Why poor becomes poorer?

From time immemorial, there is a huge gap between rich and poor. In fact, there is a popular saying as —

“The top X% billionaires has money equivalent to the bottom Y% of people in the world” with X~(0,1] and Y~[50,80].

There is a huge income imbalances in the world. (Source: GlobalResearch)

Whenever we read headlines like this, we simply blame Government. But before blaming the government, are we questioning ourselves

“Is it actually the fault of Government?”

While the governments/policies are partially to blame, that’s not the complete story.

“The sad truth is the poor themselves are partly responsible (unknowingly) for becoming poorer.”

What I mean by “poor becoming poorer” corresponds in relative terms. In fact, today’s poor earn more than the poor 50 years back (after scale adjusted) thanks to many advancements in technology, policies etc; In other words “Rich earn more money faster than poor”

Yes! It must be hard to digest the fact but it’s true. Irrational beliefs and habits such as “Time inconsistency” are partly responsible for them to be struck in “Poverty trap”

Poverty trap

Suppose you have Rs.100/- and would like to invest. If I say about a scheme where

“Tomorrow’s money < Today’s money if initial investment < Rs.500/-” “Tomorrow’s money > Today’s money if initial investment > Rs.500/”-

Would you like to invest?

Obviously not. Either you try to save till Rs.500/- and start investing or don’t invest at all. But what if you invest in it unknowingly? Eventually, you lose all your money and become poor. That self-reinforcing mechanism which causes poverty to persist is known as Poverty trap.

It requires an initial, predefined amount to come out of poverty trap. Poverty traps exist in the first place because of initial capital investments, labor resources etc; Observe the curve to the left of the red vertical line. There today’s income > tomorrow’s income thus making eventually poor. Similar case for the right side of the red vertical line.

Time Inconsistency

Suppose I say “I will give you Rs.1,00,000/- today or Rs.1,00,001/- tomorrow”. Which one will you chose?

Now, assume I say “I will give Rs.1,00,000/- after 365 days or Rs.1,00,001/- after 366 days”. Which one will you chose?

Behavioral economics and psychology says that most people chose Rs.1,00,000/- in case 1 and Rs.1,00,001/- in case 2 though the difference is the same i.e Rs.1/- in 1 day. This shift from one scheme towards another as time progresses is “Time inconsistency” and helps in understanding why poor are unable to come out of poverty.

“But why this time inconsistency exists?”

Our brains are wired to give more weight to our present than our future thus leading to “Present-bias”. Also, our brains thrive for “Instant gratification”. This added to the lack of willpower causes time inconsistency. (Read Marshmallow experiment for insights about instant gratification)

Cover page of Poor Economics by Abhijit V Banerjee and Esther Duflo (Nobel Laureates in Economics 2019)

The book “Poor economics” by Abhijit V Banerjee and Esther Duflo explains many factors in greater depth, where there is scope of self-improvement for poor to come out of poverty trap and thus escape poverty. It’s a great read for everyone and doesn’t expect one to be familiar with economics topics.

Areas of focus

1. Nutrition— Eat well and become rich

We all know that if we don’t eat proper food, we can’t work properly and it effects our income and ultimately our health. The same applies to poor as well. As they are not able to eat proper food, their productivity reduces which makes it worse for them to have proper food thus forming a vicious cycle.

The irony is, when subsidies are provided to the poor, many have chosen “better tasting, more expensive food rather than more nutritious food”. They diverted their food savings towards junk, high fat food and their tobacco, alcohol intake increases which ultimately results in more chronic diseases, less productivity and thus struck in poverty.

“But why do they do so?”

1. “Most of them are unaware” — If they know, definitely, they will make judicious decisions on food intake.
2. Behavior while purchasing — Diverting to tasty, unhealthy food
3. Justifying oneself as “Already I am poor, can’t I have at least tasty food?”

Our choice of food directly implies our productivity in the long run (Source: WeeklyStoryBook)

Also, it’s observed that when their income goes up, they don’t eat more or better food because obviously they have many things to take care of. So, it is important to start changing food priorities to escape poverty.

It’s natural to expect that our productivity saturates at a certain level and won’t increase irrespective of food intake

2. Health — People against vaccine

The poor knows that it takes a lot of money to cure diseases. So, when someone goes and says “If you take this shot, you won’t get the disease. And it’s absolutely free”, their natural tendency is not to trust. They think “How a shot can avoid disease and if so, why are they giving it for free?”

