Banking in developing countries

Conventional wisdom would have it that one of the important obstacles to surmounting poverty is lack of access to formal banking services. It is assumed that once people are given access to bank accounts, they will manage their finances more efficiently, save more, and also leverage it to raise capital for their self-employment and other entrepreneurial needs.

However, as I have already written here, this may only be a partial interpretation. There is mounting evidence to show that conditional on access to a bank account, the majority of people use their bank accounts sub-optimally, most often as a mere storage for their cash balances. The Economist, which points to a newly released World Bank report (pdf here) on banking services usage across the world, writes,

The vast majority of people in developing countries - 88% - say they use banks solely for personal use. The commonest reason for taking out a loan, for example, is to pay for family emergencies (typically someone falling ill). That is followed by school fees, home construction and the expenses of a wedding or funeral. In Africa, 38% of those with bank accounts say they use them to receive remittances from family members abroad. One particularly important reason for having an account in Europe, Central Asia and Latin America is to bank money from the government, either salaries or benefits. In comparison, banks do not seem to be used so much for what seems like a basic purpose: saving money. More than a third (36%) of adults said they had saved some money last year. But only a fifth (22%) said they used a bank or other formal financial institution to do it; 29% saved, but not at a bank (presumably they put the money under the mattress or used it to buy jewellery).

 A few graphics from the report highlights these findings. Accounts penetration is very low in South Asia.



Even among those saving money, banks have not been able to marginalize the informal sources.

Further, a majority of those with bank accounts did not save.

Loans were mostly drawn for personal consumption than for business purposes. 

 Purchases of insurance products for health and agriculture is minuscule.
 

The last-mile challenge in banking for the poor

It has always been thought that lack of access to formal bank accounts prevented poor people from saving more and once accounts were opened they would be able to more optimally manage their finances. But now that we have made some progress, albeit tiny (only 5.5% of 650,000 Indian villages have bank branches and half the adults in the country do not have access to bank accounts), with access through the campaign for total financial inclusion (TFI), have the desired outcomes been achieved for those people?

Surprisingly, it does appear that having a bank account does not automatically translate into its use, much less efficient management of personal finances. Livemint points to a study by Skoch Development Foundation which found that only 11% of 25.1 million no-frills accounts opened between April 2007 and May 2009 are operational mostly because of the high costs.

India Development Blog points to an IFMR study of the impact of TFI campaign in Gulbarga District of Karnataka (claimed to have achieved 100% financial inclusion), which found that 36% of sample households remained without access to formal and semi-formal savings mechanisms and more importantly, access to bank accounts did not translate into bank account usage. It was found that the accounts were used mostly to manage NREGS payments or SHG transactions. Critical to the lesser than expected account usage is the high transaction costs, especially by way of travel costs.

I am inclined to believe that even if access to formal banking systems, by way of opening a bank account, is increased, actual usage is likely to remain low unless bridge the last mile gap and take banking to the door-step of the people, especially in rural areas. The recent decision by the Reserve Bank of India to approve the deployment of mobile bank business correspondents, equipped with electronic terminals, to transact at the sub-branch level is certain to increase the quality of access. This will ensure that, unlike now, rural account holders are more likely to actively transact using their accounts.   

In this context, mobile phones have the potential to revolutionize banking and increase utilization dramatically. Mobile phones-based technologies offer the attraction of directly placing the bank account in the hands of the customer, thereby lowering transaction costs and increasing the likelihood of account usage. It may therefore be tempting to get carried away by this possibility, coupled with a campaign to increase financial literacy, and assume that it will ensure account usage.

However, dovetailing NREGS and other government cash transfers through TFI accounts, extensive use of business correspondents and mobile phone-bassed technologies, and financial literacy, while necessary are not sufficient conditions to ensure optimal account usage.In fact, unless complemented with other initiatives, mere increase in access to banking accounts, could be counter-productive. It could just as easily enable access to debt and other less than desirable financial products, whose extensive adoption could be detrimental to the interests of the poor people.

Behavioural science teaches us that even with access to their accounts and adequate financial literacy, human beings are cognitively constrained. This in turn means that despite firm commitment to save or spend on certain things, people tend to renege and fall short on achievement. People discount the value of later rewards by a factor that increases with the length of the delay. They are therefore tempted to spend on immediate needs as opposed to save for important long-term requirements. Further, drawing from theories of "mental accounting", it has also been found that people tend to save optimally when they they know what they are saving for.  

It is therefore necessary that the bank accounts are structured to address these cognitive biases. This assumes importance since we need to bear in mind that the ultimate objective is not to merely enable access to bank account, but to enable poor people with systems to more effectively manage their scarce finances. What can be done to ensure that poor people save more, optimize on their interest returns, manage their long-term needs like health care, children's education and pensions, make more effective purchase decisions, and so on? In simple terms, how do we ensure that people not only manage their finances effectively, but also overcome their cognitive urges which are often determental to their interests?

I have written about several examples of how innovative financial products can overcome such cognitive biases and increase the likelihood of optimal outcomes for poor people with management of their finances. In fact, bank savings accounts and financial products, with subtle commitment features, have the potential to dramatically increase not only usage but also effective usage of bank accounts. I have bloggged earlier about Save More Tomorrow, default pension savings, lottery savings products, products to increase fertilizer consumption, multi-tier accounts (also here), and budgeting family expenditures. See also this and this.

In this context, there is a big window of opportunity. Bill and Melinda Gates Foundation have just pledged $500 million to helping poor people learn to save money. They propose to fund research and project interventions in this area to emulate the examples like the hugely successful mobile banking for the poor — via cellphone in Kenya and Bangladesh and smart card in Mexico. Spurred on by the low domestic savings rate, this area has been the focus of considerable interest in the US too. It is appropriate that some part of this be leveraged into experimenting with financial products and structured accounts that help overcome cognitive biases.

It needs to be borne in mind that TFI and optimal utilization of bank accounts by the poor needs to go beyond mere door-step acceess to bank accounts.

Global poverty rates are down

Tim Taylor points to a briefing note by Shaohua Chen and Martin Ravallion which indicates progress in global poverty reduction. The graphic captures the decline in poverty levels during the 1981-2008 period.

Looking back to the early 1980s, East Asia was the region with the highest incidence of poverty in the world, with 77% living below $1.25 a day in 1981. By 2008 this had fallen to 14%. In China alone, 662 million fewer people living in poverty by the $1.25 standard... In 2008, 13% (173 million people) of China’s population still lived below $1.25 a day. In the developing world outside China, the $1.25 poverty rate has fallen from 41% to 25% over 1981-2008, though not enough to bring down the total number of poor, which was around 1.1 billion in both 1981 and 2008... The $1.25 a day poverty rate has fallen in South Asia from 61% to 36% between 1981 and 2008. The proportion of poor is lower now in South Asia than any time since 1981.

But on the $2 a day basis, 70.9% of South Asia's population were living below the poverty line, down only marginallty from the 87.2% in 1981. On both poverty counts, a much greater proportion of Chinese were living below the poverty line in 1981. However, as the graphics below indicate, on both poverty standards, by the beginning of 1990s, China had overtaken India.




India's poverty rate reduction has been far slower than China's, reflective of the trickle-down, redistribution-driven economic growth strategy pursued by it.

