two
How the Other Half Finances
The season of plenty should then provide for the season of want; and the gains of summer be laid by for the rigours of winter. But it must be obvious, how difficult it is, for even the sober labourer to save up his money, when it is at hand to supply the wants that occur in his family;—for those of intemperate habits, ready money is a very strong temptation to the indulgence of those pernicious propensities.
—PRISCILLA WAKEFIELD, 18051
If I had my way I would write the word “Insure” over the door of every cottage, and upon the blotting-book of every public man, because I am convinced that by sacrifices which are inconceivably small, which are all within the power of the very poorest man in regular work, families can be secured against catastrophes which otherwise would smash them up for ever.
—WINSTON CHURCHILL, 19092
Do you remember when you first heard about microcredit? Did it surprise you that one could help poor people by putting them in debt? The root of such surprise is the microfinance movement's successful replacement of the old story of lending to the poor—a story of usury—with a new one about microenterprise. After all, it seems, poor people can be masters of their fates, incipient entrepreneurs who lack only credit to bloom.
On the one hand, this upbeat story is rightly animated by the belief that people are no less ingenious or resourceful for being poor. On the other, it confines their creativity to one financial service and one use: credit and enterprise.
Living up to the spirit of respect embedded in microfinance requires minimizing preconceptions about how poor people do and ought to use financial services. Thus, I start my investigation of microfinance from the clients' points of view. This perspective reveals that microcredit for microenterprise indeed has some value: lacking jobs, poor people more often work for themselves than do wealthier people. But microenterprise is just one use for credit and other financial services, and it is best thought of as subsistence, not a ladder out of poverty.
Broadly, poor people use financial services to meet the same needs as the rich do: transacting with others, investing for the future, building assets for security, and sustaining consumption of necessities. Embedded within most of these grand problems is a mundane one: accumulating small sums into large ones. Most financial services can be seen as helping people do that, partly by providing a safe place to put funds and partly by helping people impose discipline on themselves. And it turns out that because poor people live close to the jagged financial edge, they need this service more than rich people. As Priscilla Wakefield wrote in 1805, they need ways to set aside money on good days and in good seasons and draw it down in bad. Loans, savings accounts, insurance, and money transfers can all help them do that. Thus financial services are like clean water, sanitation, and electricity: they generally do not lift people out of poverty, but they improve life.
Unfortunately and inevitably, while rich people can usually find services tailored to their specific needs, those less fortunate must choose from options that are more expensive and less well matched to the needs at hand. As the seminal book Portfolios of the Poor, by Daryl Collins, Jonathan Morduch, Stuart Rutherford, and Orlanda Ruthven, has shown, poor people must patch together loans from friends, store credit, neighborhood savings clubs, and similar outlets to manage their finances as best they can.3 Microfinance is about improving their options. This fuller, more realistic view is essential to understanding why microfinance can be a development success even if it isn't a reliable path out of poverty.
How Rich People Use Financial Services
Rich people can access a spectacular variety of financial services: checking and savings accounts, home mortgages, car loans, credit cards, mutual funds, and insurance for life, car, health, and home. It is hard for a New Yorker who samples a new restaurant each week to understand the life of a Guatemalan highlander subsisting on tortillas and beans; just so, it is hard for those who enjoy a wealth of financial services to empathize with a woman for whom saving means hiding money from her husband in the folds of her sari.
Table 2-1. My Financial Services
| Service | Purpose |
| Savings account | Prepare for emergencies, such as job loss |
| Checking account | Transact safely over long distances or in large amounts |
| Wire transfer | Send and receive money internationally (rare) |
| PayPal account | Send money to friends; buy things online |
| Credit cards | Transact without cash; buy things I want before I have the money |
| Home mortgage | Live in a home I own before I can pay for it |
| Home equity line of credit | Same as above; and use cheap credit to improve house |
| Car loan | Own a car before I can pay for it |
| Student loan | Invest in my own skills for higher pay after graduation |
| Retirement savings | Prepare to support myself when I no longer work |
| College savings | Prepare to invest in children's education |
| Health insurance | Protect family against financial catastrophe in event of serious health problems; assure access to care |
| Homeowner's insurance | Protect family against financial catastrophe in event of serious harm to home |
| Automobile insurance | Protect family against financial catastrophe in event of serious harm to car, or liability for accident |
| Umbrella liability insurance | Protect family from liability suits in general |
| Life insurance | Protect family against financial catastrophe if I die |
| Disability insurance | Protect family against financial catastrophe if I am unable to work |
Despite the gulf in experience, a rich person can gain insight into poor people's use of financial services by contemplating her own. Try this exercise. List all the financial services you use. For each, determine what it helps you do. Transact? Invest? Build a business? Spend money you have yet to earn? Then confront this question: if you had to give up all these services but one, which would you keep?
Table 2-1 is my list, which is fairly typical for middle-class American families.
