Development economics in a developed country: how do poor Americans save?

This recent episode of NPR’s planet money talks about the financial lives of poor Americans. A few practices mentioned in the article, such as group lending, private lenders, and high interest rates for loans, are strikingly similar with what poor people do in developing countries in Africa and Southeast Asia.

This resemblance leads me to think whether ideas and methodologies in development economics can be (more extensively) applied in developed country settings. Classic models in development economics such as health-based poverty trap and credit constraint can be easily applied to study the causes of poverty in a developed country setting. Comparative studies of poor individuals in developed vs. developing countries can shed light on the impact of institutions, governance, and infrastructure on addressing poverty.

The data mentioned in this episode are pretty amazing — 235 poor households across America tracked over a year with high frequency financial diaries. I bet interesting research based on this data is on the way.

Recommended reading

1. NY Times post on using game theory to design high school application system in the New York City. I also found an older article by Alvin Roth reviewing the theory of deferred acceptance and its applications.

2. Professor Marc Bellemare on how academic economists can use social media for research. I echo the following reason he has for using social media to talk about research:

I believe all of us should spend some time contributing to public goods by helping people think through social problems in your area. This is especially true for those of us whose research is publicly funded and whose isn’t? With more and more Americans questioning the value of a college education, we have a duty to show that universities play a much broader role, and to put knowledge in the service of society.

I also agree with him that it is important to keep the blog fresh by writing regularly and succinctly (obviously I haven’t done a good job in that regard, at least recently).

3. Yale job market candidate Alex Cohen on how imperfect factor markets dampen the positive impacts of relaxing credit constraints. I’m excited to see more structural approaches being used in development economics.

4. The Economist on whether the government should regulate digital monopolies. The internet is essentially a two-sided market which provides a platform for multiple parties (in this case, companies which advertise their products, and consumers) to make transactions more efficiently . To evaluate the welfare consequences of policies, we need to be more clear about whose welfare we want to maximize.

5. World Development Report 2015 focuses on understanding mind, society and behavior, questioning the fundamental rationality assumption in economics and suggesting alternative methods to analyze individual behavior.

Microfinance through rational eyes: reflections on David Roodman’s Due Diligence

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/picture: Caritas SACCO, Nkokonjeru, Uganda/

Microfinance has been under the spotlight ever since it gained currency in the 1990s. David Roodman, senior associate at Center of Global Development, evaluates the impact of microfinance in his 2011 book Due Diligence: An Impertinent Inquiry into Microfinance.

Roodman builds his argument incrementally throughout his book. In the first two chapters, he points out important differences between how the poor and the rich use financial services. While the rich can navigate their way through complicated banking products and increase wealth, the poor, with low financial literacy, often view the bank merely as a safe place (relative to their mattresses) to store their money. Moreover, there are explicit and implicit barriers preventing the poor from fully utilizing financial services. Managing a fixed savings account requires a steady income to put aside, which is challenging for agricultural households with fluctuating seasonal incomes; getting a loan requires collaterals, guarantors and a lengthy process which many feel reluctant to go through.

Recent years have seen a growing literature on evaluating microfinance, but Due Diligence stands out by evaluating microfinance according to three definitions of development. This treatment reconciles conflicting evidence of microfinance’s ability to foster development.

The first definition, development as escape from poverty, is widely adopted in academic evaluations. Roodman points out problems with most microfinance evaluation studies ranging from naive econometric regressions, implausible instruments and assumptions, to the lack of wide applicability of Randomized Controlled Trials (RCTs). After reviewing several classic economic studies about microfinance, Roodman concludes:

First, poor people are diverse, and so are the impacts of microcredit upon them.
Second, there is no convincing evidence that microcredit raises incomes on average.
The ambiguity about average impact arises from four intertwining factors:
– Different people use microfinance in different ways.
– Even people who use it in the same way can experience different outcomes.
– Families, villages, and neighborhoods are complex webs of causal relationships, which are hard to disentangle.
– Average effects depend as much on the ability of microfinance institutions to select those most likely to use finance well as it does on the potential effects on each user.

I echo the first reason in particular. Savvy businessmen are more likely to get loans of appropriate amount and make wise investments than illiterate, uninformed farmers. Self control also determines how much one gains from microfinance, as many poor people borrow not to invest in productive activities but to consume.