Another Governance Failure?

India’s income per head grew more than fourfold between 1990 and 2010; yet the proportion of underweight children fell by only around a quarter. By contrast, Bangladesh is half as rich as India and its income per head rose only threefold during the same period; yet its share of underweight children dropped by a third and is now below India’s... Brazil cut the number of underweight people by 0.7% a year between 1986 and 1996 and reduced stunting by 1.9% a year. Bangladesh reduced both rates by 2% a year in 1994-2005...

... better nutrition can be a stunningly good investment. Fixing micro-nutrient deficiencies is cheap. Vitamin supplements cost next to nothing and bring lifelong benefits. Every dollar spent promoting breastfeeding in hospitals yields returns of between $5-67. And every dollar spent giving pregnant women extra iron generates between $6-14. Nothing else in development policy has such high returns on investment.

(HT: The Economist)

Tax and transfer to reduce inequality

I have blogged repeatedly about the critical role played by government transfers in reducing inequality and the unsustainability of economic growth in conditions of high inequality. However, transfers require tax revenues. This highlights the importance of taxation in addressing poverty and creating conditions for sustainable economic growth. The graphic below from The Economist draws attention to this.



In most European nations, the poverty rates are lower only because of the significant role played by government transfers. Transfers nearly halve poverty rates in these countries. Contrast this with the United States where the lower extent of transfers are responsible for keeping poverty rates high.

The role of taxes and transfers is even more pronounced with inequality measures. Similar trans-Atlantic trends persist with inequality reduction due to taxes and transfers. In case of many developing countries, as the cases of Mexico, Brazil, and Chile show, the low levels of transfers contribute towards their poverty and high inequality rates.

Why taxes are important to reduce poverty and inequality?

Free market conservatives oppose big government and favor reduction in taxes as the preferred route to the achievement of economic growth. They argue that governments are inherently ineffective in efficiently allocating resources and therefore should give way and facilitate private enterprise to achieve the same objective.

They claim that economic growth, thus achieved, will "trickle down" to benefit everyone by way of more jobs, higher wages, and better living standards. They therefore advocate that government's role should be confined to unshackling the restraints to private enterprise and providing everyone with the basic opportunities - health care, education, and skills - to compete in the market.

However, as Lane Kenworthy (see also this earlier) points out with empirical evidence, reality is not as simple. In fact, examining the trends in income levels among those at the lower end of the income ladder in the advanced economies since the 19760s, he finds that it was not trickle down but direct transfers that kept incomes growing. He writes,

"In almost all of these countries (Ireland and the Netherlands are exceptions) the earnings of low-end households increased little, if at all, over time. Instead, increases in net government transfers — transfers received minus taxes paid — tended to drive increases in incomes when they occurred."

The graphic below captures the average household income in the bottom decile of the posttransfer-posttax income distribution. Group 1 is Denmark, Finland, Ireland, Netherlands, Norway, Sweden, and United Kingdom, while Group 2 includes Australia, Canada, Germany, Switzerland, and United States.



Clearly, incomes have increased substantially after transfers for those in Group 1. In fact, Kenworthy goes further and argues that jobs and higher wages cannot produce the same trickle down effect on those at the bottom end. He writes,

"At higher points in the income distribution, they do play more of a role. But for the bottom 10 percent there are limits to what employment can accomplish. Some people have psychological, cognitive, or physical conditions that limit their earnings capability. Others are constrained by family circumstances. At any given point in time, some will be out of work due to structural or cyclical unemployment. And in all rich countries, a large and growing number of households are headed by retirees. We surely can do better at helping able adults get into (or back into) employment, but we shouldn’t pretend that paid work is a realistic route to guaranteeing rising incomes for everyone."

He also points to the importance of keeping income transfers dynamic enough to ensure that its share of incomes do not fall appreciably with time. He draws attention to the fact that in most affluent nations, including the Scandinavian ones, while transfers have increased, it has not done so at the rate required to keep its share of the GDP from falling. He writes,

"In most of these affluent nations... increases in the share of GDP allocated to public transfers largely stopped after the 1970s. In recent decades, the distinction has been between countries that kept transfers rising in line with GDP versus those that did not. Sometimes doing so requires no explicit policy change, as benefit levels tend to rise automatically as the economy grows. This happens when, for instance, pensions, unemployment compensation, and related benefits are indexed to average wages. Increases in other transfers, such as social assistance, typically require periodic policy updates. That’s true also of tax reductions for low-income households."

In particular about the US, his suggestion is,

"What the income data tell us is that the United States has done less well by its poor than many other affluent nations, because we’ve failed to keep government supports for the least well-off rising in sync with our GDP... Modest, regularized increases in the inflation-adjusted benefit levels of existing social programs — the Earned Income Tax Credit, unemployment compensation, social assistance (TANF and SNAP), housing assistance, and disability benefits — would yield significant improvements in the incomes of America’s least well-off."

Kenworthy's findings carry important lessons for policy makers in India. It clearly establishes that economic growth alone cannot address the problems of poverty and inequality, all the more so in regulated and under-developed markets like India. Government transfers are more important in achieving poverty reduction objective, especially for those at the bottom of the income ladder. However, there are two points of qualification.

One, transfers can be meaningful only when the the fiscal balance is in order and governments have the resources to carry out such transfers. Robust economic growth is the only route to keeping public finances in good strength. Two, it is important to ensure that these resources are utilized to deliver bang for the buck. The most effective strategy to optimize public spending is to channel it towards those activities which address market failures and enables equality of opportunity to all citizens in accessing the market. This requires a very scarce commodity - far-sightedness in public policy making.

The psychology of poverty

Conventional wisdom on poverty has been that poor remain poor because of low incomes and their certain lifestyle and behavioural traits - lack of cleanliness, limited self-control, wasteful expenditures, idling away time etc. While incomes are not within their control, it has been argued that the poor could be encouraged to change certain behavioural traits that could increase the likelihood of their overcoming or atleast mitigating poverty.

This post is a summary of considerable research that appears to point to a significant role of behavioural psychology in determining the behaviour of the poor.

1. I had blogged earlier about the bee-sting theory of Charles Karelis.

When we're poor our economic worldview is shaped by deprivation, and we see the world around us not in terms of goods to be consumed but as problems to be alleviated. This is where the bee stings come in: A person with one bee sting is highly motivated to get it treated. But a person with multiple bee stings does not have much incentive to get one sting treated, because the others will still throb. The more of a painful or undesirable thing one has (i.e. the poorer one is) the less likely one is to do anything about any one problem. Poverty is less a matter of having few goods than having lots of problems. Poverty and wealth, by this logic, don't just fall along a continuum the way hot and cold or short and tall do. They are instead fundamentally different experiences, each working on the human psyche in its own way.

Karelis argues that poverty introduces a diminishing marginal utility to putting in effort, "One doesn't have enough money to pay rent or car insurance or credit card bills or day care or sometimes even food. Even if one works hard enough to pay off half of those costs, some fairly imposing ones still remain, which creates a large disincentive to bestir oneself to work at all."

2. Conventional wisdom would have it that people exercise their free willpower to resolve conflicts among competing choices and demands on their scarce resources (be it money, time, space, attention, affections etc) and make decisions in a rational manner and in their best interests. In other words, these decisions are thought to be under the control of the respective individuals.

