinct reasons the poor may be particularly likely to find amazing opportunities. First, they haven’t been given a chance, so their ideas are probably fresher and less likely to have been tried already. Second, the market so far has mostly ignored the bottom of the pyramid. As a result, it is argued, innovations that better the lives of the poor have to be the low-hanging fruit, and who better than the poor themselves to think of what they could be?

  CAPITALISTS WITHOUT CAPITAL

  Indeed, every self-respecting MFI has a Web site with a number of stories of successful microfinance clients who took advantage of an unusual opportunity to make a fortune. They are real: We have met several of those clients. In Guntur, in Andhra Pradesh, we met a client of Spandana who had built a very successful business collecting trash and sorting it. She started as a trash collector, which is pretty much as low as you can go in the Indian social and economic hierarchy. With her first loan from Spandana, she just paid back the loan she had from a moneylender, with its crippling interest rate. She knew that the businesses that bought the trash from her sorted it before selling it to recyclers—there would be bits of metal and tungsten from the filaments of used lightbulbs, plastics, organic matter for composting, and so forth, each of which went to a different recycler. With the breathing space that the first loan bought her, she decided to do the sorting herself to make some extra money. With her second loan and the savings from the first, she bought a cart, which helped her collect more trash, and because there was now more sorting to be done, she somehow managed to get her husband, who used to spend most of his time drinking, to start working with her. Together they were
making significantly more money, and after receiving the third loan, they started buying trash from others. By the time we met her, she was at the helm of a large network of trash collectors, no longer a collector herself but an organizer of trash collection. Her husband, too, was working full-time by then: We saw him pounding away on a piece of metal, looking sober but a trifle glum.

  MFIs advertise the stories of their most successful borrowers, but there are also entrepreneurs who succeed even when they have no access to microfinance. In 1982, Xu Aihua was one of the best middle-school students in her village, in the Shaoxing region of Zhejiang Province in China. Her parents were peasants and, like almost everyone else, had very little disposable cash. She was so bright, however, that the village decided to send her for a year to the local school of fashion design (whatever that meant, exactly, since everyone still wore Mao suits). The idea was that she would eventually take a leadership role in the local town and village enterprise that had just been set up (these were the early years of Chinese liberalization). But when she came back after her training, the local elders got cold feet—she was a girl, after all, not yet twenty. So she was sent unceremoniously home, jobless.

  Xu Aihua had no intention of sitting idle. She decided that she had to do something, but her parents were too poor to help. So she borrowed a megaphone and went around the village offering to teach young girls how to make garments for a fee of 15 yuan ($13 USD PPP). She recruited 100 students, and with the money that she had just collected, she bought a secondhand sewing machine and some surplus fabric from the local state-owned factories, and started teaching. At the end of the course, she kept her eight best students and launched a business. The women would arrive every morning with their sewing machines on their back (they each got their parents to buy them one), then start cutting and sewing. They made uniforms for the local factory workers. At first they worked at Xu Aihua’s home, but as the business expanded and Xu Aihua trained and hired more people, they moved to a building that she rented from the village government.

  By 1991, she had saved so much from the profits of her business that she could afford to buy sixty automatic sewing machines for 54,000 yuan ($27,600 USD PPP). Her total fixed capital had grown more than a hundredfold in eight years. That is 80 percent per year. Even if we allow for an inflation rate of 10 percent per year, a real growth rate, net of inflation, of more than 70 percent a year is impressive. By this time, she was an established entrepreneur. Export contracts arrived soon after, and she now sells to Macy’s, Benetton, JC Penney, and other major retailers. In 2008, she made her first investment in real estate of 20 million yuan ($4.4 million USD), because, as she says, she had some cash sitting around, and most other people did not.

  Xu Aihua is not a typical case, of course: She was especially bright, and her village sent her to school. However, there is no dearth of success stories of entrepreneurship among the poor. And there is certainly no shortage of entrepreneurs. On average in our eighteen-country data set, 50 percent of the extremely poor in urban areas (those who live on under 99 cents a day) operate a nonagricultural business. Even among the rural extremely poor, many—from 7 percent in Udaipur to up to 50 percent in Ecuador (and 20 percent on average)—operate a nonagricultural business, in addition to the large number who run a farm. The number of entrepreneurs is roughly the same among the somewhat less poor in the same countries. Compare this to the Organization for Economic Co-operation and Development (OECD) average: 12 percent of those in the workforce describe themselves as self-employed. Purely in terms of stated occupations, most income groups in poor countries seem to be more entrepreneurial than their counterparts in the developed world—the poor no less so than others, an observation that inspired Harvard Business School professor Tarun Khanna’s book, Billions of Entrepreneurs.2

