Most
economists
have long
favoured
a view that
in the end,
individuals
are in control
of their
destiny,
as long
as growth-oriented
policies
offer a
sea of economic
opportunity.
Fighting
poverty
is simply
reduced
to offering
opportunities,
by removing
the controls
on the economy
and stimulating
competition.
Hard work
and determination
mean that
socioeconomic
prospects
are largely
under an
individual's
control.
Poverty
does not
entrap.
But why
do so many
people around
the world
stay poor,
despite
unprecedented
economics
growth?
One reason
is that
poverty
persists.
For example,
even in
the US,
the land
of free
and home
of the rags-to-riches
tale, if
your parents
were in
the poorest
ten percent
of income
earners,
then your
son is twenty-four
times more
likely to
achieve
an income
in the lowest
ten percent
of earners
than in
the highest
ten percent.
What matters
in the US
is even
more strikingly
repeated
in much
of the developing
world.
This is
not consistent
with standard
economic
theory:
forms of
convergence,
also in
living standards,
should be
the norm.
In recent
years, much
work has
focused
on the theory
of
poverty traps-which
is looking for
an explanation
for this poverty
persistence.
One strand shows
that credit
markets are
unlikely and
even unable
to function
conform to the
ideal of a perfectly
competitive
market, and
combined with
initial wealth
inequality,
that this may
be causing this
poverty persistence.
Furthermore,
true 'traps'
may emerge if
wealth needs
to reach minimal
threshold values
before economic
opportunities
can be embraced.
With no access
to capital,
insurance or
basic social
safety nets,
some poor people
cannot escape
poverty through
their own efforts:
staying destitute
is the best
they can do
with their own
effort and determination,
even in a growing
economy with
seemingly plenty
of opportunities
for enrichment.
Poverty traps
are really difficult
to deal with
for policy makers.
They are characterized
by serious asymmetries:
they are easily
fallen into,
but extremely
hard to escape.
For example,
consider a family
that is doing
not badly at
first. A serious
family illness
causes large
expenses and
their small
initial wealth
gets quickly
eroded. Profitable
albeit small
scale economic
activities,
such as petty
trading or artisanal
activities,
may need to
be abandoned
because no working
capital is available
anymore. With
assets below
this critical
threshold for
these activities,earnings
go down, and
a downward cycle
develops from
which escaping
will become
increasingly
more difficult.
Credit markets
are some of
the hardest
markets ever
to confirm to
the ideal of
a perfectly
competitive
market. Even
in rich economies,
they are characterized
by the most
obvious sign
of market failure.
Credit is an
intertemporal
transaction:
cash is offered
to be repaid
later, and anyone
with a credible
plan to make
sufficient money
from using the
loan so that
it can be repaid
with interest
should, in a
perfectly competitive
market, receive
a loan. Whether
you have assets
to start with
should be irrelevant.
In practice,
such transactions
are rare: collateral
is in fact taken
for granted
as a standard
part of the
lending process.
It is a sign
of market failure,
and the type
of market failure
that specifically
hurts the poor,
who lack collateral.
Credit market
failure conspires
with poverty
to exacerbate
poverty. Without
credit, the
poor cannot
take advantage
of new opportunities
to get out of
poverty; it
will also reduce
the efficiency
by which the
poor use their
meagre other
assets, while
leaving the
rich largely
unaffected.
Collateral requirements
are not a capitalist
conspiracy to keep the
poor poor, even if they
have the same effect.
Collateral can be understood
as an important means
by which credit markets
handle the central problems
that bedevil these markets:
asymmetric information,
such as moral hazard
and adverse selection,
and enforcement problems.
Since imperfect information
means that borrowers
may not be able to know
which projects are more
risky among many risky
projects, or whether
lenders will implement
other actions than initially
committed to after the
loans have been granted,
collateral may be asked
for to secure the loans.
Collateral may also
help to enforce the
repayment of loans.
The relevance of providing
capital to the poor
has of course not gone
unnoticed to many for
a long time. However,
for decades, most interventions
in credit markets were
a total and costly failure,
simply because these
are very hard markets
to fix. Especially finding
means to substitute
for the informational
and incentive role played
by collateral has bedeviled
interventions. It is
here that contribution
of the Grameen Bank
and Dr. Yunus has been
most striking: by appealing
to social collateral,
whereby groups are jointly
responsible for repaying
loans, the credit transactions
could find a real alternative
to standard collateral
that is consistent with
the necessary incentives
in credit contracts.
The massive rise in
microcredit across the
world, often using the
joint liability models
developed by the Grameen
Bank, is a tribute to
the imaginative solutions
first developed in Bangladesh.
Microcredit alone is
not going to break the
poverty trap faced by
many poor. More standard
growth-oriented policies
are relevant as well:
the poor have to have
economic opportunities
that they can take advantage
of. But microcredit
is offering one of the
many necessary steps
that are required to
break the cycle of destitution
and exclusion from economic
development.
Stefan Dercon
is Professor of Development
Economics at the University
of Oxford.
