The Economics of Poverty: Why the Poor Stay Poor
Living in Rural East Africa forces you to question a lot of your assumptions - none more so than economic assumptions. Despite technically working in Financial Technology, I've largely avoided economic study up until now. However, some of what I've seen gives me perspective others may lack - I believe a new economic model is needed to account for the differences between Western and Rural East African psychology and (hopefully) shape effective aid policy.
The basic unit of Western/classical economics is the rational, self-maximizing individual. This is a simplification - if it were 100% accurate, no one would use casinos. However, it kind of works in the West... but doesn't seem to apply that well in East Africa. Here, the basic economic unit is the group - the extended family or neighborhood is typical. Hardships are shared; it's quite common for neighbors to ask each other for money in times of need (or just steal from each other). Good fortune/wealth is most often treated as the ability to alleviate hardships (such as by employing neighbors); the social network effects trend towards all individuals having the same average net worth/income.
Some anecdotal statements that I've heard in this context:
1. "The more successful I am, the larger my family becomes" (I'm expected to support a larger group of people)
2. "I prefer investing in land to investing in businesses, animals or other physical items - my family doesn't expect me to sell the land in hard times, so I can actually hold onto it."
3. "Children are investments, the idea is to have many of them and hope that one becomes rich enough to support the whole family."
4. "If we deliver fertilizer several months before it is needed, people are far more likely to sell it in order to support a community member/pay hospital bills/etc. The best strategy is to deliver items right before they are needed."
5. "Kenyan politicians may be corrupt as hell, but they don't keep all the money they steal. When a politician's helicopter lands, people flock to it; they often just give out cash directly to their voters. In one sense they're buying votes; in another they're justifying corruption by supporting their communities."
While I'm no economics expert, I do like the economic theory proposed by Eliyahu Goldratt in "The Goal". His economic theory was developed for businesses/factories but can be reinterpreted at the individual level. He classifies money into three categories:
1. The immediate social network drains all "Cash on Hand" quite quickly. Hardships are shared among a large network, so if any one member of that network obtains liquid income it will quickly evaporate. This money dissipated by the social network isn't invested, it's purely spent in the form of expenses like funeral/wedding costs, hospital fees, or school fees*. This is a large part of why poor people stay poor - very little "cash on hand" can be transformed into "investments".
2. Contrary to propaganda about poor people wasting money, Rural East Africans (especially women) tend to be quite savvy about investments and spending money with an eye towards future profit. Indeed, only invested money is "safe" from the immediate social network; investments in businesses, land, livestock or agricultural inputs are generally considered a wise idea. However, by their very nature these investments are difficult to liquidate in the event of an emergency, leaving people "land rich but cash poor" and vulnerable to unexpected expenses.
3. Earned income can be either in the form of cash or physical objects, but either is treated as "cash on hand". Income tends to be seasonal (based on harvests) and difficult to predict.
4. Expenses in the East African context are disproportionately large; for a farmer at the poverty line (making $700/year), a $30 doctor visit is quite a large bill. Even spread across an entire social network, expenses are still disproportionate to both "cash on hand" and "investments".
5. Both income and expenses are subject to a very high degree of uncertainty; the social network effectively acts like an insurance policy. Social network spending helps to control risk by spreading it across a large group of people.
It's worth noting that the Western economic model makes it possible for American cities to have billionaires living next to homeless people - I'm not going to make a value judgement that the Western economic model is better, just different. The Rural East African model is frustrating on paper (no one ever becomes wealthy in this model) but does a fairly good job of keeping individual community members alive - if anything, it's better for survival of the group than the Western individualistic model. Unfortunately, the Rural East African model can keep a group alive but prevents any one member from thriving and makes it difficult to effect long-term changes.
In a Western context, raising someone's income level/"cash on hand" level via direct cash injection would be sufficient to raise their standard of living.
Income -> Individual Cash on Hand -> Individual Investment -> Future Profit
However, in a heavily networked context, the majority of cash flow is more like:
Income -> Individual Cash on Hand -> Hardship in Social Network -> Expenses of Social Network -> No Future Profit
Some of this money is invested, but the overall trend is toward expenses rather than investments.
So what actions are appropriate within the Rural East African economic model? The key insight from my personal experience is counter-intuitive:
Minimized Liquidity.
One Acre Fund's business model incorporates this by using asset-based agricultural inputs delivered just before they are to be used, maximizing the chances that these inputs will be used as investments rather than liquid cash. Minimized liquidity can be frustrating for customers, but accounts for a lot of OAF's success at driving long-term change. With minimal liquid cash, the social network has as little chance as possible to dissipate the money. OAF buttresses this lack of liquidity through formal insurance programs (crop failure insurance, funeral insurance, etc.).
This insight isn’t obvious for Western economics, which explains why a lot of Western economic models fall apart under East African conditions. Basically: liquid cash injected in the East African context can never drive long-term change. Even if cash is injected at massive scale (to thousands of people), the recipients’ social networks will often grow to accommodate and dissipate the new income. Only money in the form of investments (specifically investments that have local buy-in and training) can realistically yield future profit and drive long-term change. For understandable reasons, this sort of program is unpopular; depriving a social network of liquid cash makes everyone's life more precarious.
For aid organizations, this presents an ethical dilemma - if liquid cash is required to keep a child alive and an aid organization is only offering cash in the form of investments, then the child will die. Long-term change is diametrically opposed to social network survival needs; Western organizations operating in this context set ourselves up as the enemy. This makes aid work an impossible choice: either provide immediate relief at the cost of long-term change or long-term change at the cost of immediate relief.
TL;DR - effecting long-term change is HARD.
*School fees and other child-related costs would be classified as expenses in Goldratt's model, this is debatable though.
