How Not to Lose the War on Poverty

ETHOS Issue 11, Aug 2012

Author Aneel Karnani, who teaches at the University of Michigan’s Ross School of Business, believes that being poor should not be romanticised. In movies such as Slumdog Millionaire (2008), he argues, the poor are depicted as having an uncanny ability, strength and will to rise above their depressing lot in life if they put their minds to it. This notion of the poor, Karnani says, is damaging to the fight against poverty as it gives the wrong impression that the poor can alter their own situation. The simple fact of the matter is that the poor for the most part are unable and incapable of doing so. They need help.

Nor does Karnani believe that economic growth in itself will lead to the alleviation of poverty. The pervasiveness of poverty in a sea of relative global affluence suggests that prosperity does not always trickle down to those who need it most, nor do the very poor — with little economic or political representation — have the means to seek the help they need.

Instead, Karnani believes poverty eradication depends on efforts of three main actors — the private business community, the government and civil society. He regards each of these sectors as having distinct roles to play and, rather than remain aloof or even disdainful of one another’s contributions, they should take a more constructive, collaborative view of how they can work together to alleviate poverty around the world.

Debunking “Microfinance” and “Bottom of the Pyramid” Strategies

Significantly, Karnani spends a good portion of Fighting Poverty Together debunking the efficacy of two major poverty alleviation strategies that have captured the popular imagination: Microfinance, and the Bottom of the Pyramid (BOP).

The Limits of Microfinance

Contrary to popular belief, Karnani argues, microfinance has not managed to reduce poverty — for several reasons. First, the money from most microloans is spent on consumption rather than invested in business ventures, and therefore cannot result in increased income for the poor. Second, most poor lack the entrepreneurial skills to succeed at running their own businesses. Third, the microenterprises funded lack economies of scale and have low productivity, yielding the borrowers too little income to lift themselves out of poverty. Fourth, if the interest rates are too high (as reflected in many microfinance strategies) the borrower might even become poorer rather than wealthier.¹ Fifth, there is a tremendous lack of transparency in the industry, so much so many of its failings have gone undetected and the poor suffer in silence due to the lack of representation. Even the purported abusive loan recovery systems of Grameen Bank, whose chief was the creator of microfinance, have for the most part gone unreported.

Even the propounded benefits of microfinance, such as the empowerment of women, do not bear out under analysis, according to Karnani. Women might have access to loans but they do not have control over the loan or the income generated from the microenterprise. Loans made to the women often get passed on to the male breadwinners in their families. In other words, microcredit does not in itself overcome patriarchal systems of control.

Nevertheless, microfinance could still succeed in alleviating poverty. Karnani suggests that appropriate regulation is key and that industry self-regulation could be a useful supplement to legal regulation. Large commercial banks could pressure the banking industry to exercise social responsibility. International organisations such as the World Bank and U.S. Agency for International Development could also pressure their clients to prevent exploitation of the poor, and help developing countries build up effective regulatory regimes. Civil society could keep a check on private banks that behave inappropriately when disbursing microfinance funds to the poor, and help educate microcredit users about their rights.

The Fallacy of the Bottom/ Base of the Pyramid (BOP) Market

Karnani argues that those who propose that businesses could make good profit while helping to alleviate poverty by selling to the poor — the so-called Bottom of the Pyramid (BOP) approach — are mistaken. He rebuts the key propositions of BOP.

Proposition 1: There is much untapped purchasing power at the bottom of the pyramid. Private companies could make significant profits by selling to the poor.

Karnani argues that this is a fallacy because the BOP market is much smaller than estimated. Most of the income of the poor (at least 80%) is spent on basic necessities like food, water and shelter (unlike the income of the more affluent). There is little left over for anything else. Furthermore, the cost of serving this market can be very high. The poor are often geographically dispersed, increasing distribution costs and making it difficult to reap economies of scale. Weak infrastructure and small transaction sizes further increase the cost of doing business.

Proposition 2: By selling to the poor, private companies can bring prosperity to the poor, and thus can help eradicate poverty.

Reducing the prices of products purchased by the poor might be expected to increase their effective income and thus help them to accumulate savings, or invest the extra income, for example, in education. But Karnani argues that this is hardly ever possible because the price would have to be reduced by 90% for the products to make any impact on the income of the poor. Many business ventures into the BOP market have proven not to be cost-effective in the short or long run, and economically unsustainable.

Proposition 3: Large multinational companies (MNCs) should play the leading role in this process of selling to the poor.

Large MNCs have been playing an active role in selling to the poor. Most have been unsuccessful; they have either stopped selling to the poor and gone upscale to sell to middle-income earners instead, or closed down operations altogether due to the lack of cost effectiveness.

While there is no fortune to be made from marketing to the poor, Karnani suggests that it might be viable on a limited scale, provided there are strong symbiotic partnerships between local governments, NGOs and businesses, and if the products sold to the poor truly benefit them.

Going Forward: The Roles of Government, Civil Society and Private Business in the Fight against Poverty

Karnani believes that poverty reduction efforts should aim to increase the income of the poor by viewing them as producers (and not as consumers as reflected in the BOP approach). His book argues for the creation of employment opportunities suited for the poor — a task he believes the private sector is best suited for. In Karnani’s view, civil society could support this effort as a catalyst for action, advocate and watchdog, intervening where necessary to identify and bridge market gaps.²

Governments, Karnani argues, should facilitate job creation by fostering an environment conducive for business to grow and thrive, and improve the employability of the poor: by improving their skills and capabilities, and by reducing friction in labour markets. Governments also have a major role to play in addressing market failures through regulation, and service provision. Karnani argues that state responsibilities are magnified in the case of the poor, because markets for the poor fail more often and the poor are more critically dependent on public services. The provision of basic public services such as education, public health, sanitation and infrastructure is therefore the government’s key responsibility in the fight against poverty, as the poor bear a disproportionate share of the burden when these services are inadequate.

Conclusion

While microfinancing has not taken off in Singapore’s banking industry, civil society groups here have considered the possibility of providing microfinance loans to the poor (those without collateral), although none have yet come to fruition. Karnani’s cautionary analysis of microfinance offers a sobering perspective for any organisation considering such efforts. Nevertheless, microcredit approaches to help the poor could succeed if carefully crafted and managed well, as with any business strategy.

Fighting Poverty Together is a salient reminder that poverty alleviation requires a concerted effort by many stakeholders in society. Government can keep public services within the reach of the poor, who are disproportionately dependent on such services to get by. It can also provide the necessary infrastructure, education and jobs in order that people, especially the poor, are provided with the tools to become self-reliant. But private businesses and civil society can also play an important part by increasing the income of the poor and being more vigilant in identifying market gaps, respectively.

NOTES

1. This was the case with the Mexican bank Banco Compartamos whose actual interest rates could reach more than 100% per annum. Karnani opined that organisations that charged high interest rates contributed to rather than helped alleviate poverty.
2. One cited example of an effective NGO is TechnoServe, which identifies high potential but underperforming economic subsectors and helps resolve the identified market failures that constrain their development.