Poor Economics by Abhijit Banerjee and Esther Duflo
Date finished: 2/29/12
How I found this book: I heard about this book several months ago in a Planet Money podcast from NPR.
Poor Economics doesn’t fit under any one country, but it’s definitely a very global book and it impressed me so much that had to share it here anyway. The basic premise of the book is that the effectiveness of programs to aid the poor can and should be rigourously tested, when possible via a randomized controlled study. As a science-y person, I appreciate that approach. The authors place a big emphasis on the idea that there is no magic bullet solution to poverty, instead there are many approaches that are moderately effective.
Most importantly, I feel like from reading this book I have gained a substantially improved understanding of what it means to be extremely poor, living on a dollar a day*. Poor Economics is short on personal anecdotes, though it does occasionally use specific people’s stories to illustrate particular points. Instead, the authors identify the unique challenges and incentives that the extremely poor face and make sense of the decision-making processes observed in their studies. One interesting example was the purchase of a television. Many poor households who lack in other basic household needs manage to find the funds to purchase a television. From a relatively well-off perspective, that decision seems crazy. How can you buy a television when you can’t afford what we would consider to be basic medical care? The book puts this into perspective: if you’re someone who only is able to find work intermittently and therefore have a fair amount of time on your hands and have very little access to or money for other forms of entertainment, it suddenly is more understandable that you would put a high priority on owning a television.
There are so many interesting insights that this book makes that I think I will have to settle for discussing a single chapter. While I am more skeptical of the author’s conclusions in some chapters than others, the book covers many interesting topics including health, savings, entrepreneurship, population control and more. I will talk here about the chapter on microfinance, the idea that lending out small quantities of money to groups of borrowers can help people to improve their lives. The first thing that the authors point out in this chapter is that the innovation of microfinance does not lie in lending money to very poor people, as I had always assumed. In fact, poor people have plenty of access to money-lenders, the problem is that interest rates are very high. It would be easy to conclude that the interest rates are very high because the money lenders are exploiting the poor. But if that were the case, why wouldn’t some money-lender lower their rates and outcompete the others? Interest rates for the poor are high, not because of exploitation or even because default rates are high, but rather because the costs associated with lending to the very poor are also high. The money lender has to invest quite a bit of time in assessing and keeping track of those people to whom they lend money. The innovation of microfinance, then, is to lend to people in groups which are mutually responsible to each other and thus the members of this group take on the burden of monitoring each other.
So, does microfinance work? The authors were part of a randomized controlled study which compared neighborhoods in which microfinance was offered and neighborhoods where it was not. They found that families in neighborhoods where microfinance was offered were about 2% more likely to have started a new business and were also more likely to have purchased large durable goods like a bicycle or a refrigerator. The authors concluded that, yes, microfinance works. It has a moderate positive effect. Interestingly, many of the large microfinance organizations rejected their work because it didn’t live up to the large promises many of these organizations were making about how beneficial microfinance is. The message here is the same as for many instances discussed in the book- this is an intervention that works, but it won’t solve all problems.
The book also examines the limitations of microfinance. In areas where microfinance was available, only about a quarter of loans were through microfinance while half of loans were through traditional money-lenders at higher rates. Why? There are many types of loans that microfinance is not conducive to. Microfinance loans are very small, so if you want to expand your business beyond a certain scale, they won’t help you. Microfinance also requires that borrows start repaying loans very quickly. So, if you need to borrow money for a health expense, microfinance might be unrealistic. Microfinance is a great solution for some types of loans, but there are still unmet needs for which alternative solutions are still needed.
I keep going on and on about this but there are so many insightful findings here. Read this book!
*Whenever I’ve heard those dollar a day statistics, I always thought, “Wow, that’s bad, but at least a dollar is worth more there. It’s not as hard as living on a dollar a day in the U.S. would be.” Turns out, that statistic is corrected for purchasing power parity. So, it is in fact exactly as hard as living on a dollar a day in the U.S. would be.