A recent New Republic article points to the pioneering work of researchers from Case Western Reserve University, Roy Baumeister, Ellen Bratslavsky, Mark Muraven, and Dianne Tice, who found that an individual’s capacity for exerting willpower was finite. Their experiments found that self-control was depletable - exerting willpower in one area makes us less able to exert it in other areas subsequently in the immediate future.

They had food-deprived subjects sit at a table with two types of food on it: cookies and chocolates; and radishes. Some of the subjects were instructed to eat radishes and resist the sweets, and afterwards all were put to work on unsolvable geometric puzzles. Resisting the sweets, independent of mood, made participants give up more than twice as quickly on the geometric puzzles. Resisting temptation, the researchers found, seemed to have "produced a 'psychic cost'".

In another experiment, participants were asked to remember a number – the number was randomly selected to either be a short two digit number or a seven digit number – and then to walk down a hallway to another room for an interview. As a seeming afterthought, they were told there is a snack cart in the hallway and to help themselves to one of the snacks. The snack choice was either fruit salad or chocolate cake. The subjects asked to remember the two-digit number selected the fruit salad in equal proportions to the chocolate cake. The subjects tasked with remembering the longer seven digit number overwhelmingly chose the chocolate cake. The authors attribute this to depletable self-centrol - when attention is focused elsewhere, such as on retaining a long number, there is less of this resource available to guide the decision over snack choice.

In another experiment in rural Rajasthan by Dean Spears, people were, in random order, offered to purchase a well-known brand of soap at a highly discounted price and they were also asked to squeeze a mildly resistant handgrip for as long as possible (handgrips are common way to measure cognitive control, with the duration determined by mental will power). He found that if the hand grip came before the offer of discounted soap, both poor and rich respondents squeezed the grip for an average of two minutes. But if the decision to purchase soap was taken before the hand grip exercise, the rich respondents still held the handgrip for an average of two minutes, while the poor gripped for a full 40 seconds less. He found that by making economic decision making more difficult for the poor, poverty depletes cognitive control.

These results have been corroborated in more than 100 experiments, where researchers have found that exerting self-control on an initial task impaired self-control on subsequent tasks - consumers became more susceptible to tempting products; chronic dieters overate; people were more likely to lie for monetary gain; and so on. In addition to self-control decisions, these researchers have expanded the theory to cover tradeoff decisions - like choosing between more money and more leisure time. They have found that tradeoff decisions require the same conflict resolution as self-control decisions and appears to similarly deplete our ability to muster willpower for future decisions.

In all these cases, willpower can be understood as the capacity to resolve conflicts among choices as rationally as possible, and to make the best decision in light of one’s personal goals. And, in all of them, willpower seems to be a depletable resource. The Development Impact blog writes,

"The conditions of poverty exact a heavy toll on cognitive resources through the everyday challenges of scarcity. The repeated trade-offs confronting the poor in daily decision making – i.e. "should I purchase a bit more food or a bit more fertilizer?" – occupy cognitive resources that would instead lay fallow for the wealthy when confronted with the same decision. The rich can afford both a bit more food and a bit more fertilizer, no decision is necessary...

My impulsive desire may prefer the consumption good in front of me, but my cognitive control can resist that impulse and select the alternative investment good if it hasn’t already been depleted through recent repeated usage. If my control resource has been depleted through earlier use, then the conditions of poverty can induce behavior that in turn prolongs poverty... because cognitive control is a depletable resource, the higher frequency of difficult economic decisions confronting the poor takes a toll on subsequent decisions."

Dean Spears did field experiments in India and analysed the American Time Use Survey and found that poverty is responsible for lower performance and control.

3. The theory of declining temptations says that the fraction of the marginal dollar that is spent on temptation goods decreases with overall consumption. Sendhil Mullainathan and Abhijith Banerjee argue that "declining temptations can help to explain a large range of phenomena, from poverty traps to credit and investment behavior". They argue that this "has a number of striking implications for the investment, savings, borrowing and risk-taking behavior of the poor".

They advocate using these insights to design commitments savings products (that both force savings and limit withdrawals) for poor people. Nava Ashraf, Dean S. Karlan, and Wesley Yin designed commitment savings products for a Philippine bank and found that those who opened the account increased savings by 192% and 337% over 6 and 12 months respectively relative to the control group.

4. Lack of control

Psychologist Martin Seligman has propounded the concept of "learned helplessness", as a "condition of a human person or an animal in which it has learned to behave helplessly, even when the opportunity is restored for it to help itself by avoiding an unpleasant or harmful circumstance to which it has been subjected". It follows that clinical depression and related mental illnesses may result from a perceived absence of control over the outcome of a situation.

Accordingly, when we don't feel we have some level of control over our lives we get depressed. And when we feel we have no control for a long time we stop trying to improve a terrible situation because we don't think it's possible anymore. Eric Barker writes about the story of taming elephants - after being leashed by a chain and realizing that they cannot break-free, elephants stop trying to get free even if the chain is replaced with a rope. Such feeling of lack of control, arising from factors like unfair workplaces, bad bosses, and unemployment, have been found to lead to poor health. It is therefore natural for a poor person, who faces a series of continuous struggles on even the most mundane and basic of things, to feel that things are mostly out of his control and accordingly feel depressed and unproductuive.

5. Decision fatigue

I have blogged earlier about a study by Shai Danzigera, Jonathan Levavb and Liora Avnaim-Pessoa of the changes in the nature of decision-making by eight experienced parole judges in Israel during a court session. They found that the prisoners appearing for parole were "anywhere between two and six times as likely to be released if they are one of the first three prisoners considered versus the last three prisoners considered".

The larger message sought to be highlighted by this experiment is that human beings are vulnerable to decision fatigue - the ability to discriminate and make objective decisions get depleted as the session or day (or even life?) progresses. Jon Tierney sums it up nicely,

"No matter how rational and high-minded you try to be, you can’t make decision after decision without paying a biological price. It’s different from ordinary physical fatigue — you’re not consciously aware of being tired — but you’re low on mental energy. The more choices you make throughout the day, the harder each one becomes for your brain, and eventually it looks for shortcuts, usually in either of two very different ways. One shortcut is to become reckless: to act impulsively instead of expending the energy to first think through the consequences... The other shortcut is the ultimate energy saver: do nothing. Instead of agonizing over decisions, avoid any choice. Ducking a decision often creates bigger problems in the long run, but for the moment, it eases the mental strain. You start to resist any change, any potentially risky move — like releasing a prisoner who might commit a crime. So the fatigued judge on a parole board takes the easy way out, and the prisoner keeps doing time."

This analysis is similar to the arguement above that people have a finite store of mental energy, which enables them to exert self-control. Therefore, once they indulge in activities that require utilization of this self-control (like decision making), their reservoir of mental energy is depleted, and they are likely to show less mental commitment in subsequent activities. This phenomenon manifests itself in people making irrational and often impulsive choices and decisions when their mental energy level gets depleted.

Extending this analysis to poor people could help throw light on some of the elements that characterize people living in poverty. Experiencing scarcity in everything (time, money, space, jobs, physical strength etc), more than any others, poor people have to constantly make decisions involving trade-offs. This depletes their pool of mental energy faster, leaving them to either act impulsively or not act at all. The popular caricatures of poor people with different manifestations of these attributes can atleast partially be attributed to decision fatigue and depleting mental energy.