The second definition, development as freedom, is more subtle. High repayment rates are usually built upon tight repayment schedules and credible threats against default. Yes, the poor might be getting the loan they want. But they have to pay a significant portion of their incomes back to the lender every week. This is not only a burden but also limits them from reinvesting business incomes into other productive use. Upon sickness of a household member, weekly repayments can force a household into a debt cycle which is hard to get rid of.

The third definition, development as industry building, places development into a macro picture instead of micro-level households. Challenges exist on the way to “creative destruction”.

Roodman writes with rigor and maintains a logical flow of his arguments. An outstanding feature is the wide citation of research from other disciplines, especially anthropology. I have found the quotes from Helen Todd intriguing and thought provoking.

Microfinance, like all other initiatives to reduce poverty, will not reach its goal unless it is combined with government efforts to improve people’s ability to use it. Economists and policy makers are often tempted to design one-time interventions and expect these to change lives, but often ignores the complex social mechanism operating in the background. Affordable quality education, reliable energy supply, water and sanitation, transportation networks, healthcare facilities, and many others remain to be established before we can trully talk about development.

Struggling on your own? A reflection on Chinese education philosophy

A recent New York Times article writes about differences in Chinese and American learning philosophies. Here is NPR’s report on this topic.

The simplest way to summarize her findings (Jin Li’s) is that Westerners tend to define learning cognitively while Asians tend to define it morally. Westerners tend to see learning as something people do in order to understand and master the external world. Asians tend to see learning as an arduous process they undertake in order to cultivate virtues inside the self.

Jin Li’s arguments make a lot of sense to me. The Chinese education values hard work and sees it as the only way to perfection. But perfection itself is loosely defined. In the Chinese context, it is more about excelling others than exploring the truth. Rankings are constantly posted and a tension between peers is always present. As I see it, the Chinese education places too little importance of teamwork.

Critical thinking ia another missing link in Chinese education. The lack of critical thinking of Chinese students is especially salient in graduate school. In my first semester’s seminar class, I simply felt reluctant to ask questions. My mind seemed to be accepting whatever it encountered, without ever asking “Is this true” or “Why is this so”. This weakness in critical thinking may have stemmed from the reverence for authority in Chinese culture. In a classroom setting, the teacher is the authority. Teachers are painted as knowledgable and superior figures offering guidance to students. Students are therefore supposed to follow the lead and work hard towards perfection. A fundamental fear of authority prohibits the development of our critical thinking.

My mentor, a senior business executive for a large company, once mentioned how hard it is to find a good executive in Asia. Senior leadership roles require much more than only completing the assigned tasks. “Hong Kong education is better than the mainland,” he says, “but it’s still far from satisfactory in terms of building up people’s leadership and teamwork ability.”

I’ll end my discussion with a joke I saw a couple of days ago. “A typical discussion session in *** (a university in France) works like this: French students identify the problems. Then German and Chinese students solve it. British students tell jokes when people are tired. Finally, American students present their project in front of the class.” It may be exaggerating, but there’s certainly some truth in it.

Inefficiencies in US food aid

I was listening to a podcast  called”Hedging Against Hunger” by Center of Global Development. We also had a short discussion on this in my development economics class today. It seems that the food aid from the US is not reaching to the needed population effectively.

The US contributes a big chunk for the World Food Program (WFP in short) under United Nations, but it is estimated that 200 million dollars were lost in transaction costs from years 2008 to 2010. It’s useful to investigate the breakdown of this. First of all, WFP US buys domestic food for aid. While this is welcomed by domestic farmers, it calls for a bureaucracy to supervise the procurement process and thus increase the costs. Another source of transaction costs comes from the requirement of the US that food must be shipped by US vessels. This was initially out of national defense concerns, but seems to be obsolete for the current situation.

The inefficiencies above can downplay the effect of the food aid. It takes a long time to get to the place where the food is needed. Moreover, if the food comes in the harvest season, it will exacerbate competition in the local market and depress the price of the food. The local food producers in the recipient countries are the ones to suffer.

