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Tuesday, May 24, 2011

Seeing the Poor as Investors

Sir Partha Dasgupta
Upon reading Sir Partha Dasgupta’s extremely informative book on development economics, An Inquiry into Well-Being and Destitution (Oxford: Clarendon Press, 1993), I came across the following very interesting insight (pp. 245-248).

Development economists, NGO’s, and assorted concerned policymakers often say that one of the pressing obstacles to bettering the condition of the very poor in developing countries is a lack of capital accumulation that can lift them out of the dreary cycle of living hand-to-mouth. If you cannot save any money because all of your income goes to immediate consumption — to keeping yourself fed and clothed — then you cannot save anything that can be invested in a way that will help you to move up the economic ladder. Low wages, at least at the extreme of poverty considered by Dasgupta, are a trap.

Dasgupta doesn’t argue with the sad fact that extreme poverty is a trap, but he offers a different way of conceptualizing it. Standard economic models of savings and investment, he says, don’t translate well to poor peasant economies, where “savings” are not necessarily composed of money kept in a bank, and where much “investment” doesn’t pass through one either. When a peasant spends his meagre wealth (or his labour, which is much the same thing) to terrace or irrigate a field, the standard models view this as consumption, whereas the peasant obviously views it as investment. Looked at from the peasant-level point of view, there is a lot more investment going on in the peasant community than is captured using the standard economic models, whose measurements rely on savings and investment tied to financial and other economic institutions.

As poor as such peasants may be, there are those who are still poorer. Consider, for example, a day labourer in India, who owns no land, and whose wages are just enough to support his continued existence and no more (or if you prefer Marxian terminology, his wages are only enough to reproduce his labour). Again, for this day labourer, the conceptual line between consumption and investment is very blurry. When he spends his wages on rice to keep body (but not soul) together, the standard economic models treat this as consumption. But for the labourer, it is an investment in the only capital he owns — his labour. The simple fact is, if he doesn’t eat, or if he doesn’t eat enough, he will not be able to earn.

(Elsewhere in his book, Dasgupta notes a related phenomena about the extremely poor: their productivity is particularly path-dependent on their nutritional history: a recent history of nutritional deficiency — which could be caused by a short period of lost wages due to a work slowdown — will represent a lost ability to work, which may result in more lost wages and further lost nutrition. But that is just another of the many tales Dasgupta can tell you about the lives of India’s poor.)

Because of their failure to see that there is a blurry line for the very poor between consumption and investment, standard economic models characterize the plight of these people as an inability to save enough money to escape poverty. In short, the main problem of the poor is presumed to be insufficient capital, because what they get all goes to consumption. According to these models, the solution is for countries to increase their savings rate. This is a macroeconomic solution that according to Dasgupta, misses the point. Increasing the savings rate is fine, except that the only people in the country who are likely to increase their savings rate are those whose incomes are already high enough that they can plausibly save more. The very poor don’t have that luxury.

Dasgupta’s alternative way of seeing the situation of the very poor is that they actually do invest rather than just consume, although this isn’t captured by the standard models. As a matter of fact, viewed correctly, the poor spend a greater proportion of their income on investment than the more affluent do. The poor do not suffer from a low savings/investment rate; as a proportion of income their rate is actually higher than average. Their real problem is that their return on investment is very low. In the case of the day labourer, what this means is that, in the very limiting case, his investment (the bowl of rice he eats) only enables him to earn enough to buy another bowl of rice. In other words, his return on his investment is effectively zero. He is doing no more than barely replacing his capital. If his wages were increased, then the return on investment of his bowl of rice would increase too.

It’s not immediately clear to me what policy difference would result from adopting Dasgupta’s view. However, I think there are a couple of possibilities. First, at the very least, his model would have us stop believing that the very poor spend everything they have on consumption. This might in itself be a good thing, since such a mistaken belief can too easily veer into the more ignorant assumption that the very poor are improvident wastrels, incapable of industry or foresight. In truth, they are just as entrepreneurial and industrious as anyone — technically even more so.

Second, and in a somewhat similar vein, I imagine that seeing the very poor as investors of a sort might make institutions more willing to lend them capital, which the poor can then use to increase their return on investment. This is part of the motivation behind microfinance schemes, which are predicated on the idea that the poor in developing countries are not necessarily bad credit risks. Indeed, given the opportunity, their credit might turn out to be exemplary. Microfinance has by most accounts proven very successful at helping the poor.

Third, the orthodox assumption that the national savings rate needs to be increased might actually be detrimental to the very poor. If the only people who actually can increase their savings rate (i.e. the more affluent) were to do so, the immediate effect might be that many very poor people would lose their livelihoods, which are gained from the consumption and improvidence of the more affluent.

At the very least, Dasgupta’s conceptual shift is worth pondering. The economics taught in Western universities might be more parochial than we care to imagine. Its theories might not translate well to other social milieus and may be better at catering to the needs of the affluent than to those of the poor, even when that is not the intention.

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