Tierney offers a neat summary of all these new behavioural psychology theories of poverty,

"This sort of decision fatigue is a major — and hitherto ignored — factor in trapping people in poverty. Because their financial situation forces them to make so many trade-offs, they have less willpower to devote to school, work and other activities that might get them into the middle class. It’s hard to know exactly how important this factor is, but there’s no doubt that willpower is a special problem for poor people. Study after study has shown that low self-control correlates with low income as well as with a host of other problems, including poor achievement in school, divorce, crime, alcoholism and poor health."

Mathew Effect in Poverty

The experience from Great Recession has once again conclusively shown that as the economy weakens, the under-privileged and disadvantaged are the most vulnerable. It is doubly ironic that these people are suffering in a recession caused by those at the top of the social and income ladder, most of whom have been spared the worst and many are even prospering. Clearly, the poor are paying for the sins of somebody else!

Consider these three graphics from the impact of the Great Recession on the American society. People with a four-year degree — who have an unemployment rate of just 4.3 percent — are barely experiencing an economic downturn. It should come as no surprise that not only were the least educated most vulnerable during the plunge into recession but also the least successful during the recovery. In fact, those with the best education levels enjoyed an increase in employment rate during the recession.



Among all industries, those with lower than high school education performed much worse than those at the higher end.



This graphic captures the magnitude of the disparity



A more rational analysis would explain this irony as the natural order of things in a modern economy. Not only are those at the lower end of income ladder more vulnerable to recessions and slowdowns, they are also among the least likely to benefit from any booms or upturns.

For a start, those at the lower end of the income ladder obviously do not have the wealth to cushion them from any dips in their incomes, just as those at the other end can draw down from their pots. But more critically, the dynamics of modern economies - education-premiums, skill-bias etc - militates against those initially disadvantaged or under-privileged. A form of Mathew Effect - "For to all those who have, more will be given, and they will have an abundance; but from those who have nothing, even what they have will be taken away" - is a distinguishing characteristic.

Therefore, as economies globalize, the case for a strong, universal, and dynamic social safety net becomes ever more relevant. People are more exposed, often directly, to global economic forces, many of which may adversely affect their livelihoods and push them into poverty or deepen their existing poverty-stricken condition. Further, unlike earlier times when economic mobility was mostly upwards and at a slower pace, such mobility is becoming increasingly rapid and also involves two-way movements.

In the circumstances, if economies are to cushion their vulnerable sections of population to the vagaries of these global economic forces, a social safety net should be a priority. This comfort is also necessary to increase the political acceptability of policies that involve trade liberalization and making labour markets more liberal and flexible.

The dynamic nature of these changes in income status also means that increasingly social safety entitlement programs should have an automatic entry and exit provisions. Those who suddenly fall into poverty (by say, an easily identifiable event like job loss or migration back into his village etc) should be able to avail of the social safety benefits just as those who experience an increase in incomes should drop-off. This automaticity, like with unemployment benefits in the US, will minimize the role of governments, with all its political dimensions, and make these programs more efficient and less distortionary.

At some time, when Aadhhar becomes more universal, and integrated national databases are available, it may be possible to have such dynamic poverty programs in India too. For example, those who get a government job could be declared ineligible for food rations with immediate effect. This will address one of the current biggest problem with entitlement programs in India - absence of sunset clauses.

The Economics of Migration

Removal of cross-country barriers to labour mobility has often been described as the largest single policy intervention to address global poverty and the last remaining prominent distortion in the global economy.

Micheal Clemens, one of the leading researchers on labor migration and who has described it as the "world's greatest arbitrage opportunity", has an excellent summary of the literature on migration in the current issue of JEP. His conclusion about the benefits of labor migration is unambiguous,

"The available evidence suggests that the gains to lowering barriers to emigration appear much larger than gains from further reductions in barriers to goods trade or capital flows — and may be much larger than those available through any other shift in a single class of global economic policy... For the elimination of trade policy barriers and capital flow barriers, the estimated gains amount to less than a few percent of world GDP. For labor mobility barriers, the estimated gains are often in the range of 50–150 percent of world GDP. In fact, existing estimates suggest that even small reductions in the barriers to labor mobility bring enormous gains."

He finds "trillion dollar bills on the sidewalk" from liberalizing restrictions on emigration. The paper has a nice summary of the estimated benefits from emigration.



He argues that research on migration has hitherto focussed on remittances and "brain drain", and paid limited attention to the considerable direct and indirect human capital externalities that arise when people migrate from poorer countries to richer in search of livelihood opportunities. More fundamentally, migration research has focussed on the effects of immigration but little on emigration. He therefore sets out the agenda for work on this field,

"It should be a priority of economic research to seek a better characterization of the gains to global labor mobility and to investigate policy instruments to realize a portion of those gains. The four questions in this paper suggest one structure for that agenda. We clearly need a better theoretical and empirical understanding of human capital externalities; the dynamics of labor demand under large-scale migration flows; the magnitude and mechanisms of the effect of workers’ location on their productivity, relative to the effect of workers’ inherent traits on their productivity; and the policy instruments that might make greater labor mobility possible."

As Prof Clemens writes, the reason why "migration packs such an economic punch" is that a worker's productivity depends much more on location than any other factor, including skill. An earlier study (see also here), profiled the wage gaps of Peruvian workers with different profiles working in Peru and as immigrants in the US, and found massive differentials. The same would apply to workers from any other developing country migrating to developed economies and doing the same occupation. Differences in work environments, regulatory environments, legal systems, technology spill-overs, proximity to other high-productivity workers, etc explain this difference. The graphic below captures the differential for Peruvian domestic workers and immigrants.



The biggest challenge in achieving success with reduction of barriers to emigration will be political. In particular, it immediately raises the regular bogeys - loss of jobs for the destination country labour, downward pressure on wages there, impact on national security, and so on. Surmounting these very formidable and entrenched fears will be a big challenge before the issue of barriers to emigration can be addressed to some level of satisfaction.

The current weakness in developed economies is a dampener to immigration. The political opposition to immigration can be blunted only when the economy is flourishing and when the domestic workers in these developed economies are themselves not constrained by unemployment. At a time when protectionism is slowly creeping into international trade, policies that favor relaxation of restrictions on labour mobility may generate intense opposition in these economies.

However, the silver-lining could be the demographic trends in many developed economies. As the demographic profiles of these economies shift upwards, they will experience labour shortages across many areas. Once this starts affecting their economies, like what is already happening in Japan and parts of Western Europe, policies that favor immigration will find greater acceptance. This shortage is more likely to manifest itself in less knowledge-based and lower skilled professions, especially in services, which the older-aged workers will not be able to perform. Fortunately, these are also precisely the same labour categories where the marginal gains from immigration are the largest.

There are possibly two other reasons why this differential will be predominant among lower skilled than high-skilled knowledge workers. In case of the later, as part of globalization and demand in advanced economies, restrictions on labour mobility have been eased considerably over the past two decades. This has also had the effect of lowering arbitrage opportunities in their wages. Further, many of these activities are not location based and could be easily off-shored. In contrast, many semi- and lower-skilled professions in the services sector cannot be off-shored, and their persistent high wage differentials coupled with the impending labour shortage (in developed economies) will offer attractive opportunities for migrants.