Another inefficiency of WFP is that it always buys food on-the-spot without any forwarding or risk-hedging measures. This is partly because they raise funding whenever needed. This “reactive approach”, mentioned by Connie Veillette in the podcast, generates a thin and unstable income stream and greatly reduces the possibility of risk-minimizing through various financial instruments. It makes sense to publicize charity when there is a natural disaster and an obvious need for food. It makes people feel good when they are saving others’ lives after the problem of shortage is already visible. This can be clearly seen in the US WFP’s brochure on its website (http://issuu.com/erinkoepke/docs/wfpusa_2010annual_web?mode=window&backgroundColor=%23222222). The second reason is that donors provide food but not cash. In contrast, in Canada the WFP provide financial support lasting multiple years. This gives the organization greater freedom and better hedging. Lastly, the international organization itself is governed by different political voices and this may lead to  gap between the theoretical best practice and the real-life reaction to a problem.

Mobile phones: small solutions to big problems?

In my economic development class, we listened to an interview with Jenny Aker at Tufts University which applauds the wide adoption of mobile phones in Africa and the resulting welfare gains to the people there.

It might be counterintuitive for one to know that mobile phones are more widely used in Africa than landlines. Mobile phones, relying primarily on a net work of specialized base stations, cost much lower than landlines which require cables being built to every community. In terms of communication, mobile phone also excels landline because it is portable and personal.

The author argues that mobile phones reduce the search costs and improve market efficiency. Households can check out information about input and output prices more easily, and they can find jobs in a bigger area which increases labor mobility and improves market efficiency. Moreover, mobile phones themselves are generating an industry and providing more jobs for the local population.

In Africa, mobile phones also worked for people in ways that you might not expect. M-Pesa (which stands for “mobile Pesa”), a Kenyan mobile banking service, was introduced in 2007 and was well received. This service allows people to transfer money, pay bills, and to keep small amounts of money invisible to others by mobile phones, thus reducing the risk of theft. But there are two problems here. First, as one of my classmates who worked last summer at Kenya suggested, the mobile phone company is not accountable for the money “saved” as M-Pesa. The mobile phone service is just saving steps for daily banking activities, but cannot serve as a reliable means for savings and future investment. Second, the “savings” on the phone do not generate any interests, so it is merely a way to protect the money from being stolen. The role of financial institutions cannot be overlooked, and the M-Pesa on the phone is not a substitute for the physical banks which allow people to plan how they should invest into the future.

It is good to know that mobile phones are improving people’s welfare by distributing health information and encouraging education (CNN report) to a wider range of people. In the class, the professor also mentioned that a mobile phone service which sends out healthcare information for migrant women in Beijing, China. But we need to examine the business models behind these projects to make sure they are sustainable.

As Jenny Aker pointed out, mobile phones are not the silver bullet to solving development problems. In my personal view, whatever good policy takes good institutions to make it truly happen. This is often missing in the picture, and even if it is addressed, it is much deeper to tackle.

Rigor in program impact evaluation

In my development economics class today, we had Michael Clemens (bio) from the Center for Global Development as a guest speaker. He talked about the impact evaluation of aid. Poverty reduction is appealing especially to people living in the developed world; hundreds of millions of dollars are donated for poor countries and regions around the world. The impact evaluation, however, is often neglected.

By “impact evaluation”, we mean a comparison of the post-project situation with what would have happened had the project not taken place that is cost-effectively rigorous. Clemens suggested three ways to increase the rigor of impact evaluation: independence, consistency, and transparency Firstly, the evaluation should avoid insider judgements as they tend to be biased; evaluation by outside parties such as other scholars/academia or consulting firms are usually more convincing. Secondly, the project should be evaluated for its fixed goals rather than shifting objectives. Thirdly, the information should be made to the public for further inspection.

Jeffrey Sachs advocates the Millenium Village Project (website) and the project is aimed to reduce extreme poverty by half by 2015. The information on the website about impact evaluation sounds encouraging:

Improved drinking water, with household usage increasing from 21% to 68%; Expanded access to HIV testing, from 8% to 28% of adults tested in the last 12 months; Reduced malaria prevalence, from 22% to 5%

But such information can be misleading because (a) it does not show how other regions and districts are doing in the same period and therefore neglects the fixed time effect acting behind both treated and untreated groups, and (b) it does not address the central objective of the project — poverty reduction.

The counterfactual is always difficult to measure because history only happens once. But beneficiaries of the project should be able to provide some suggestions of their satisfaction towards the program and therefore give researchers some idea about its effectiveness.

Clemens also mentioned that the right rigor of impact evaluation does not equal randomization. Difference-in-Difference estimation can be useful in some contexts as well.