The Economics of Poverty: Taking a step back (Part I)

In this post, let’s talk poverty. As to why it remains a topic of discussion to this date is probably not a mystery to anyone since poverty is still a central issue that largely shapes many of the local and international policies. We, as modern humans, have experienced tremendous growth in welfare over the past two centuries. Subsequently, once our own basic and some higher-order needs were met, we began to also grow considerable sympathy for those less fortunate. It then led to paternalistic behaviours reflected in the desire to shelter the homeless, cure the sick, and feed the starving. Yet, poverty is a concept often misunderstood. Why might this assertion be true?

To answer the question, we begin by looking at how poverty is conceptualized and taught by some of the most widely-recognized international organizations. Extreme poverty is formally defined as the inability to meet the minimum income level of $1.9 per day, a threshold that marks the international poverty line last updated in October 2015 by the World Bank. Poverty (absolute poverty) is further elaborated by the United Nations in 1995, and I quote, as “a condition characterised by severe deprivation of basic human needs, including food, safe drinking water, sanitation facilities, health, shelter, education and information. It depends not only on income but also on access to services.” Yet, while these definitions are broad and inclusive, they also invite misconception on the part of, not just the general public, but also policy research and development aimed at addressing poverty.

Economics, in that sense, offers better tools and framework for contemplating and analysing poverty. I would not go as far as to say that the formally defined “poverty” is false per se, but the underlying problem is simply that the definition is somewhat misleading. These conventional perceptions of poverty have made the majority of common folks and even some of the experts, to an extent, to regard poverty as a disease, while in its actual form, poverty is a symptom. Precisely speaking, poverty ought to be viewed as a symptom of other social and economic diseases such as persistent inter-generational capital deficit, hyperbolic discounting tendency, institutional corruption, subpar design of economic system, and sometimes adverse geographical conditions. But then, another question arises. By merely looking at different angles (that is, by steering away from the mainstream teaching), what difference can it make to how a nation addresses the issue and to he effectiveness of the cures?

To illustrate, let’s think of poverty as a social disease (i.e., the kind of thinking that conforms to the fallacy we earlier discussed). If that is truly the case, then we could just reverse engineer the problem. If poverty is the lack of sufficient income to sustain oneself, then it should be relatively easy to combat poverty through lump-sum redistribution of income. One can, for instance, create a progressive income tax system (more tax levied on those in higher income brackets) to channel more resources to the bottom. We can even relax our definition a bit and consider multi-dimensional poverty, that is being poor in terms of income, health, and education (a.k.a, Low Human Development Index or HDI). If that is the case, then the most straightforward answer to poverty is to increase HDI by providing whatever improves HDI such as more education, healthcare infrastructure, and employment assistance to bolster income earning capability. But, as history has unveiled, decades of attempt using such measures have resulted in a scenario where so little value is produced by so much effort even if we disregard the transportation cost of resources, administrative spending, and the likes.

I believe that better remedies exist, but only when we treat the actual diseases and not the symptom. Holistic approach is highly recommended, but how? I think that the first step forward is to NOT attempt to cure poverty and to recognize that poverty per se is not the disease but a result of other deep-seated social problems. In that sense, we need to think of and bring improvement to the followings:

I. Persistent Inter-generational Capital Deficit:

A homeless person in the US. A sad reminder that poverty is not limited to the third word.

A major problem that causes chronic deprivation of resources for a certain segment of the population is the inability to save, raise capital, and invest in the future. Being poor means you produce so little for yourself and your family that meeting daily consumption is already a challenge. Any little saving you have is quickly depleted through an array of misfortunate events, mostly due to the huge volatility of your own economic conditions. Having one sick child, for example, is enough to deteriorate your entire saving. This prevents any sizeable capital accumulation and thus children of the poor usually receive so little or no bequest from their parents at all (which then lock them at the bottom of social hierarchy for generations). Furthermore, poverty cripples one’s capacity to borrow as well. NINJA loan (i.e., a type of loan that requires No Income, No Jobs, and No Assets as collaterals) is scarce. Usually, it demands a level of trust beyond contract, and aside from very few close relatives/friends, such benevolence is extremely rare. Being poor, thus, prevents a person from borrowing any meaningful sum of money to invest, to seize the economic opportunities presented to them, to take advantage of their nation’s economic growth.