On rights-based development and populist quick-fixes

Pranab Bardhan has a brilliant essay in Boston Review that strikes an immediate chord with development discourse in India. Instead of commenting, let me reproduce portions.

He appreciates the concern among civil society groups and activists at the extreme poverty and vulnerability of the marginalized and their enthusiasm for a rights-based approach (as against the dole-based approach of traditional welfare state). However, he cautions against the prevailing craze for it,

"It (rights-based approach) serves to raise consciousness among the poor and the vulnerable about their entitlements, and remind them that they are not mere supplicants to politicians and bureaucrats. In a weak administrative and institutional context, however, the NGO approach of uncompromising support for citizen’s rights can cause more harm than good. If the structure for implementing some of these rights is weak and corrupt, then the rights are hollow and promoting them breeds cynicism."

In the context of India where courts have joined civil society groups in taking up the cause of the poor and vulnerable, he strikes a much-needed but politically incorrect note of caution,

"India is already littered with hundreds of unenforced or spasmodically enforced court injunctions, some of them on the implementation of rights. This proliferating judicial activism, egged on by the rights-based movement and the media, may end up, for all its good intentions, undermining the credibility and legitimacy of the judiciary itself."

Prof Bardhan hits the nail on its head when identifying the real limitation of civil-society activism driven rights-based approach to development in societies where the ability of governments to deliver is severely constrained. He writes,

"The social activists share with left-wing unions a preoccupation with redistribution, and a lack of concern for generating enough surplus to enable it. There are obvious trade-offs here between incentives for private enterprise and the need for social justice... When real capacity to create wealth is missing, social activism is often reduced to mere populism, which in the long run can be wasteful and counterproductive."

This is the biggest problem with the dominant development policy discourse in India - too much of wealth re-distribution and too little of wealth creation!

Again, in light of the political drama surrounding anti-corruption activists and their populist quick-fixes, Prof Bardhan questions their right to appropriate the mantle of popular legitimacy in democratic societies,

"In the policy arena... such non-party organizations cannot and should not threaten to replace the role of traditional party organizations in a democracy. Voluntary groups, as single-interest advocacy lobbies, lack the mechanism of transactional negotiations and give-and-take among diverse interest groups that large party organizations, representing and encompassing those varied interests, possess.

This kind of give-and-take is particularly important when resolving controversial issues and requires complex trade-offs and balancing of diverse interests. Those who speak for the poor usually underplay the diversity among the poor and sometimes romanticize their traditional way of life. A dam may benefit thousands of small farmers in hitherto parched land, even as it displaces thousands of others; a development project may displace some from their ancestral land but provide jobs and more productive livelihoods for others; and so on. Each such case involves complex trade-offs and demands negotiated compromises and compensations across groups and over time. Such deliberations should take place within a party forum where diverse interests and stakeholders are represented."

Finally, this message for those opposing capitalism on the grounds that capitalist exploits the poor, is extremely relevant,

"Activists who romanticize the pristine life of the poor and the indigenous, and ignore a great deal of misery and stagnation, should keep in mind that the horrors of capitalism fade in comparison with the horrors of pre-capitalism."

A market solution to child malnutrition problem?

Poor households in big city slums invariably live in unbelievably cramped single room accommodation, with access to limited civic amenities like water supply and sanitation. Furthermore, both parents generally have to work to earn atleast food for the family.

In the circumstances - strapped for time, space, and resources - women make do with cooking simple, but unhealthy, carbohydrate heavy meals (say, rice/roti and curry), which are filling and keeps away hunger. The women do this despite being aware of the importance of nutritious food and what constitutes such foods. The higher cost of nutrient-rich foods is just another reason for this, though this is debatable.

Policy makers have long debated various strategies to improve the nutrition status of atleast the children living in slums. The Anganwadi centers are among the most visible of such interventions, and have had considerable successes in some areas. However, the overall nutrition of the family remains elusive. The large numbers of small eateries - women squatting on street margins, push carts, road encroachment stalls etc - in slums too provide much the same carbohydrate and fat heavy foods.

Faced with similar circumstances in the over-crowded slums of Jakarta, an NGO Mercy Corps started a healthy street food business for children called Kedai Balitaku, or My Child’s Café in April 2009. It started with a $120,000 donation, has since spun off into a for-profit company. The idea was that once people have access to healthy foods at very cheap prices (same as those of the unhealthy foods available elsewhere), they will prefer such foods over their traditional ones, atleast once a day. Creating a buzz around such foods, by careful marketing helps. An article by Tina Rosenberg in the Times describes KeBal,

"KeBal sells niche street food. Its clientele is children — and it focuses on those 5 years old and younger. The most popular meal is a chicken, rice and vegetable porridge, which costs the going rate of 20 cents. The leading snack is a 10 cent gelatin pop. Such pops are a common snack but they are almost always made with artificial fruit flavors; KeBal’s are made with real mango, strawberry, melon or other fruits. The menu also includes meatballs, macaroni and cheese and shu mai dumplings. The carts use food-grade materials and vendors get regular health inspections from KeBal’s management.

Nutritionists designed the menu, but just as important as what went into the food was convincing mothers to buy it and children to eat it. The advertising firm Saatchi & Saatchi donated the design of the visual brand and a marketing strategy aimed at children. The carts have bright colors and play music. Four dolls on the cart represent different food groups and are named for benefits of good nutrition — Strong, Smart, Lively and Taller. The cart also has built-in toys teaching shapes or colors that kids can play with while they wait. They display hand-washing messages and have jugs of water with soap so vendors can wash dishes and children can wash before they eat. The food is displayed at a child’s eye level. The Times column writes,

The food is prepared by KeBal employees in a cooking center, which starts work just after midnight to make food to sell to eight vendors, who begin their routes around 5 AM. The vendors take the risks and keep all the profit on the food they sell. KeBal is about to open a second cooking center, and is planning to have six by the end of the year, each providing food to at least eight vendors. Next year, as soon as Indonesian franchise law allows, KeBal will also start selling cooking center franchises. By 2013, the company hopes to own 21 cooking centers and have 10 more owned by franchisees. That will allow it to feed 6,000 children daily and take in projected revenue of at least $2 million a year."

An approach that mirrors KeBal, catalyzed with initial government or some non-government foundation support, and initiated in different cities across the country, has the potential to be a major intervention to improve nutrition levels in countries like India. The menus will have to be customized to meet local food requirements and locally available healthy foodstuffs.

Poverty and vulnerability in India

One of the most interesting graphics in the recently released World Bank report on poverty in India is one that highlights how much vulnerable are a large proportion of the non-poor to aflling into poverty. Vulnerability is defined in terms of the threat of the family falling into poverty in future. It is a measure of the volatility of household incomes and exposure to various external risks.

The graphic below captures the clustering of rural, urban, and mega-urban populations around the poverty line. The intensity of clustering has hardly changed over the decade.