If you show your list to a microfinance client (assuming it resembles mine), the luxury will become apparent—in the college education foreseen and the home valued in six figures, as well as in the low price and tailored suitability of the services. But if you articulate the needs that underlie your use of these services, you two might understand each other well. In my list, I discern four major reasons I use financial services. All come from universal needs:
1. To transact. The credit cards and checking account help me move sums too large to be safe in my wallet. They also help me remit amounts large and small over long distances. And they make it easy: My paycheck goes into the checking account automatically. The mortgage payment comes out just as smoothly. A swipe of a card pays for gas at the pump.
2. To invest. I borrowed to help pay my college tuition, and I save to do the same for my sons. Notably, like most people in rich countries, I have not used financial services to invest in my own business, for I have none. I prefer the stability of my job.
3. To build assets. Some people ascribe an investment purpose to the home mortgage, but in fact, on general principles, a mortgage-financed home is a terrible investment. It puts a lot of financial eggs in one basket, violating the principle of diversification. Using credit to buy a home—investing with leverage—multiplies the risk. And homes can be illiquid, meaning they are hard to sell. I bought my house for other reasons. With ownership comes security. By holding a title to my home, I need not worry about being forced out by a landlord who does view the building as an investment. And, as Peruvian economist Hernando de Soto has famously argued, title to a major asset also serves as collateral for credit.4 I once borrowed against my house to fix the roof and could borrow again to help put my sons through college.
4. To sustain consumption. I was struck to discover that most of the services on my list secure my family's ability to obtain such necessities as food and clothing through thick and thin. The savings account is a safety net if I lose my job. Retirement savings should let me buy what I need after I stop working. Credit cards and the home loans let me make big purchases without starving. The insurance policies take the financial bite out of life's traumas.5 Economists call this function consumption smoothing.
To respond to the challenge I posed earlier, if I was told I had to live with just one financial service, I would beg for two: life and health insurance. They protect my family from bankruptcy in the face of life's greatest tragedies.
We can learn a few more lessons from this exercise. First, risk is intimately intertwined with money. Insurance policies embrace risk head-on. But they are not unique in involving it because whenever one party commits to delivering money under certain circumstances at some future date, there is risk. Perhaps a borrower will not repay or a bank holding deposits will go under. Second, and related, many financial services bind even as they serve. The mortgage and other loans force me to set aside money each month. The retirement accounts add inertia to my financial regime since my employer automatically makes the contributions out of my paychecks. In appropriate doses, this discipline is healthy; we all need help resisting the temptation to spend now.
Third, what financial services you can use depends on who you are. If I were a poor American, my financial service inventory would look different. I might not have the steady job that would make me an attractive risk for lenders. My compensation might not include a retirement plan. I might have trouble maintaining a minimum balance in a checking or savings account. To borrow a term from the Commission on Thrift, a coalition of U.S. nonprofits, the “concierge services” of government-subsidized retirement and college savings accounts would probably disappear from my list of financial services.6 So might most of the insurance and the checking account. In their place would appear check cashers and payday lenders extending credit at 400 percent per annum. Just as more drugs exist for male impotence than for malaria, the financial services available to the rich outshine those for the poor in quality, diversity, and cost.
This, too, is worth noting: my wife's inventory is identical to mine. But in many countries, law and custom come between women and formal finance.
Perhaps the most important lesson is about how financial services, like roads and piped water, undergird the comfortable life. Imagine living without financial services: no bank accounts, no bank loans, no credit cards, no insurance—just cash. The importance of financial services is belied by their intangibility. Their paramount benefit is the last one on my list of four, namely, helping people manage and maintain consumption, especially during catastrophes. In the vocabulary of the Nobel Laureate economist Amartya Sen, financial services give people more agency, more freedom. However, as Sen emphasizes, freedom begets freedom: those who already have more agency, thanks to being rich or male, say, can access more and better services.7 Those who come to the financial service marketplace with fewer advantages leave with fewer.
The Financial Challenges of Poor People
“The rich are different from us,” F. Scott Fitzgerald once observed. “Yes,” retorted Ernest Hemingway, “they have more money.”
That exchange is actually a bit of Hemingway fiction, a put-down of his rival's fascination with the lives of the rich.8 But it does capture a real question for us: is there much difference between being rich and being poor? Do the global rich and the global poor use financial services in essentially the same ways?
Broadly, rich and poor are no different: all need to transact, invest, build assets, and sustain consumption. But the financial circumstances of poor people are qualitatively, not just quantitatively, distinct. Poor households are not just microrich ones, and microentrepreneurs are not simply microversions of the iconic entrepreneurs who perpetually roil the capitalist economy.