The basic unit of Western/classical economics is the rational, self-maximizing individual. This is a simplification - if it were 100% accurate, no one would use casinos. However, it kind of works in the West... but doesn't seem to apply that well in East Africa. Here, the basic economic unit is the group - the extended family or neighborhood is typical. Hardships are shared; it's quite common for neighbors to ask each other for money in times of need (or just steal from each other). Good fortune/wealth is most often treated as the ability to alleviate hardships (such as by employing neighbors); the social network effects trend towards all individuals having the same average net worth/income.
Some anecdotal statements that I've heard in this context:
1. "The more successful I am, the larger my family becomes" (I'm expected to support a larger group of people)
2. "I prefer investing in land to investing in businesses, animals or other physical items - my family doesn't expect me to sell the land in hard times, so I can actually hold onto it."
3. "Children are investments, the idea is to have many of them and hope that one becomes rich enough to support the whole family."
4. "If we deliver fertilizer several months before it is needed, people are far more likely to sell it in order to support a community member/pay hospital bills/etc. The best strategy is to deliver items right before they are needed."
5. "Kenyan politicians may be corrupt as hell, but they don't keep all the money they steal. When a politician's helicopter lands, people flock to it; they often just give out cash directly to their voters. In one sense they're buying votes; in another they're justifying corruption by supporting their communities."
While I'm no economics expert, I do like the economic theory proposed by Eliyahu Goldratt in "The Goal". His economic theory was developed for businesses/factories but can be reinterpreted at the individual level. He classifies money into three categories:
- Throughput: Money coming in/"Cash on Hand" (earnings in liquid currency, able to invest/spend at will)
- Inventory: "Invested Money" (in Goldratt's context money spent on machines/tooling/parts, but really any money that can't easily be converted to a different form and is expected to yield a future profit)
- Operational Expenses: money spent on things that are not investments, such as labor or rental costs - expenses don't directly yield any future profit.
1. The immediate social network drains all "Cash on Hand" quite quickly. Hardships are shared among a large network, so if any one member of that network obtains liquid income it will quickly evaporate. This money dissipated by the social network isn't invested, it's purely spent in the form of expenses like funeral/wedding costs, hospital fees, or school fees*. This is a large part of why poor people stay poor - very little "cash on hand" can be transformed into "investments".
2. Contrary to propaganda about poor people wasting money, Rural East Africans (especially women) tend to be quite savvy about investments and spending money with an eye towards future profit. Indeed, only invested money is "safe" from the immediate social network; investments in businesses, land, livestock or agricultural inputs are generally considered a wise idea. However, by their very nature these investments are difficult to liquidate in the event of an emergency, leaving people "land rich but cash poor" and vulnerable to unexpected expenses.
3. Earned income can be either in the form of cash or physical objects, but either is treated as "cash on hand". Income tends to be seasonal (based on harvests) and difficult to predict.
4. Expenses in the East African context are disproportionately large; for a farmer at the poverty line (making $700/year), a $30 doctor visit is quite a large bill. Even spread across an entire social network, expenses are still disproportionate to both "cash on hand" and "investments".
5. Both income and expenses are subject to a very high degree of uncertainty; the social network effectively acts like an insurance policy. Social network spending helps to control risk by spreading it across a large group of people.
It's worth noting that the Western economic model makes it possible for American cities to have billionaires living next to homeless people - I'm not going to make a value judgement that the Western economic model is better, just different. The Rural East African model is frustrating on paper (no one ever becomes wealthy in this model) but does a fairly good job of keeping individual community members alive - if anything, it's better for survival of the group than the Western individualistic model. Unfortunately, the Rural East African model can keep a group alive but prevents any one member from thriving and makes it difficult to effect long-term changes.
In a Western context, raising someone's income level/"cash on hand" level via direct cash injection would be sufficient to raise their standard of living.
Income -> Individual Cash on Hand -> Individual Investment -> Future Profit
However, in a heavily networked context, the majority of cash flow is more like:
Income -> Individual Cash on Hand -> Hardship in Social Network -> Expenses of Social Network -> No Future Profit
Some of this money is invested, but the overall trend is toward expenses rather than investments.
So what actions are appropriate within the Rural East African economic model? The key insight from my personal experience is counter-intuitive:
Minimized Liquidity.
One Acre Fund's business model incorporates this by using asset-based agricultural inputs delivered just before they are to be used, maximizing the chances that these inputs will be used as investments rather than liquid cash. Minimized liquidity can be frustrating for customers, but accounts for a lot of OAF's success at driving long-term change. With minimal liquid cash, the social network has as little chance as possible to dissipate the money. OAF buttresses this lack of liquidity through formal insurance programs (crop failure insurance, funeral insurance, etc.).
This insight isn’t obvious for Western economics, which explains why a lot of Western economic models fall apart under East African conditions. Basically: liquid cash injected in the East African context can never drive long-term change. Even if cash is injected at massive scale (to thousands of people), the recipients’ social networks will often grow to accommodate and dissipate the new income. Only money in the form of investments (specifically investments that have local buy-in and training) can realistically yield future profit and drive long-term change. For understandable reasons, this sort of program is unpopular; depriving a social network of liquid cash makes everyone's life more precarious.
For aid organizations, this presents an ethical dilemma - if liquid cash is required to keep a child alive and an aid organization is only offering cash in the form of investments, then the child will die. Long-term change is diametrically opposed to social network survival needs; Western organizations operating in this context set ourselves up as the enemy. This makes aid work an impossible choice: either provide immediate relief at the cost of long-term change or long-term change at the cost of immediate relief.
TL;DR - effecting long-term change is HARD.
*School fees and other child-related costs would be classified as expenses in Goldratt's model, this is debatable though.
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