I can think of four implications for poverty eradication and development policy-making from this finding

1. It is as much important to monitor and support those who have moved into poverty (from being non-poor) as it is to assist those who are below the poverty line. In other words, the poor are a dynamic population, more so in rural India. People continuously move in and out of poverty, possibly with seasonal periodicity. Given the close clustering of people around the poverty line, especially in rural areas, large numbers of people are likely to fall into poverty in times of economic uncertainty (in rural areas mainly, weather related shocks, say, a poor monsoon).

2. Targeting those below the poverty line becomes a near impossible task given this close clustering, especially in rural areas. Even if we are able to narrowly and quantitatively measure those below and above the poverty lines, it is impossible to qualitatively assess, with any reasonable degree of satisfaction, whether their lives correspond to those of the poor or non-poor.

In other words, accuracy in targeting, even with technologies like bio-metric identification, will come up against the difficulty of cracking the eligibility criterion. The fact is that, atleast in rural areas, most people are either poor or run the risk of falling into poverty. This also means that strategies that seek to leverage self-selection (the non-poor will naturally de-select themselves from accessing the benefits, and therefore enable more effective targeting) becomes relatively ineffectual.

3. In view of the tight clustering of the overwhelming share of the population around the poverty line, is there a case for universal subsidy transfers, especially in rural areas? Why not subject the same flawed below poverty line (BPL) figures in various states to more rigorous analytics to identify the degree of clustering, and decide on making subsidy universal if the numbers of poor exceed an agreed cut-off parameter? The transaction costs and inefficiency distortions associated with targeting (and a dual-price regime) would far outweigh the additional expenditure required for the expansion.

4. Addressing this type of pervasive poverty may require going beyond the prevailing development paradigm in India that seeks to overcome poverty through wealth re-distribution (welfare programs, self-employment and livelihood programs, etc) instead of wealth creation (rapid and equitable economic growth, and massive job creation).

Welfare enhancing policies cannot address the issue of development when poverty is so widely pervasive. It works best when poverty exists at the margins, and that too only to the extent of providing welfare support. It is growth promoting policies that are required to pull an entire population out of poverty, as is the case with the widespread poverty in India.

This is not a call to junk all welfare programs, but only a reminder that welfare policies cannot achieve the objective of poverty eradication. That requires policies that promote growth and create jobs. Welfare policies can at best provide the cushion or platform on which wealth creation policies can be sustained (or its risks mitigated).

How the rich and poor benefit from government

I had blogged yesterday on the critical role played by governments in the effective functioning of free markets. I also pointed out that despite being more critical of governments than the poor, the rich benefit disproportionately from government and its activities.

Here is a Venn diagram that captures the relative shares of rich and poor in both private and public provisions of physical infrastructure and rule of law.



The circle (B+E+C) represents government provision of physical infrastructure and rule of law. The remaining part of the square represents private provision of infrastructure and social and private capital driven contracts.

The rich rely on the governments to provide a major share (C) of both these - physical and social/economic - infrastructure. The rely on private provisioning only where governments fail. In contrast, the poor rely mostly on private provisioning of all infrastructure (A) and have a limited uptake of public infrastructure (B). The intensity of government provisioning of both types of infrastructure is much more in cities than villages, where most of the poor live. Even in case of the urban poor, they work mostly in the un-organized sector and transact in the parallel un-regulated economy.

So, despite the very evident benefits that the rich derive from the role of governments, why are they and the middle class the most vocal critics of governments? Why do they want to down-size the very agency whose activities underpin their own success? There are obviously many reasons, ideological and non-ideological. However, I have three fundamental explanations that come to mind

1. There are a few related cognitive biases at play here. Human blindness to availability bias means that they easily recall the high-profile failures of governments (and there are no dearth of such ones) while over-looking the several government-driven provisions that are taken for granted. Their vulnerability to representativeness bias means that they over-estimate the probability of government failures instead of using a Bayesian calculation to weigh the relative successes (or benefits) and failures (or losses) of governments.

2. On a more material dimension, human beings naturally prefer to partake of benefits without having to pay for it. Public provision of physical and social-economic infrastructure is expensive and requires that people pay substantial taxes. Who likes to pay taxes? It must be one of those rare things which though everyone dislikes, is essential to maintain a functional society and economy.

3. People find government a convenient "other" that can be blamed for everything that is wrong with the economy and society. Government (by implication politicians and officials) is responsible for corruption, inefficiency, poor quality of service delivery, poverty and under-development, deficient infrastructure. Though the blame is richly deserved, it is not their exclusive preserve. It should be apportioned among the larger society itself, its populist opinion makers, our own disinclination to pay taxes, free-ride on public infrastructure, and so on.

Free distribution or positive subsidized price?

Over the last few years, there have been a proliferation of field experiments across developing countries which have tried to examine the impact of pricing on the uptake of various health protecting products by poor people. What is the price (in terms of both incentivizing purchase and ensuring usage of the product) or subsidy that delivers the greatest bang for the buck?

The standard belief has been that people will not value products and services that are provided free. It is therefore most effective if these products and services are delivered at some small nominal cost, so as to foster a sense of ownership among the beneficiaries. People are more likely to use soap for cleaning their hands or chlorine for sanitizing drinking water or ITNs to keep-off mosquitos if these products are provided at nominal rates.

However, Randomized Control Trials (RCTs) in Kenya, Zambia and India have shown that uptake for products like insecticide treated bednets (ITNs), soaps, chlorine pellets, and de-worming tablets was highest when they were distributed free and uptake reduced exponentially when prices were raised even slightly. These findings are now being invoked to call for free distribution of health protecting, education improving and other welfare enhancing products and services to poor people across the world.



In fact, the RCT experiments have gone further and explored various other dimensions of usage. Pascaline Dupas and Jessica Cohen found several interesting results from their ITNs RCTs in Kenya - those who purchase ITNs are no more likely to be sick at the time of purchase (screening effect); those who are distributed free are no less likely to use it than those who paid (subsidized prices) and purchased nets (sunk-cost effect).

However, they found that subsidized positive prices dampens demand - ITNs uptake drops by sixty percentage points when its price increases from zero to $0.60 (or from 100% to 90% subsidy). Another study that provided un-subsidized ITNs with micro-consumer loans in India found that the uptake (usage the previous night) was just 16%, compared to 2% in control areas and 47% with free distribution.

There are several imponderables and mixed results that prevent drawing any generic inferences about pricing from these experiments. It is not possible to argue that free provision unambiguosly increases usage. Further, if a price is charged, it is even more difficult to arrive at a reasonably accurate price point where both purchases and usage is optimized for each product. Uncertainty on pricing can tip the scales either way. A few observations from these studies

1. It is premature to start generalizations from these results. I am inclined to believe that there may exist a trade-off between awareness and price that determines uptake of such products. Accordingly, the uptake is likely to be more even with positive subsidized prices if people are aware of its benefits (this does not equate to those who require such products more). Conversely, with lower awareness, free provision is likely to be more effective. It is however, difficult to draw a generic conclusion to this effect for all products and services.

2. Further, unlike non-acute care products like ITNs, critical care products are likely to exhibit lower price elasticity of demand (uptake). In other words, they are likely to be less sensitive to prices. This begs the question, what are non-acute care and which are critical care products?

3. The inferences from these studies are critically dependent on the contexts and varies across products. For example, while there is little evidence that those most in need of ITNs are more likely to buy and use it, the purchase (though not usage) of chlorine disinfectant liquid has been found dependent on need.