Here is one difference: Poor families are more apt to send a member to the big city or to another country for work. That generates a need to transfer money over distance. Living in 1995–96 in a village in southern Bangladesh served by the Grameen Bank, graduate student Sanae Ito discovered that the surest way for residents to get out of poverty was to get out of the village. A family would save up or borrow to send a daughter or son or husband to the capital to work as a day laborer and send home money.9 In Kenya, the wildly popular mobile phone–based money transfer service, M-PESA, got its start with the slogan “Send Money Home.” The original target client (and there were millions) lived in Nairobi and needed safe ways to remit funds to his parents, wife, and children in the countryside.10 Many villages in developing countries export workers even farther afield. Today, Bangladeshi villages are sending workers to the Middle East, thanks to a religious affinity. Bangladeshi men working on Kuwaiti construction sites (among others) are sending billions of dollars home.
Thus the global financial system is hugely valuable for linking dispersed families—if they can hook into it. BRAC Bank, a spin-off from the giant Bangladeshi nonprofit from which it gets its name, gives its low-income clients just that access through an arrangement with Western Union, turning its branches into money transfer points. In Kenya, M-PESA is working to bypass Western Union by extending its network internationally. Worldwide in 2010, $325 billion was remitted to developing countries, about three times the foreign aid from industrial democracies. For twenty-one receiving countries, the flow exceeded 10 percent of domestic economic output, which is a sign of how economically important the foreign earnings are for many poor families.11
The differences do not end there. Even before migration became the economic option that it is today, poor households had fundamentally different financial needs than their rich counterparts. Poor people are short not just of money but also of control over their financial circumstances. Their incomes and spending needs are more variable and unpredictable and their lives more dangerous than is true for rich people. Perhaps the most important financial distinction between poor and rich—leaving aside the superrich—is that by and large, rich people have salaries. My steady paycheck rivals all my insurance policies in bestowing financial security. It allows me to think long term, helping me invest in my children. And it makes me more creditworthy, helping me borrow to build up assets. Reviewing findings from household surveys done in thirteen developing countries, MIT economists Abhijit Banerjee and Esther Duflo found that what most distinguished people living above or below $2 a day was not education, health, or even wealth, but a steady job.12 To put that another way, as I wrote in chapter 1, most people who live on $2 a day don't live on $2 a day: they make $4 one day, $1 the next, and $0 the day after that. Or perhaps their big earnings come once a season, at harvest time.13
No work has made this reality clearer to the world's salaried minority than Portfolios of the Poor. Following a suggestion some ten years ago by the University of Manchester's David Hulme, detailed financial transaction logs called financial diaries were assembled for a few hundred families in Bangladesh, India, and South Africa. Typically, a researcher visited a household biweekly for up to a year to update the logs, noting down every income and outflow, every instance of borrowing or saving.
Among the stories revealed in the diaries and the book is that of Pumza, who cooks and sells sheep intestines out of a stall in a Cape Town slum. After netting out her spending on firewood and raw intestines, Pumza made $95 a month on average during the eight months that researchers visited her. A $25 child support grant brought her monthly income to $120, which for Pumza and her four children worked out to $0.80 per person per day. Hidden within that average, however, was a great deal of daily and monthly unpredictability and volatility, shown in figure 2-1. The human body does not thrive on a diet that alternates between feast and famine: despite her volatile income, Pumza needed to feed the children every day.
Figure 2-1. Pumza's Revenues and Expenses, March–November 2004
Source: Collins and others (2009), 41.
Note: Dollars are converted at the rate of $1 to 6.5 South African rand.
The collision between volatile income and constant needs creates an intense demand for financial services, ways to set aside money on good days or seasons and pull it out on bad. At least once when income fell below expenses, for example, Pumza went to a moneylender for a short-term loan at interest of 30 percent per month. Another time, she used a payout from a savings club she belonged to (see discussion of Rotating Savings and Credit Associations at the beginning of chapter 3). Interestingly, Pumza was also a provider of financial services, if an informal and hesitant one. To people she knew, she sometimes sold her wares on credit.14
As if income volatility weren't hard enough, poor people's spending needs also tend to be more unpredictable than rich people's, above all because of health problems. Disability and death are more frequent visitors at the doorsteps of poor people. And where a middle-class office worker can get by with a bad back, a poor laborer may have to stop working and earning when hurt. Together, the cost of medicine and doctors and the loss of income when a breadwinner takes sick can undo years of saving and asset building, plunging a family into destitution.
