Book review: 'Poor Economics - Rethinking Poverty and the Ways to End It'

How people respond to incentives is really at the heart of all economics. Be it the question of what’s wrong with investment banking in the west or why the poor of the world behave the way they do.

“Are there really a billion hungry people?” ask Abhijit V Banerjee and Esther Duflo in the second chapter of their book Poor Economics - Rethinking Poverty and the Ways to End It.

While the aid wallahs might like to put out these big round numbers in order to continue to attract aid from the richer nations, the answer to this question is not so straight forward.

As the authors write, “In Udaipur, for example, we find that the typical poor household could spend up to 30% more on food than it actually does if it completely cuts expenditures on alcohol, tobacco and festivals. The poor seem to have many choices and they don’t elect to spend as much as they can on food.”

Also, even when the poor spends more money on food they don’t spend it to maximise the intake of calories or micronutrients. “When very poor people get a chance to spend a little bit more on food, they don’t put everything into getting more calories. Instead, they buy better-tasting more expensive calories,” the authors point out.

In two randomly selected regions in China, poor households were offered a subsidy on their staple food (rice in one region and wheat noodles in another). And the results were surprising. “We usually expect that when the price of something goes down, people buy more of it. The opposite happened. Households that received subsidies for wheat and rice consumed less of those two items and ate more shrimp and meat, even though their staples now cost less. Remarkably, overall, the calorie intake of those who received the subsidy did not increase (and may even have decreased), despite the fact that their purchasing power had increased,” write the authors.

In fact, things that make life less boring are a priority. “This may be television, or a little bit of something to eat or just a sugary cup of tea,” the authors write. Also, the poor in countries like India and Mexico, which have a large domestic economy where a lot of consumer goods are available, tend to spend the lowest on food.

As Banerjee and Duflo explain, “Every village in India has at least one small shop, usually more, with shampoo sold in individual sachets, cigarettes by the stick, very cheap combos, pens, toys, or candles, whereas in a country like Papua New Guinea, where the share of food in the household budget is above 70% (it is 50 % in India), there may be fewer things available to the poor.”

The book is full of such insights about the poor. The authors talk about fruit sellers in the city of Chennai who buy Rs1,000 worth of produce every day from a wholesaler on credit, and at the end of the day pay an interest of 4.69% when they repay. This works out to an annual rate of interest of a whopping 1.8 billion %.

Of course, a situation like this is ideal for microfinance. “Consider the fruit sellers: Imagine they can get Rs1,000 loan, even at a hefty rate of, say, 10% monthly. In one month, they would each have saved Rs4,000 in interest paid to the wholesaler, more than enough to repay the microfinance agency. They could grow their business and escape poverty in a matter of months, at least in theory,” the authors point out.

Also, till very recently microfinance loans were easily available still people continued to borrow from the money lender at extremely high rates of interest. The authors give the example of a slum in Hyderabad where MFIs were providing loans. Around one fourth of the families living there borrowed from MFIs whereas nearly half borrowed from moneylenders, despite MFIs offering lower rates of interest.

So what was at work here? MFIs follow a standard model where weekly repayments start a week after the loan is disbursed, which is not ideal for people who want the money right now but aren’t very sure of when they will be able to start repaying it. “Money lenders will allow their borrowers to choose how they borrow and the way they repay - some repay once a week, but others repay whenever they have money in hand. Some repay only the interest, until they are ready to repay the entire principal,” the authors point out.

The book is full of such interesting insights and is worth reading for anyone who really wants to know why the poor of the world behave the way they do. And things are not always as bad as they are actually made out to be.

— The writer can be reached at chandniburman@yahoo.com