Rich Financial Lives of Poor People

Science magazine has Anirudh Krishna's review of Portfolios of the Poor How the World's Poor Live on $2 a Day by Daryl Collins, Jonathan Morduch, Stuart Rutherford, and Orlanda Ruthven. Krishna writes:

Far from being disconnected from the market economy, poor households, including those living on less than one dollar a day, are deeply invested in financial transactions. Because these transactions are mostly informal, thus undocumented, they remain invisible to one-time visitors and others who look at written records. But if one were to take the trouble of visiting households twice a month over the course of a year, recording the details of all financial transactions, then one would recognize how diligently poor people, using a variety of instruments, manage their portfolios. Conducting such an exercise for 300 households in Bangladesh, India, and South Africa, the authors of Portfolios of the Poor found that a "triple whammy" characterizes the financial lives of the poor. Incomes are not only low; they are also irregular and unpredictable. Large expenditures arise suddenly on account of illnesses, deaths, insect infestations, and demolition drives. Inflows and outflows of money can be, and quite often are, severely mismatched over time.

Yet, as the authors document, only very blunt tools are available for smoothing cash flows. All poor households set aside money in savings, but they tend to store these savings in unproductive and insecure forms: "Mumtaz in a locked box in a drawer in the cupboard, Subir in a cloth bag tied into the roof timbers." Short-term consumption loans, necessitated by force of circumstance, are most often taken out from relatives and friends and, if need be, from informal moneylenders, who charge high interest rates.

It sounds as if institutionalizing appropriate mechanisms to create rights in property that poor people own and financial institutions to allow them to capitalize that property would do a lot of good for poor people and indeed for poor countries. The problem is that were such institutions easy to create, they probably would have evolved over past centuries. Evolutionary processes that take place over centuries are quite powerful, and it is probably an illusion that we can analytically invent better institutions in a year or a decade.

Still, do you have a better idea? Certainly we have expanded the reach and reduced transaction costs in financial institutions serving the middle classes greatly in recent years using both technological and process innovations, and while some of those innovations are showing up with major problems, there is a hope we can extend the innovations down to serve the poor.