  The sheer number of business owners among the poor is impressive. After all, everything seems to militate against the poor being entrepreneurs. They have less capital of their own (almost by definition) and, as we saw in Chapters 6 and 7, little access to formal insurance, banks, and other sources of inexpensive finance. Moneylenders, who are the main source of untied financing (trade credit is an example of tied financing because it is tied to buying something and therefore cannot be used for paying wages) for those who cannot borrow enough from friends or family, charge interest rates of 4 percent a month or more. As a result, the poor are less able to make the investments needed to run a proper business and are more vulnerable to any additional risk that comes from the business itself. The very fact that they are still about as likely to go into business as their richer counterparts is often interpreted as a sign of their entrepreneurial spirit.

  The fact that even after paying very high interest rates, the poor still manage to make enough money to repay their loans (we have seen that it is very rare for them to default) must mean that they are earning even more money per rupee invested. Otherwise, they would not borrow. This implies that the rate of return on the cash invested in their businesses is remarkably high. Fifty percent a year, which is what many of them pay, is quite a bit more than you can get by investing in the Dow Jones (especially these days, but even the long-term average return is about 9 percent a year).

  Of course, not everyone borrows. Perhaps only the few entrepreneurs who have high returns in their businesses borrow, and everyone else has very low returns. However, a project conducted in Sri Lanka suggests otherwise. A number of owners of tiny businesses—retail shops, repair shops, lace makers, and the like—were invited to participate in a lottery. The winners (two-thirds of them) would get a grant for their business, worth either 10,000 rupees ($250 USD PPP) or 20,000 rupees ($500 USD PPP).3

  The grants were tiny by global standards but were reasonably large as far as these businesses were concerned; for many, $250 was the entire capital stock they had started from. The lottery winners of the grants had no trouble putting the money to good use. The return on the first $250 was over 60 percent a year for the average business. Subsequently, the same exercise was repeated with small businesses in Mexico.4 The returns found in that experiment were even higher, reaching 10–15 percent per month.

  Another program, conceived by BRAC, a large MFI in Bangladesh, and now imitated in a number of developing countries, shows that when given the right kind of help, even the poorest of the poor have the ability to succeed in running small businesses, and these small businesses can change their lives. The program targets those identified by their fellow villagers as the poorest among them: Many of them live purely on others’ generosity. MFIs typically do not lend to these clients, who are deemed incapable of running a business and regularly reimbursing their loan. To get them started, BRAC designed a program in which they would be given an asset (a pair of cows, a few goats, a sewing machine, and so on), a small financial allowance for a few months (to serve as working capital and to ensure they would not be tempted to liquidate the asset), and a lot of hand-holding: regular meetings, literacy classes, encouragement to save a little bit every week. Variants of this program are currently being evaluated in six countries, using randomized control trials (RCTs). We were involved in one of these studies, in partnership with Bandhan, an MFI in West Bengal. We visited households before the program was started and heard, from each of the families that were selected for the program, stories of crisis and desperation: A husband was a drunkard and regularly beat his wife; another died in an accident, leaving a young family behind; a widow was abandoned by her children; and so forth. But after two years, the difference is impressive: Compared to other extremely poor households that were not selected to participate, the beneficiaries have more animals and other business assets; they earn more from livestock and other animals, but they also work longer hours and earn more from working for others. Their total monthly spending is up by 10 percent; food expenditure is what increases the most, and they are less likely to complain that they do not have enough to eat. Even more impressive, their outlook on life seems to have changed. The way they descr
ibe their own health, happiness, and economic status is much more positive. They save more and are also more likely to say they are willing to borrow—they are now eligible to borrow from the MFI—and they feel confident managing assets.

  Of course, this has not made them rich by any standards—they are only 10 percent richer after two years in terms of consumption, which means they are still poor. But the initial gift and support seem to have started a virtuous circle: Given the chance, it seems that even people who had been hit by extreme hardship were able to take charge of their lives and start their exit out of extreme poverty.5

  THE BUSINESSES OF THE POOR

  Seeing results like these, it is not difficult to share the enthusiasm of Muhammad Yunus or Fouad Abdelmoumni for the potential of investing in the poor: So many have managed to be entrepreneurs in the face of so much adversity, and have made so much out of so little. There are, however, two troubling shadows in this otherwise sunny picture. First, while many of the poor operate businesses, they mainly operate tiny businesses. And second, these tiny businesses are, for the most part, making very little money.

  Very Small and Unprofitable Businesses