One day in 1989, recounts Portfolios of the Poor, a Bangladeshi rickshaw driver named Salil complained to his wife of a sore throat. He consulted a series of doctors. To pay them, he sold off his three rickshaws, the capital of his livelihood, one by one. The doctors did not help. Salil ended up in a hospital, was diagnosed with throat cancer, and died within days. Throughout the period his wife, bereft of income, borrowed to support the couple and their three small children. His widow and children became the poorest Bangladeshi household in the financial diary studies.15
Salil's story may be unusual only in degree. Fifty percent of the Bangladeshi households studied experienced illness during the periods of financial diary collection, as did 42 percent of Indian ones. Fully 81 percent of the households in South Africa, where AIDS is common, were financially affected by funerals outside the immediate family.16 Also summarizing household surveys, Banerjee and Duflo found that depending on the country, 11–46 percent of households living on less than $1 a day (on average) had someone who had been bedridden or had needed a doctor within the last month.17 A World Bank project to collect and analyze thousands of life stories in fifteen developing countries cited the second-most common cause of falling into poverty, after regional or national economic troubles, as “health/death shocks and natural disasters,” at 19.4 percent of cases.18
One way families manage risk on the income side of the ledger is diversification. A survey of twenty-seven villages in West Bengal, India, found that households typically had three workers who among them practiced seven occupations. Banerjee and Duflo found that one-fifth of urban households in Peru living on less than $2 a day per person earn from more than one source, as do a quarter in Mexico, a third in Pakistan, and half in Côte d'Ivoire. In the countryside, it is common for a person to work his own land and the land of others. In the extremely poor Udaipur district in the Indian state of Rajasthan, almost everyone owns and farms some land, but 74 percent of those below $1 a day earn most of their money in day labor. Self-employment is common, too, found among a quarter of similarly defined poor and rural households in Guatemala and a third in Indonesia and Pakistan.19 Banerjee and Duflo explain the attraction of working for oneself:
If you have few skills and little capital, and especially if you are a woman, being an entrepreneur is often easier than finding an employer with a job to offer. You buy some fruits and vegetables or some plastic toys at the wholesalers and start selling them on the street; you make some extra dosa [rice and bean pancake] mix and sell the dosas in front of your house; you collect cow dung and dry it to sell it as a fuel; you attend to one cow and collect the milk. These types of activities are exactly those in which the poor are involved.20
Subtle Truths about Microenterprise
Self-employment, then, is one natural response to being poor in a poor country. But thanks to the promotion of microcredit, microenterprise became something more in the public imagination: not just one reason the poor want financial services but the reason, not just a way to increase or diversify income but a way out of poverty.
While poor people do fend for themselves economically more than rich people do, accurate data on the extent and strength of microenterprise are hard to come by. The process in which a rich investor finances microcredit for a poor borrower can be seen as a chain with a reality at one end and an image at the other. The investor, say, a user of the online peer-to-peer microlending site Kiva, might lend money to one of the “entrepreneurs” listed on the site. The funds would go to Kiva, a local microcreditor, and then a borrower rather like the one pictured on the site.21 That borrower might use the credit for microenterprise—or might not. Somewhere along the chain, the simple image and the complicated reality must come into tension. The more a fundraiser like Kiva promotes the image to raise funds, the more that point of collision is pushed toward the client. Microfinance institutions borrowing money from Kiva, for example, will understand that they should emphasize entrepreneurship in their own rhetoric. When collecting stories from clients, they will cue their clients in the same way. What clients really do with the credit, elusive under the best of circumstances, falls further below the radar.
When asked how they use a service, microfinance clients often give the answer they believe is wanted. They respond this way out of ordinary self-interest; to ignore self-interest is a luxury most poor people cannot afford. In Bangladesh, a borrower's husband told anthropologist Lamia Karim with a smile, “We took a cow loan. Fifty percent will be spent to pay off old debts, and another fifty percent will be invested in moneylending. If the manager comes to see our cow, we can easily borrow one from the neighbors.”22 But the fabrication is not always from whole cloth. Beatrice, the female half of an entrepreneurial couple in Zambia's Copperbelt, explained to British researcher James Copestake that, in Copestake's words, “the main difference the loans had made over the last year was in freeing their own capital for construction of their house.” Formally, microcredit went into the business, but its main effect, because of the fungibility of money, was to bump the couple's own capital into additional personal uses.23
The Malaysia-based writer Helen Todd succeeded better than most researchers in piercing the fog, giving us a rare statistical view of what microcredit allows poor people to do. Throughout 1992, she and her husband David Gibbons lived and studied in two villages in the Tangail district of Bangladesh, one of the first regions in which the Grameen credit program operated on a large scale. With a research team that included Bangladeshis, they tracked the financial and personal lives of sixty-two women, forty of whom borrowed from Grameen. The researchers record every loan payment, sale of rice paddy, and lease of land. Todd and her team complemented their quantitative data with “qualitative” evidence—records of hundreds of conversations and observations. Table 2-2 shows their tabulation of how the forty borrowers said they would use the credit so they could obtain loan approval and how they actually used it. All the stated purposes were investments. Todd writes:
According to the [Grameen] Bank records, 35 of our 40 member sample took loans in 1991/92 for either “[rice] paddy husking” alone or “paddy husking/cow fattening.” As far as we could tell, only four women did any paddy husking for sale during the year and…only for limited periods. Two young women who lived in the same bari [homestead lot] had taken their last few loans for “cow fattening.” Although I was in and out of their bari for seven months of the year, I never saw hide nor hair of any cows.24
Todd's assessment revealed an interesting diversity of pragmatic uses. Nine of the forty took credit for what is usually thought of as microenterprise. Of these, four bought cows; another two invested in equipment or stock for back-breaking work grinding the oil out of mustard seeds; and three bought rickshaws, presumably for their husbands to use as a source of income. But more was going on. Two women used the loans to pay dowry, breaking a vow they took as Grameen members.25 Others bought rice, which could be a kind of consumption smoothing, making sure there is enough to eat every day. One bought materials to improve her house, which we could call asset building. In fact a majority did use the credit for what could be called business activities, though not ones usually thought of as microenterprise: moneylending and the leasing or buying of rice land. Bank policy proscribed land leasing in particular, viewing the rents as usury extracted by landlords, a perspective that reflects the historical intertwining in South Asia of moneylending and land monopoly. But for many families, leasing land was a step up in security and freedom. Instead of working someone else's land for a daily wage, the husband could plant and manage the family's “own” field. Once during the research project, Grameen Bank founder Muhammad Yunus visited Todd and Gibbons, who briefed him on their findings. Todd wrote that they urged him to allow land leasing:
Dr. Yunus listened but did not commit himself.