The implication is the perpetual lack of capital to invest in all sorts of future determinants of better livelihood such as labour and time saving equipment, education, business start-up, etc. In fact, the consequence of not having a sizeable sum of cash on hand (when the time calls for it) is actually more dramatic and tragic than simply not being able to start a business and attain education. For example, Josh can only earn $20 a day, all of which is used to meet his and his children’s immediate needs (food, water, utilities, etc). Suddenly, his old stove broke down, and he, after having exhausted all options, could not fix it or have it fixed. In rich country, repairman would also be too expensive (due to both minimum wage and high opportunity cost of labour), but let’s just assume the stove is irreparable. Buying a new stove would cost, say, $300, and that is beyond any meagre amount of saving Josh can come up with. Of course, consumer loan is not that easily obtainable and the accessible extra-system loan (predatory loan typically under illegal conditions) would be quite costly due to high interest rate and notoriously aggressive (sometimes life threatening) repayment enforcing methods. What this translates into is a greater cost of living in the long run. Think about it. Now, without the stove, Josh and his family might need to eat out at cheap fast-food chains like McDonald more often (assuming he has the money for that). The catch is that, on top of the unhealthy factor, the recurrence of small spending is cumulatively expensive. Consider the table below:

The figure provided is pure guesswork, but this is not far detached from what is really happening to poor families around the world. As you can clearly see, being poor is “expensive”, not just in relative terms (that poor people pay a greater proportion of their income on basic needs), but also in absolute terms (since poor people cannot take advantage of the financial system and make due cost-saving and income-expanding investment). If Josh could afford the upfront payment of $300 for the new stove, then his periodic spending would be reduced considerably. Otherwise, he would incur $50 additional expense every week (add up to $100 per week), and that results in greater total spending. Of course, micro consumer loan is available, but the reliable and legally approved one is usually inaccessible to family in extreme situations like the NINJA situation we described earlier. Ultimately, everything culminates in “Poverty Trap” which is, by this point, self-explanatory.

What we can infer from this catch-22 complication is the need to provide a little spark somewhere along the line of the NINJA situation. Micro-credit (with reasonable regulations to prevent exploitation) is thus conducive to poverty alleviation. But, that comes with caveats we will soon explain. Of course, tagging along with the offer of micro-credit to low-income individuals should be the availability and accessibility of micro-saving, and I believe this one should feature a rather low degree of liquidity for the reason we will discuss in the second part as well (hint: It has to do with impulse purchase). Employment assistance is without doubt useful, and my prior criticism is not on the method itself but how it is utilized separately. In other word, employment assistance should be a part of the solution and not the entire solution. Think about it. Since income can easily be depleted via external shocks (sick family member, literally rainy day that thrusts a hole in your house, etc), what is the point of helping poor (and usually unskilled) people find low-paid job when no other services to bolster their capital accumulation capability are present? That, I even assume people know how to manage their personal finance. If that assumption is relaxed, then we will have to pray that whatever little amount a poor person earns is not blown away by gambling and irrational spending/investment decision. Moreover, low income also increases very little the people’s ability to borrow. Thus, employment training and assistance alone as a poverty alleviation strategy are to no avail, especially in developing economies. While we are on this subject, legitimizing ownership of assets is also of vital importance to growth. This is because lawful ownership usually implies the ability to legally sell or invest in the property, and that enables the use of the property (land, house, etc) as collaterals for borrowed capital. It allows people to invest in the future by borrowing from the future, and that is one of the primary functions (and merits) of property rights in free market economy.

Summing up the point so far, the deprivation of wealth-creating capital is one of the greatest forces that has been keeping poverty afloat in many nations, even the economically well-developed ones. Hence, it is through the comprehensive enhancement of capital borrowing and saving ability from all corners that poverty can be eradicated. Of course, a holistic approach to tackle one of our worst enemies, poverty, requires more than addressing the persistent capital deficit problem.

The never-ending plight, how I wish it is only the result of exogenous factors uncontrollable by the impoverished. But, things are not that simple, and the real-world findings of the root-causes seem to point simultaneously towards many direction. Therefore, the next quest to embark upon is to properly understand the self-defeating behaviour common to many of us known as Hyperbolic Discounting which we will discuss in the upcoming second part of the article.

Here is a bit of background knowledge to keep you engaged:

HYPERBOLIC DISCOUNTING

Hyperbolic discounting is the tendency to choose sooner-smaller reward over greater-later reward. What is perplexing is that, based on empirical evidence, this preference is inconsistent and dependent on the length between now and the expected time of reward (i.e. on how far the delay is from the present). Addressing this sort of problem is an art, and the best solution so far is to introducing incentive (i.e., relocating incentive) to do the right things to achieve optimal long-term outcomes at early stages.

We will discuss Hyperbolic Discounting and other poverty-induced social diseases in the second article in detail. I hope the article proves useful to you.

Until then,

Economind

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Reference:

http://www.poverty.ac.uk/definitions-poverty/absolute-and-overall-poverty