The Poverty Trap at the Bottom of the Pyramid
In 1990 there was 1.9 billion people living on less than $2/day, as of 2018 that number dropped down to 650 million, a miraculous 66% decrease in 25 years. In 2015, the UN announced that it’s possible to completely eradicate extreme poverty everywhere by 2030 thus kicking off the Sustainable Development Goals that every country in the world agreed to striving for—the eradication of extreme poverty as the first and most pressing priority in order to create a better and more sustainable future for all.
What’s even more inspiring is that once people escape the poverty trap of earning less than $2/day and start making as little as $4/day, their kids will, on average, go on to earn $16/day, and the subsequent generation will earn $32 per day or more. If you’re earning $32/day in Sub-Saharan Africa you can save up to buy a car, a nice house, and a good education for your kids. At $32 per day you’re not just surviving, you’re thriving and you’re able to pursue a life without physical and psychological barriers holding you back from achieving your full potential as a human being. If we achieve our goal of eradicating extreme poverty by 2030, we’re just two generations away from giving everyone in the world the opportunity to live their life to the fullest—a life of hope and opportunity.
On the other hand, if we don’t ever eradicate extreme poverty, poverty will live on and continue to spread. People who earn less than $4/day never seem to escape poverty unless they receive a little help. They go on to have large families with kids who don’t get educated. They suffer from malnourishment and higher rates of easily preventable disease. They live shorter, unhealthier, and depressingly desperate lives. They’re stuck because their incomes will never grow enough for them to save for the future. They’re constantly worrying about surviving day by day, keeping them hopelessly stuck in an endless poverty trap suppressing them from being able to think about the future and create a better future for themselves and their families.
The poverty trap of the poor isn’t a new concept, it’s been well recognized for decades that if we could give the poorest people in the world the boost they need, then they would be free to thrive and grow their economies independently. How did the world respond to this news? Nations and non-profits distributed free rice in Haiti, gave out free shoes in Africa, and dumped two trillion dollars of aid into poor countries from 1970 to 2000. The result? In the 1970s alone, poverty in Sub-Saharan Africa grew from 11% to 66%. People starved… and died… out of the kindness of our hearts.
Bill Clinton’s program to distribute free rice in Haiti put all the rice farmers out of business, so they moved into the city to live off of free rice, expanding the slums. When the Haitian rice program was deemed a “dud”, the aid program’s funding was cut, the rice stopped arriving at the docks of Haiti, and without their own supply of food, people starved. Toms shoes made a “buy a pair, give a pair” program with their shoes. If you bought a pair, they’d give a pair to someone in Africa. In order to get the free shoes into the hands of the poor, they bought a truck and went from town to town distributing free shoes—systematically putting shoe makers out of business by satisfying everyone’s shoe needs for six months. Then when people needed shoes again, there was no one to make them, leaving more people shoeless than before the truck arrived.
There are lots of unintended consequences by giving money to the poor. One of the worst is the mindset supported by donations. When you give you a hand out, it tells them that they don’t have control over their life. It tells them that the only break they’ll ever get is by winning the next lottery. But if you give someone a hand up—an opportunity to work for what they want—it encourages them to take control of their own life. It empowers them to earn their own way out of poverty, and inspires them to work hard. There’s a reason parents don’t give their kids everything they want without having to work for it. Why should we treat people in poverty any differently than we would our own children?
In the late 90’s and early 2000s, the world realized that the “help” poor people needed to escape poverty does not mean we need to give out donations. In Africa, uncorrupted leaders were begging nations and non-profit organizations to stop sending aid. It’s the single biggest cause poverty in Africa today. It funds corruption, competes with existing industries, and decreases real economic productivity.
Don’t get me wrong. I’m not against aid. It has it’s place in the world. Aid (free money) is important in many cases, such as recovering from natural disasters, wars, and economic crises. It worked marvelously to repair Europe after World War II and it could certainly help accelerate growth by funding some sectors, such as education. Every child should be given equal opportunity to go to school, even if their parents can’t afford to send them—but by no means is aid a sustainable economic development plan. You can’t build an economy off of aid, because by nature it’s not sustainable. It doesn’t replenish itself. More on this later.
The question became, how then should we help the poorest people in the world escape the poverty trap? In the wake of the aid crisis, a Bangladesh economist named Mohommad Yunus published the research he had been conducting and implementing in his own company, Grameen Bank. His new strategy, which I will discuss in further detail in a later post, dramatically reduced the risk involved by giving the poorest people in the world a loan to start a small business.
In fact, what’s now called the Yunus Model of micro-financing became such a risk-averse and scalable model that it exploded globally. Following the publication of his work, the UN declared 2005 as the “International Year of Microfinance”, and in 2006 Yunus received a Nobel Prize for how effectively his model was deployed all over the world. Using the Yunus Model, companies all over the world started to pop up—mostly in Asia and Eastern Europe. Latin America, followed suit and now it’s spreading across Africa and the Middle East. In the first decade following the year of micro-finance, the amount of money invested in providing economic services to the poor grew by 30% per year and became recognized as one of the most stable and risk adverse investments in the world—more on that in a later post.
Seemingly overnight, micro credit became a wide spread phenomenon. Economists revered it like it was a silver bullet solution to sustainable economic growth and the end of poverty (It’s not a silver bullet. I’ll explain why in another post). Nonetheless, it’s one of the most powerful tools in the poverty eradication arsenal. It’s not uncommon to see a micro entrepreneurs jump from making $1/day to $4/day and from $4/day to $20/day over the course of a six month loan.
For the first time in human history, poverty eradication seems possible because we’re able to sustainably provide financial services for the poor. Looking into the future, I'll discuss why micro financing is so effective—and when it’s not. I’ll explain how and why it’s possible for micro-entrepreneurs to multiply their profit by three, four, five, or even seven times after receiving a simple $200 loan. We will discuss the history of financing and aid, the development of micro-finance markets, and the economic gaps that are yet to be filled. I’ll discuss the cutting edge research that’s happening on the forefront of financial inclusion in emerging markets including insurance for the poor and help scale micro businesses into small and medium sized enterprises. And I’ll back everything up with anecdotes and stats, which will help empathize with the impact without skewing the reality of the situation.
My hope by writing this blog is that by helping educate you about the pros and cons of micro-financing, you become an educated investor that sees emerging markets not just as a cry for help, but as a real investment opportunity. You won’t have to choose between doing good with your money and being smart with your money. Follow along, or else the biggest investment opportunity of the 21st Century will slip right underneath your nose.