“Let's go to the village,” he said….
Professor Yunus questioned Kia [a borrower] about [a new] loan.
“Do you want one?”
“Yes, sir!”
“What will you use it for?”
I saw Kia hesitate for a moment. Then she looked the Managing Director in the eye.
“I won't lie to you,” she said. “I am going to lease in some land.”26
Todd's data and stories suggest that people generally use loans to incrementally diversify and improve their control over their sources of income. This often does include what is called microenterprise. But the lines blur between microenterprise and agriculture, between investment, asset accumulation, and consumption. Few would consider stocking up on rice to be microenterprise. But how different is it from buying a cow? Both are ways to assure food supply. Yunus did not sanction land purchase and leasing when he initiated his microlending, but is buying an acre so different from buying a rickshaw? Both can be combined with the owner's labor to earn an income. Certainly, users of microcredit do not feel confined by such abstract distinctions. Even paying dowry, though it perpetuates an institution that makes women an economic burden, can be a smart investment if it transfers a daughter to a household where she will be better fed. When you look closely, “microenterprise” begins to look like one more resourceful survival strategy.
Table 2-2. Approved and Actual Use of Select Grameen Bank Loans, 1992
Note: Loans were made to forty women. Those loans used for more than one purpose are listed more than one time. $1 = 40 taka.
Source: Todd (1996), 24.
It is worth reflecting on how wealthy societies label people who work for themselves as a matter of survival. In the eighteenth and nineteenth centuries in the British Isles, such people were “industrious tradesmen.”27 Some on the Continent saw them through the lens of the labor–capital divide—as workers who could become small capitalists.28 Today, rickshaws drivers and mustard grinders are often said to be running “microbusinesses.” They are “microentrepreneurs.” This fusion of a Silicon-era prefix with a capitalist projection appears to have originated with a volunteer for Acción International named Bruce Tippett in 1974, not long after “microprocessor” entered currency.29 “Microentrepreneur” is apt in important respects because the people so labeled risk their tiny bits of capital, work for themselves, and reap the profits and loss of their operations.
But “microentrepreneurs” differ from the prototypical rich-world entrepreneur in important ways. Few tap capital markets, innovate, expand, or create jobs. They do not abandon steady employment to launch themselves into bold ventures. Rather, they are conservative in investing in themselves. Evidently, living on the edge curtails one's appetite for risk. An experiment in Sri Lanka showed that injecting modest additional capital into microenterprises let the owners earn average returns of 5 percent per month.30 The same experiment in Mexico generated returns exceeding 20–33 percent per month.31 Why poor people leave these potential winnings on the table by underinvesting in their own businesses is not clear. They may not recognize the opportunities to sew more saris or better stock their shelves. They may struggle to pull together the lump sums needed to invest. Or perhaps microbusinesses are like tech stocks: high return on average but also high risk. To reduce risk, poor people diversify across several businesses (as we saw), not investing too much in any one.
Whatever the reasons, poor entrepreneurs are not the agents of creative destruction whom economist Joseph Schumpeter saw as the heroes of economic development. They undertake—to revert to the root meaning of “entrepreneur”—in order to survive.32 To this extent, labeling them “microentrepreneurs” romanticizes their plight and implies too much hope for their escape. This is why experts distinguish between “necessity entrepreneurs” and “opportunity entrepreneurs,” and why Aloysius Fernandez, who founded the self-help group movement in India (see chapter 4), proposed the label “microsurvivors.”33
A less fashionable view of poor entrepreneurs, historically associated with the International Labor Organization, is as victims of economic systems that fail to employ them. To put this more constructively, since the Industrial Revolution, explosive job creation has powered all national economic successes. Comprehensive economic development is hard to imagine without increases in jobs. In this view, the people of whom we speak have not benefited from such development. They are “people without jobs” or “self-employed” or “own-account workers” who heroically but tenuously survive their circumstances.34
Underlying both perspectives is the fact that poor people are engaged in just getting by. What matters is not that the world settle on one view or the other but that we come to understand how poor people put financial tools to work and how better tools can improve their lives. If you've ever tried to hammer a nail with a wrench, you know that the right tool makes all the difference.