Another example of contradictory outcomes is with the provision of free school uniforms for children. Diana Hidalgo, Mercedes Onofa, and others found negative impact from a randomized experiment that provides free uniforms to primary school children in Ecuador. They found that "parents who pay for their children’s uniforms (the control group) feel more committed to the school than parents who got the uniforms for free (the treated) and therefore encourage their children to attend school". In contrast, a study in Kenya "found that providing a free school uniform increased attendance of young children by 6.4 percentage points".

4. In the final analysis, the purchase and use patterns of each of these products depend on a series of perceptions about its relative efficacy and utility for the consumer. In some cases, people are likely to show a reduced uptake when a product which was hitherto offered free was now offered for a small positive subsidized price, whereas in some others there would be no such effect. In some other cases, people are likely to see free products as signalling inferior quality and therefore show limited interest, whereas a high (but affordable) enough price would signal superior quality. In some cases, when people play a high enough price (how much is this "high enough" price?), the sunk-cost effects would take prominence and force people into using the product, while is cases like chlorine usage in Zambia showed no such effect.

5. Finally, to the extent that all such interventions are ultimately successful if they deliver on outcomes, there is no guarantee that such free supply will generate the intended results. A recent RCT of ITN usage in Orissa involving free distribution and purchase at unsubsidized prices with consumer micro-loans found little evidence of any "improvements in malaria and anemia prevalence, measured using blood tests". The authors attribute the failure to "insufficient ITN coverage" among the treatment villagers.

This debate again highlights the fundamental weakness with RCTs - the problem of generalizability. How and why do these interventions succeed? What processes and which environments are a pre-requisite for the success of a program? What is the role of cultural and other environmental issues on each intervention? Then there is also the limitation with how much can we generalize such results.

Update 1 (26/5/2011)

See this JPAL Bulletin explaining the benefits of free supply.

Minnesota FFA chapter tackles issues of hunger, poverty at banquet

http://www.postbulletin.com/news/stories/display.php?id=1448789

The Plainview-Elgin-Millville FFA chapter in Minnesota recently hosted a Hunger Banquet at their school to help their classmates gain a greater understanding of hunger and poverty.

At a hunger banquet,guests draw tickets at random that assign them each to either a high-,
middle-, or low-income tier–based on the latest statistics about the number of people living in poverty. Each income level receives a corresponding meal: the 15 percent in the high-income tier are served a sumptuous meal; the 35 percent in the middle-income section eat a simple meal of rice and beans; and the 50 percent in the low-income tier help themselves to small portions of rice and water. Guests can also assume characterizations that describe the situation of a specific person at the income level to which they’ve been assigned. Finally, all guests are invited to share their thoughts after the meal.


