“Poor people are poor because they don’t know how to save.” — a grave misconception. What if I told you that research has shown that the poor constantly save? This is the focus of my column today.
As a quick wrap up on the past three weeks discussing some findings of a research project on the financial habits of Filipino migrants in Paris, most of whom come from disadvantaged backgrounds which pushed them to migrate in the first place, I pointed out three things that the literature tells us about the financial strategies of the poor. First was that group lending and borrowing replicates sophisticated economically driven tools of financial institutions for monitoring and default risk mitigation. Second is that women are great money managers, both in microfinance and remittance studies, because being financially included empowers their decision-making, and, finally, the poor have a diversity of financial needs and because of this, they are pushed to create complex portfolios and relationships to manage these. Most surprisingly: the poor hate indebtedness and constantly save.
As Microfinance evolved, customers began using the microloans less exclusively for setting up businesses and more towards their needs like paying for school fees or health services and consumption in general. This led to a proliferation of products like micro-insurance and micro-savings. Further, the initial goal of making every poor household entrepreneurial largely shifted into addressing the vulnerability of the poor, creating a change in purpose of the loans and of the microfinance mission in general going away from microcredit. Studies have shown that combining microcredit with micro-insurance has a significant effect on empowering the poor and creates a more sustainable path out of poverty. This is because the main concern of the poor is cashflow management rather than investments in assets.
Collins et al. (2009) in a landmark study of 250 poor households in Bangladesh echoed this point. The authors found that the poor engage in frequent, small-scale transactions that do not follow their income pattern. So, imagine this: in the span of days or a week — at one point, a poor person must buy food, at another point, they must repay debt, at another, they collect debt someone owes to them, with interest income. They may also pay school fees, which is a form of investment, pay rent or amortization for a house, vehicle, or appliance, work overtime to pay off leaves they owe to their employers, or even put money in a paluwagan or a group savings scheme with their friends, which is quite like a bank account with zero interest really. These are all complex financial transactions which require skill and efficiency and planning, and, most interestingly: the act of saving. The only problem is, the savings disappear in a few days or even hours.
The poor use a portfolio approach wherein well-thought-out partial solutions are sought rather than one major solution. At any one time, the average poor household has a collection of financial relationships on-the-go. They use financial intermediation — they decide to either save (to store past income that can be spent at a later date) or to borrow (to take advantage, now, against future income) via transactions with family, neighbors, moneylenders, and saving clubs, constituting a set of formal, semiformal, and informal financial providers — that can fairly be described as a portfolio. Every household in the 250-strong sample, even the very poorest, held both savings and debt of some sort. No household used fewer than four types of instruments during the year and they used this several hundred times in a year.
Instead of long-term goals of asset accumulation, which tends to be the objective of higher income households, the main objective of the poor is cashflow management. Being able to manage immediate needs is a precondition for considering long-term ambitions. Even if the poor person’s behavior was characterized by frequent, small-scale transactions that do not follow their income pattern, such behavior was rational and thought-out.
Further, we know from the lessons of microfinance over the years, that indebtedness is all the more difficult when one is poor. Some studies have shown that indebtedness has cognitive effects. In a couple of high-profile cases in India, the pressure of repayments and extremely high interest rates led to suicides. The poor who have a much more unreliable stream of income had less psychological capacity to live with debt and this became their “jail.” They would sacrifice the money they would use for eating to meet debt repayments.
In talking with my interviewees in Paris, I found that the migrants tended to either clearly write down their debts or recall them in their heads every day because they are not only expected to repay the debt but also in a form of reciprocity, they are expected to be able to provide help in the future to the person who had helped them. This thus creates not only reputational pressure but also social pressure to repay in the future. Some persons preferred to take a debt that cost more in the form of interest so as not to have this pressure and to avoid the ruining of relationships. However, being indebted is not a choice but a necessity in their lives, a necessity they hate.
The bottom line of the financial behaviors of the poor: they are some of the most sophisticated money managers you will ever meet — adept in saving, believers in insurance, and conscient of their debts. They have the innate capacity for proper wealth management, if only they had the resources and the tools available to play with. n
Collins, D., Morduch, J., Rutherford, S., & Ruthven, O. 2009. Portfolios of the poor: how the world’s poor live on $2 a day: Princeton University Press.
Other references are available upon request.
Daniela “Danie” Luz Laurel is a business journalist and anchor-producer of BusinessWorld Live on One News, formerly Bloomberg TV Philippines. Prior to this, she was a permanent professor of Finance at IESEG School of Management in Paris and maintains teaching affiliations at IESEG and the Ateneo School of Government. She has also worked as an investment banker in The Netherlands. Ms. Laurel holds a Ph.D. in Management Engineering with concentrations in Finance and Accounting from the Politecnico di Milano in Italy and an MBA from the Universidad Carlos III de Madrid.