How Poor People Use Financial Services
Perhaps no one is a better interpreter of how poor people manage money than Stuart Rutherford. A trim man with thin-rimmed glasses and a dusting of white hair, Rutherford loves nothing more than interviewing people about just this question. Trained as an architect, he became interested in the subject while investigating the effects of the earthquake in Managua, Nicaragua, just before Christmas 1972. As in Haiti in 2010, many slum dwellers lost their homes. Yet somehow they summoned the resources to rebuild rapidly, confounding many foreign aid officials.
In his book, The Poor and Their Money, Rutherford turns his gaze to India, focusing less than I have on the purposes for which the poor use financial services and more on the transactions involved. At base, he argues, poor people need financial services to turn small, regular savings into “usefully large sums” that can go toward most of the goals I discovered in my inventory: investment, gaining ownership of assets, and managing consumption.35 The last, as we have seen, is essential. As one Bangladeshi told Rutherford, “I don't really like having to deal with other people over money, but if you're poor, there's no alternative. We have to do it to survive.”36
Rutherford emphasizes how credit, savings, and insurance help people build usefully large sums. Providers of these services can take small, regular payments from the client—loan payments, savings deposits, insurance premiums—and occasionally make large payouts. As a matter of money flow, the services differ only in when the large sums are paid out. In particular, borrowing and saving are not as opposite as they appear. Rutherford illustrates the kinship with two examples he and his research partner Sukhwinder Singh Arora found in the slums of Vijayawada, in southeastern India. The first example is of savings:
Jyothi is a middle-aged part-educated woman who makes her living as a peripatetic (mobile) deposit collector. Her clients are slum dwellers, mostly women. Jyothi has, over the years, built a good reputation as a safe pair of hands that can be trusted to take care of the savings of her clients.
This is how she works. She gives each of her clients a simple card, divided into 220 cells…. Her clients commit themselves to saving a certain amount of money, regularly, over time. For example, a client may agree to save five rupees (Rs 5) [about 10¢] a day for 200 days, completing one cell each day…Having made this agreement it is Jyothi's duty to visit her client each day to collect the five rupees….
When the contract is fulfilled—that is when the client has handed Rs 5 to Jyothi 220 times…the client takes her savings back. However, she does not get back the full amount, since Jyothi needs to be paid for the service she provides. These fees vary…but in Jyothi's case it is 20 out of the 220 cells—or Rs 100 out of the Rs 1,100 saved up by the client in our example.37
Notice that Jyothi does not pay interest on deposits as conventional banks do; she charges—at a rate that works out to 30 percent a year.38 Rutherford asked Jyothi's clients why they pay so much to save when stashing cash in a box is free:
The first client I talked to…knew she had to have about Rs 800 in early July, or she would miss out on getting her children into school. Her husband, a day labourer, could not be relied on to come up with so much money at one time, and in any case he felt that looking after the children's education was her duty, not his. She knew she would not be able to save so large an amount at home—with so many more immediate demands on the scarce cash she wouldn't be able to maintain the discipline. I asked her if she understood that she was paying 30 per cent a year…. She said she knew she was paying a lot, but still thought it a bargain…. [D]wellers in a neighbouring slum, where there is no Jyothi at work, envied Jyothi's clients.39
Bankers would call Jyothi's service a “commitment savings account.” By removing a bit of money from the house each day, Jyothi protects her clients from themselves—from temptation to spend everything on the needs of the moment—and from children, husbands, and parents pressing for cash. Jyothi facilitates thrift. Paradoxically, commitment savings ties the client's hands in a way that strengthens her control over money and her power in the family. Poor people do have other ways to save, such as in jewelry and livestock. But thieves can take rings, and pigs can die. And such assets are inconvenient: as one Indonesian pointed out, “When you have to pay the school fees, you cannot sell the cow's leg.”40
In India, Rutherford also talked to clients of a moneylender, whose
working method is simple. He gives loans to poor people without any security (or “collateral”), and then takes back his money in regular installments over the next few weeks or months. He charges for the service by deducting a percentage (in his case 15 per cent) of the value of the loan at the time of disbursal. One of his clients reported the deal to me as follows.
“I run a very small shop” (it's a small timber box on stilts on the sidewalk inside which he squats and sells a few basic household goods) “and I need his service to help me maintain my stock of goods. I borrow Rs 1,000 from him, but he immediately deducts Rs 150, so I get Rs 850 in my hand. He then visits me weekly and I repay the Rs 1,000 for ten weeks. As soon as I have finished he normally lets me repeat.”