So, they avoid taking the shot, eventually falls prey to the disease and spend all their savings to get cured. Irony is that some educated people also don’t believe in vaccination. The notion “Prevention is better than cure” needs to be properly explained so that the poor gets vaccinated thus not spending their meager savings on this.

Even some educated doesn’t believe in vaccination. So, there is no surprise with the poor rejecting the magical bullet (Source: Seattle Times)

3. Population — Preference to have more kids

The poor are the best to distribute their risk. They know that “One should not put all the eggs in the same basket”. But they apply this rule to the wrong scenario. They believe that if they have only one kid, and if that kid fails financially, then it will be very difficult to live at old age. So, they believe having many kids will help as it provides financial freedom at old age because they trust that at least one kid succeeds and takes care of the entire family. So, this increases their expenses thus ultimately making them poorer, unless the successful kid pulls them out from poverty zone.

Though most of the poor end up having many kids, it is not entirely true that having lots of kids makes one poor (Source: Clipart Library)

4. Education — Isn’t is waste of time?

The poor makes their children to do work at an early age, so they become a source of income. But most of them also know that through proper education, their children can earn more money. So, why don’t they prefer to get their children educated despite knowing it’s benefits?

Poor prefers their child to work over education, though the situation is changing slowly (Source: Vikaspedia)

The theory of “Time inconsistency” answers this. It’s because the benefits are expected in long run, i.e you study for 12–15 years, then you can start earning money. But the mindset is wired such that “Why to wait 12 years to earn money? Isn’t it waste of time and resources. Also, what about the money that he/she is currently earning through wages?”

5. Loans — Where can I get it?

Just imagine a hypothetical situation:

Suppose you have Rs.10,000/- and would like to build a house. But to build a house where you can stay, it requires Rs.1,00,000/- So, what will you do?

You can either

1. Start building with Rs.10,000/- and make incomplete construction

2. Wait until you earn Rs.1,00,000/- and then start

Majority of the poor choose option 1 thus going into poverty trap because of unfinished product (An unfinished product takes only input i.e money, energy and doesn’t produce output i.e profit).

But can’t they just take a loan of Rs.90,000/- from bank and proceed? While it seems plausible, unfortunately banks don’t provide loans for the poor with such ease. They have valid reasons such as

1. More administrative costs — To make Rs.1/- profit, banks need to spend more than Rs.1/- when dealing with poor
2. Default rates might be high — Given the risk associated and governments often waiving outstanding loans during elections, many might opt not to clear their debt
3. Can’t produce collateral — If poor have the ability to produce collateral, then they won’t be poor

Banks need security while poor want to make an asset in their lifetime to be secured in future. A French proverb “One lends only to the rich” might suit best.

Microfinance institutions can help till some extent but it has it’s own valid limitations such as “Very high interest rates” which goes up to 30–40% (Our normal bank loans has an interest rate of 12–15%).

Explaining the situation of microfinance (Source: Asia Left Observer)

But it should not be a major concern and the poor should consider more financial options before starting business because the loan amount is low, it’s simple interest and the poor can repay easily.

6. Investments and Savings — Have patience before spending

There are similar issues with savings and investments as well. “Poor can’t save money at home” because every day one or the other problem comes and their savings drain out. Lack of willpower and giving more importance to present i.e time inconsistency makes it harder for them to save.

Before spending money/resources or starting a business, one should have a minimum capital and knowledge to avoid falling into poverty trap. Because no one purchases unfinished goods.

“Invest little, make little money and remain too poor to invest much more OR invest enough to cross the hump and then become rich and invest even more and get even richer”

Rich makes most of their money via investments and these tools are of less access to the poor due to lack of knowledge, irrational fears and beliefs (Source: Vox)

7. Governments and policies — Is it out of scope!?

Yes!! How much ever the poor can fight to come out of poverty, the government policies has a huge impact on them and poor has less control on this aspect though this situation is slowly changing, by involving more diverse people while forming policies.

Therefore, while the governments have huge role for income imbalances, the poor can come out of poverty trap with few hacks. In fact, the irony is “One who reads this blog might not be poor, else he/she can’t afford to read in phone”. The simplest thing we can do is to make people understand how poverty works and inculcating new habits. Personally, we can imbibe some habits such as “Be careful with time inconsistency” to become financially flexible.

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