FFA member Kimberly Wingard says she first participated in a hunger banquet when she attended FFA's Washington Leadership Conference.

~~~

Are you interested in hosting a hunger banquet at your school?

Free resources are available through Oxfam America.

Drops Not Drones, Vaccines Not Marines

You are likely to be judged by the company you keep. In Osama bin Laden's case, the isolated mountains of tribal Afghanistan and Pakistan provide a perfect safe haven for him and for polio. Thirty years of conflict and low economic development have resulted in security and health infrastructure that is inadequate for deploying an effective regional eradication program. Thus the Af-Pak borderlands remain one of only a handful of places (including India and Nigeria) where polio is endemic, though flare-ups also occur across Africa and Central Asia due to importation.

As the Afghan war moves into its tenth year and intensifies to ten airstrikes per day, the time is beyond ripe to question whether we're packing the right payload. The United States spends more than $100 billion per year executing the war in Afghanistan, while Afghan GDP is around $15 billion. Clearly this is unsustainable.

Compare this to the figures required for global health and development. Bill Gates said recently that $2 billion is needed for polio eradication over the next two years, while the campaign is currently experiencing a $700 million shortfall. In a speech at the former Roosevelt home in New York, Gates delivered his annual foundation letter in which he outlines his strategy for charitable giving. Polio eradication is the key focus this year, and his rationale centers on four points:

1. We are close to eradication: There are only about 1,000 cases left per year globally;
2. Eradication will permanently free up resources for other vaccination and health campaigns;
3. The affected regions will benefit in terms of economic productivity; and
4. Eradication will provide a motivational victory for the health industry, driving further hope and investment.

As polio is just one affliction of poverty among many, it's important to consider the opportunity costs. Critics such as D. A. Henderson, the leader of the team who eradicated smallpox, feel that dumping billions into polio eradication is a misallocation of funds. Polio is difficult to kill because of a number of combined factors: the variety of strains, asymptomatic carriers, a vaccine that is not 100 percent effective, parental refusal, a lack of infrastructure, and management problems in organizing all the national campaigns. It is very much a door-to-door endeavor, but so was smallpox eradication.

THE GATEWAY IMMUNIZATION

A point in favor of financing polio eradication is that the vaccine can be viewed as a gateway process leading to routine immunization services for more common diseases. One-fifth of children today don't have such access. Beyond the obvious health consequences, lack of access also presents an organizational problem in the fight against polio because it leads to underreporting and thus keeps the virus elusive.

There is also the issue of innovative and appropriate technologies: Something as simple as camel-portable refrigerators could go a long way toward keeping vaccine doses fresh. If the U.S. military is deploying innovative solar modules to replace the generators that power air conditioning at its forward operating bases in Afghanistan, then clearly some of these technologies can be repurposed for more benign operations.

THE MORAL DIMENSION

At the Bill Gates event, David Oshinsky, author of Polio: An American Story, said we need to motivate a new March of Dollars to "get kids interested in the moral dimension" of helping other kids around the world. The original March of Dimes organized by the National Foundation for Infantile Paralysis was able to finance research for the polio vaccine through a flood of small private contributions.

But it was much easier to motivate Americans to donate when their classmates were leaving behind empty school desks. Gates attributes the moral gap today to this physical proximity problem. Even with his computer software stitching the world together, polio mostly kills and maims people outside the eye of the rich world's collective consciousness. Few things illuminate the power and puzzle of globalization more than the world's richest man reaching out to help some of the poorest. His ethical sense drives him to do it.

COALITION OF THE HEALING

Gates has collected allies along the way. The British government has pledged to double its funding to $60 million from $30 million as a matching grant conditional on contributions from other donor governments. Sheikh Mohammed bin Zayed al-Nahyan of Abu Dhabi recently contributed $50 million, and the government of Pakistan announced an emergency response to the increase of cases in its territory.

So whose side are we on? In one corner we have Robert Gates and the U.S. Department of Defense dropping bombs from drones. In the other corner we have Bill Gates asking the world to spend more to save the most vulnerable. Send in the vaccines, or send in the Marines. It's a pretty stark simple choice.

[PHOTO CREDIT: Gates Foundation (CC).]

The M-PESA success story

It is undoubtedly true that the mobile phone is one of the really revolutionary inventions of our times, with the potential to transform human lifestyles and the way we even do business. Fundamental to its success is its ability to bridge the last-mile connect and deliver numerous services.

I have already blogged about its potential to revolutionize the way people manage their finances. The most famous example of this is the M-PESA - an SMS-based money transfer system that allows individuals to deposit, send, and withdraw funds using their cell phone - that was launched in March 2007 by the Kenyan cell-phone company Safaricom. Today M-PESA reaches approximately 65% of Kenyan households. Similarly, in the Philippines, Globe Telecom operates GCASH, and in South Africa WIZZIT facilitates mobile phone‐based transactions through the formal banking system. An excellent working paper by William Jack and Tavneet Suri documents the rise of M-PESA.

M-PESA is not a banking service. It does not pay interest on deposits nor make loans. It allows users to deposit money into an account stored on their cell phones, to send balances using SMS technology to other users (including sellers of goods and services), and to redeem deposits for regular money. In this sense, M-PESA transfers fungible cellphone talk time.

In exchange for cash deposits, Safaricom issues a commodity known as e-float or e-money, measured in the same units as money, which is held in an account under the user’s name. E-float can be transferred from one customer’s M‐PESA account to another using SMS technology, or sold back to Safaricom in exchange for money. Charges, deducted from users’ accounts, are levied when e-float or e-money is sent, and when cash is withdrawn.

Originally, transfers of e-float sent from one user to another were expected to primarily reflect unrequited remittances, but nowadays, while remittances are still a very important use of M-PESA, e-float transfers are often used to pay directly for goods and services, from electricity bills to taxi-cab fares. To facilitate purchases and sales of e-float, M-PESA maintains and operates an extensive network of over 23,000 agents across Kenya. M-PESA agents hold e-float balances on their own cell-phones, purchased either from Safaricom or from customers, and maintain cash on their premises. They only have to predict the time profile of net e-float needs, and maintain the security of their operations.

M-PESA caters to a specific category of small transactions. The paper finds that the volume of transactions effected between banks under the RTGS (Real Time Gross Settlement] method is nearly 700 times the daily value transacted through M-PESA, and the average mobile transaction is about a hundred times smaller than the average check transaction (Automated Clearing House, or ACH), and even just half the size of the average Automatic Teller Machine (ATM) transaction.

The paper documents many advantagees of mobile phone money transfers. They include facilitation of trade, making it easier for people to pay for, and to receive payment for, goods and services; provide a safe storage mechanism, and thereby increase net household savings; facilitates inter-personal transactions and thereby improve the allocation of savings across households and businesses by deepening the person-to-person credit market; by making transfers across large distances trivially cheap, it improves the investment in, and allocation of, human capital as well as physical capital (say, promote migration); it enhances the ability of individuals to share risk; it enables timely money transfers and thereby provides always-on access to money; empower women, and so on.

Outcome-based venture capital financing of social policy

Imagine this social policy experiment. Crimeland prison has among the highest prisoner recidivism rate (prisoners are convicted of another crime within one year of release) in Globonia. Then World Without Crime Foundation (WWCF) comes up with a proposal that commits to lower recidivism rate by atleast 50% (after adjusting for the national average decline) over three years. It would cost $50000 to implement the program over its three years.

So WWCF offers to finance the entire upfront investments in return for being given Prison Improvement Bonds. These Bonds would have 4 year maturity and would be redeemed with returns which are based on the percentage of reductions (over and above the promised 50% minimum) achieved with recidivism. However, if the experiment fails to yield the expected minimum returns, the investors get nothing and lose their principal.

David Leonhardt points to a real-world experiment with such bonds in Britain. The British Government has initiated a program at Her Majesty’s Prison Peterborough, where 60% of the prisoners are convicted of another crime within one year of release. A nonprofit group named Social Finance has raised about $8 million from investors and is implementing, in collaboration with the prison authorities, a program to help former prisoners find work, stay healthy and the like. Some 3000 prisoners are being covered under this, which started last year.

Investors will get their money back starting in 2014 — with interest — if the recidivism rate falls at least 7.5%, relative to a control group. If the rate falls 10%, the investors will receive the sort of return that the stock market historically delivers.

They form part of the emerging category of social policy financing - social impact bonds. It has also been called payment-by-performance by the British government officials. Non-profit groups like foundations pay the initial money for a new program and also oversee it, with government approval. The government will reimburse them several years later, possibly with a bonus — but only if agreed-upon benchmarks show that the program is working. If it falls short, taxpayers owe nothing. It is hoped that success with a few initial interventions could help build a mainstream social investment market that attracts financial institutions and retail investors.



The British government is also planning to raise about £5m to develop a further package of two or three more social impact bonds. These bonds could fund programmes reducing the number of children going into care, working with children in pupil referral units, diverting persistent women offenders from prison, and developing more effective drug rehabilitation projects. Schemes to tackle long-term health problems in the community, such as diabetes and asthma, could also produce big savings in acute hospital bills.

In the US, David Leonhardt also reports that the Obama administration is set to shortly propose seven pilot programs, costing up to $100 million, along these lines. The financing mechanism will be described as pay-for-success bonds. They are set to broadly focus on increase kindergarten readiness among low-income children; increase college completion rates; reduce criminal offenses and incarceration rates among minority youth; raise the future earnings of laid-off workers; reduce hospital readmissions among patients with chronic illness etc.

What are the advantages with such social policy venture capital funds? One, most importantly, it will bring in a culture of outcome evaluation into social policy spending. Two, governments can hedge against the downside risk of the intervention failing. It will ensure much greater bang for the buck with social policy spending. Three, the hedging against downside risks also makes it easier for governments to embrace innovative programs that would otherwise have not found the light of day for risk aversion and status quo bias.

Four, Governments strapped for cash would not need to cough-up resources upfront, especially for programs whose returns are likely to show-up only after a few years. They would need to make payments only on the successful implementation of the intervention. Five, non-government agencies, non-profit and for-profit, get the platform (with all the attendant logistical support) of government agencies to experiment on their initiatives. This would marry the professional expertise and commitment of the non-government agencies with the existing government systems. Six, it will enable more effective utilization of non-government funds. Today, much of these funds are frittered away on piecemeal interventions that have little policy value.

However, there are several formidable challenges that need to be surmounted before this approach can achieve its desired objective. Which interventions to select? Which outcomes to measure, with what parameter, and how do we benchmark them? What should be the baseline and expected outcome scores? What should be the appropriate control group?

There is the possibility of external agencies being entrusted perfectly doable projects and walking away with assured returns. Ensuring the selection of parameters that, with a reasonable degree of accuracy, measures outcomes is a difficult task and one that can be very easily subverted. Both the baseline calculation and the final outcome fixation should be done with adequate care and after rigorous due diligence. The final outcome should be adjusted for changes that would have taken place even without the intervention. In the absence of clear definition of the target population, the external agency will have an incentive to cherry-pick and present a distorted picture of its achevements. Finally, the control group should be selected with appropriate care so as to be representative with the treatment.

In fact, the details of such initiatives should be arrived at only through a rigorous professional exercise carried out by competent agencies, and devoid of political and anecdotal judgements. On a note of caution, atleast for the initial set of such financing interventions, it may be better to leave out economic cost-benefit analysis (and focus on the financial benefits by way of budgetary savings) from calculations of return on investment. It may be advisable to focus on interventions (or outcome measurement parameters) where the benefits are more easily quantifiable by comparison with a relevant control group. Further, decentralized interventions are more likely to succeed, at least in the initail stages, with such financing programs.