This client, Ramalu, showed me the scruffy bit of card that the moneylender had given him on which his weekly repayments are recorded. It was quite like the cards Jyothi hands out.41
The similarities with Jyothi's commitment savings service are striking. The moneylender, too, uses grids printed on cards to track payments. Both the savings and credit services operate cyclically, producing the same predictable rhythm of frequent, small pay-ins and infrequent, large payouts. Perhaps most importantly, both provide discipline. They help people set aside money each day or week and resist what must be strong temptations to spend or hand over it all. A study in Hyderabad, India, found that offering microcredit reduced household spending on “temptation goods,” such as tea and cigarettes, and increased spending on durable goods, such as sewing machines.42
In general, financial services provide discipline in two ways: by reminding and binding. This distinction might seem odd. Isn't discipline synonymous with compulsion? Not quite. In an experiment run in Bolivia, Peru, and the Philippines, people with voluntary savings accounts saved 6 percent more on average if they received regular text message reminders.43 Evidently, the reminders helped them summon self-discipline, and so the value of a loan repayment schedule, binding as it is, partly lies in regularly drawing clients' attention to the priority of setting money aside.
In reminding and binding, financial services meet a need that rich people experience less intensely: self-control is harder to summon when money is tighter and life is less predictable. In Nairobi, researchers Siwan Anderson and Jean-Marie Baland found that 84 percent of participants in local savings clubs known as ROSCAs were women.44 And among women, the ones most likely to join were not those earning all the household's income or none of it, but those in between. Roughly speaking, sole breadwinners did not need the leverage (with respect to husbands) of a commitment savings arrangement; non-breadwinners had no income to leverage. And evidently, women needed the leverage with respect to their spouses more than men did.
Economists Nava Ashraf, Dean Karlan, and Wesley Yin discovered the same need in the southern Philippine island of Mindanao. Working through a rural bank, they offered a new commitment savings account to randomly picked customers. Interestingly, though the commitment account locked up clients' money, it did not compensate for this inconvenience by paying more interest than the bank's ordinary savings account. Yet 28 percent of customers who got the offer took it. After one year, those offered had saved 81 percent more than those not. Of all those receiving the offer, the most likely to join were women who felt a strong tension between how they managed money in the moment and how they wished they would over the long term (as revealed by psychological tests).45 Evidently they recognized their need for external discipline.
To the extent that financial services resemble one another—in providing the discipline to turn small, frequent pay-ins into large, occasional payouts—they can substitute for one another. One woman might save to buffer her family against the possibility of a husband taking sick. Another might avail herself of rudimentary health insurance, such as that sold by the microfinance group SHARE Microfin in India.46 Another might borrow to pay clinic fees when needed. Of course, few poor people are in a position to choose from all these options. A survey in the Indian state of Karnataka found that 67 percent of households with someone who had suffered an expensive health problem in the last year tapped savings to help pay the bills, and 44 percent borrowed (and, as one can infer from those numbers, some did both).47
But financial services are neither perfect substitutes for each other nor freely substitutable. In Karnataka, only 0.3 percent of the households with health troubles drew on insurance, which is not surprising since almost none could buy any. Few could swap in this superior service to replace savings or credit. And credit and savings are opposite in crucial ways. For one, credit can cost more than savings. The core reason is that financial service providers are easier to hold accountable than their clients, some of whom can disappear overnight. Greater risk for the lender translates into greater cost for the borrower. In Vijayawada, for instance, Ramalu's moneylender charges far more than Jyothi the savings taker, rupee for rupee. After subtracting the Rs 150 fee, Ramalu's initial balance is Rs 850. He starts repaying immediately so that his average balance over the 10 weeks is half the Rs 850, or Rs 425, of which the Rs 150 is 35 percent. A rate of 35 percent for ten weeks compounds to a stunning 382 percent on an annual basis, more than ten times Jyothi's rate.
Another difference between credit and savings is in the risk imposed on clients. With savings (and insurance) the client runs the risk that the financial institution will collapse or steal her funds. Hyperinflation can effectively do the same thing. With credit, the danger is that bad luck or bad judgment will lead the borrower into repayment difficulties. Whatever mechanisms the lender uses to enforce collection—public shaming, peer pressure, the proverbial damage to kneecaps—will then come to bear.
Thus, various financial services can substitute for one another, but imperfectly. Because poor people often have scant services to choose from, they tend to use the services in ways that are not ideal. That a loan is taken in practice, for instance, does not mean that a loan is best in principle.
Conclusion
This review of the role of financial services in daily life and economic development generates a series of cautions for those who see microfinance—microcredit in particular—as an eliminator of poverty. Poor people need financial services for many things in addition to enterprise. Credit can serve many needs, but savings and insurance serve many needs more effectively when available. Microenterprise helps people survive poverty more than escape it. Next to the poverty-reducing power of industrialization, microfinance is a palliative.
Does that mean that the value of microfinance is sometimes exaggerated? Probably. Does that make it wasted charity? Not necessarily. Poor people need financial services even more than rich people do. For people navigating the unpredictable and unforgiving terrain of poverty, any additional room for maneuver, any additional control, can be extremely valuable. As Jonathan Morduch, a New York University economist and thoughtful observer of microfinance, told a writer for The New Yorker, “That is a valid critique, to a point. But get real. How long are you willing to wait for the revolution? I can't see any moral foundation for not trying to address the current deprivations of the world's poorest billions. If microfinance can help provide options in cost-effective ways, we should celebrate it.”48
The practical question is how outsiders arriving under the umbrella of “microfinance” can best help the poor solve their financial problems. It is a tough task. While it is easy to argue that the poor ought to have access to, say, health insurance, it is much harder to deliver health insurance to large numbers of poor people in a financially viable manner. To gain insight into what realistically can be accomplished, we next turn to the past for lessons. The history of financial services for the masses is surprisingly long and rich. For centuries, intelligent, ambitious, and empathic men and women have toiled at this task. Microfinance is an heir to their labors.
1. Wakefield (1805), 208.
2. Churchill (2007 [1909]), 146–47.
3. Collins and others (2009).
4. De Soto (2000).
5. Perhaps I should also have listed the government insurance programs my employer pays into on my behalf to aid me when I retire, or before then if I lose my job.
6. Commission on Thrift (2008).
7. Sen (1999).
8 . Berg (1978), 304–05.
9 . Ito (1999).
10. Mas and Radcliffe (2010), 9.
11. Mohapatra, Ratha, and Silwal (2010).
12. Banerjee and Duflo (2008). The authors use purchasing power parities to convert to U.S. dollars.
13. See also Morduch (1995).
14. Collins and others (2009), 40–42.
15. Collins and others (2009), 86–87.
16. Collins and others (2009), 68.
17. Banerjee and Duflo (2007), 149. The poverty line is $1 of household spending per member per day, converted to local currency using purchasing power parities.
18. Narayan, Pritchett, and Kapoor (2009), 21.
19. See Banerjee and Duflo (2007), 151, 152; “typical” figures are medians.
20. Banerjee and Duflo (2007), 162.
21. See David Roodman, “Kiva Is Not Quite What It Seems,” Microfinance Open Book Blog, October 2, 2009 (j.mp/1yAS6n), included in the appendix.
22. Karim (2008), 16.
23. Copestake (2002), 746.
24. Todd (1996), 25.
25. The custom of dowry makes girls economically burdensome and boys lucrative, reinforcing discrimination against girls.
26. Todd (1996), 16–17.
27. For example, Piesse (1841), 9.
28. For example, Wolff (1896), 2, 10, 16, 19.
29. Tippett coined the term “microenterprise.” Jeffrey Ashe, director of community finance, Oxfam America, Boston, Mass., interview with author, November 26, 2008. Seibel (2005) says he introduced “microfinance” in 1990.
30. De Mel, McKenzie, and Woodruff (2008a).
31. McKenzie and Woodruff (2008). Other studies have found similar conservatism among poor farmers in deciding, for example, whether to apply commercial fertilizer. See Morduch (1995), 105.
32. De Mel, McKenzie, and Woodruff (2008b).
33. Reynolds and others (2002), 13; Fernandez (2005).
34. International Labor Organization, Resolutions Concerning International Classification of Status in Employment Adopted by the 15th International Conference of Labor Statisticians, §§7, 10.3 (1993).
35. Rutherford (2009a).
36. Collins and others (2009), 13.
37. Rutherford (2009a), 16–17.
38. As discussed later, steady repayments over the saving period make the average balance half the starting balance and approximately double the effective interest rate. Extrapolating from 220 days to 365 raises the rate further.
39. Rutherford (2009a), 18.
40. Robinson (2002), 264.
41. Rutherford (2009a), 21.
42. Banerjee and others (2009).
43. Karlan and others (2010), 39.
44. Anderson and Baland (2002). The rotating savings and credit association (ROSCA) is the most prevalent form of informal group financial service. See chapter 3.
45. Ashraf, Karlan, and Yin (2006). The average effect reported here is for those receiving the offer, not those taking it. The group receiving the offer is randomly defined and is the basis for meaningful comparisons. People in the subgroup taking the offer are self-selected and might have saved more anyway. “Tension” refers to the time consistency, or hyperbolic discounting, the researchers found. Asked to choose between hypothetically receiving 200 pesos today or 300 a month later, and then between 200 in six months or 300 seven months from now, those women offering conflicting answers—200 when the choice was today, 300 when it was deferred—were more likely to join than other women, and than men generally.
46. See sharemicrofin.com/services.html. The insurance is underwritten by the U.K. group MicroEnsure.
47. Duflo and others (2008). “Expensive” means costing more than 300 rupees. The average reported cost for such episodes was Rs 1,900, which is more than twice the average per capita consumption in the sample, Rs 708.
48. Connie Bruck, “Millions for Millions,” New Yorker, October 30, 2006.