The Puzzling Nature of Poverty

How would you define poverty? There are several definitions and each one of them helps us imagine poverty in different ways. One way to define poverty is the lack of resources required to lead a basic life. By this definition, as long as your basic needs of food, clothing and shelter are met, you are not in poverty. The United Nations defines poverty as the “inability of having choices and opportunities, a violation of human dignity.” A more quantitative definition from the World Bank defines poverty as living under $1.90 (Purchasing Power Parity) per day. This is the international poverty line. Amartya Sen’s capability approach describes poverty as “a failure to achieve certain minimum capabilities.” This means that poverty is not seen purely as an issue of economic development but includes measures of human rights and access.

It does not take long to realize that poverty has many faces. In a recent project called One Hundred Homes, researchers conducted a visual survey of India to examine what a household falling under a particular income or consumption level as per a standard government survey (IHDS, NSS) would look like in real life. The result was a collection of hundred visual essays showcasing the living conditions of families to understand the connection between wealth and poverty visually. A key insight is that it is almost impossible to predict which household is wealthier just based on the appearance of living conditions. We cannot simply look at assets owned to determine who is better off or worse off. Surveys usually measure poverty through consumption spending in a given period of time on a fixed category of things. This does not account for the value of the house, credit borrowed, subsidies received from the government, etc. In addition to this, the poverty line in itself is based on several assumptions such as calorie requirements and ignores indicators of education, health and wellbeing.

Poverty, through its appearance and measurement, presents several puzzles. Some obvious facts about poverty may not be true. On the other hand, results from experiments to understand the lives of the poor may be counterintuitive.

For example, one knows about the vicious nature of poverty. But why do the poor remain poor? Do bad decisions cause poverty or does poverty cause people to make bad decisions? Sendhil Mullainathan and other researchers ran a series of experiments to understand how scarcity affects cognitive capability and decision making. For an illustration of how poverty affects thinking, they asked people to memorize a list of words similar to the one below in 20 seconds and asked them to recall as many as they can from memory.

What’s interesting is that, although “money” was not on the list, people with low income are more likely to remember seeing money in the list than people with high income because words on the list are related to financial concerns. This portrays that money occupies a significant part of the cognitive load of the poor. Further, experiments also depict that people under financial stress perform poorly in cognitive tests such as Raven’s matrices and cognitive control tasks compared to those who are not. This implies that poverty in itself impairs sound cognitive performance.

A more realistic experiment conducted on Indian sugarcane farmers tested their cognitive abilities pre-harvest and post-harvest. Sugarcane has one harvest cycle per year. Before the harvest, farmers are relatively poor and uncertain about their finances whereas post-harvest, the same farmer is relatively rich. A random sample of small farmers was tested pre- and post-harvest on Raven’s matrices, a measure of fluid intelligence and the traditional Stroop task, which gauges cognitive control. Controlling for other fixed effects such as nutrition, work effort, etc., the experiment showed that being poor reduces cognitive capacity. Farmers post-harvest performed better on cognitive tests compared to pre-harvest.

This research suggests that the poor are less capable not because of their inherent capabilities but because poverty in itself imposes a cognitive load. Imagine if you were to make a decision after staying awake an entire night. Would you be able to make the right decision? The effect of poverty on cognitive function is comparable to losing a full night’s sleep. The poor constantly make important decisions of education, health, consumption and saving in this state of mind. The implication of this is that policymakers need to be aware of the psychological nature and cognitive tax of poverty. Welfare programs with complex ordeals aimed at better targeting may be counterproductive. The timing of welfare policies is also critical. Cognitive aids such as nudge can go a long way in offsetting the effect of poverty on cognition.

This also begs the question, why do the poor have to make more decisions than the rich with regards to essential utilities like savings, healthcare, insurance and so on? A poor person, who may not have access to banking services or formal employment, must decide to save for his or her retirement. On the other hand, the decision is already made by the organization of a rich person through the provident fund. The same goes for insurance, healthcare and even water. A rich person in an urban area can simply open a tap in the comfort of their home and clean water flows out, whereas a poor person has to choose where to procure water from, uncertain of whether it is clean or not, and decide what to do if it is not clean. Poverty impedes cognitive function and affects decision making. Above this, the poor make a significantly greater number of decisions amidst a lot of uncertainty. Both these facts are detrimental to leading a good life. Human beings have bounded rationality and self-control problems, hence fewer the decisions, the better. This is the reason why in developed countries like the United States, essential utilities such as insurance, savings are left to institutions and not the individual. If a poor person has to consistently choose to save every month for his or her retirement, they are bound to run into self-control problems. It is unfortunate that despite evidence on this, policymakers have made little effort to minimize the decisions taken by the poor. What, if not this, is an indication of inequality?

Another puzzle is that of risk and entrepreneurship. More number of poor people are self-employed and own businesses compared to the rich. Entrepreneurship involves risk and uncertainty. If the rich are better at managing risk due to their endowments and safety net, why is it that more poor people start businesses than the rich? This is the mystery of self-employment. That a person for whom it is easier is less likely to do it whereas a person for whom it is harder is more likely to do it.

A possible explanation for this is that the poor are natural entrepreneurs. But the question to ask is whether poor people are creative or does poverty force them to find creative ways of earning their income? This is not to say that poor people cannot be creative. An average poor person is probably as creative as the average rich person. However, there is an overrepresentation of entrepreneurs among the poor. The poor are entrepreneurs not because they want to be, but because they have to be.

Economics teaches us that people are generally risk-averse. So, they must prefer a salaried job to starting a business. A survey question asking parents regarding their ambitions for their children confirms this belief. The results from rural Udaipur and around the world are that most poor parents want their children to be in a salaried job. Only 7% of parents want their children to run businesses. For the poor, a job is a means to achieve stability and move up the social ladder. However, public policy does not seem to understand this. The policy view is that poor people are more entrepreneurial in nature and several policies have been created to encourage the poor to turn into entrepreneurs. Rural areas have the RSETIs (Rural Self Employment Training Institutes), which focus on providing training for rural youth on entrepreneurial development. There is no such equivalent for urban areas. However, for the urban poor specifically, there is a Self-Employment Programme (SEP) under the NULM, which provides financial assistance to set up self-employment ventures.

From my field experiences of visiting and working with SHGs (self-help groups) of Maharashtra and Madhya Pradesh, the thrust has been for SHGs to begin businesses. NABARD, NRLM and civil society are invested in this idea, providing loans and market support. It is likely that most of the SHGs are not even interested in business but have to involve themselves in order to take advantage of the credit and market support. Even in the recent COVID relief package by the Government of India, the specific relief measure for SHGs was to increase the collateral-free loan limit to Rs. 20 lakh so as to meet their business needs. This differential focus on self-employment for the poor is concerning.

Additionally, the traditional investment theory of risk-reward ratio does not work for the poor because of capital and technological constraints. Most businesses owned by poor people are not profitable. Different occupations are filled with different amounts of risk and uncertainty. Agriculture is one of the riskiest, yet least profitable occupations. Agriculture is subject to whether uncertainty, price uncertainty, market uncertainty, credit uncertainty, government uncertainty and what not! Hence, a poor farmer is not the same as a poor plumber and public policy needs to give attention to this fact. A reason why agriculture is one of the most intervened sectors by the government is not just populism but also the level of uncertainty tagged with the occupation.

There are many more such puzzles in the world of poverty. To unearth these puzzles, we need to rigorously test the traditional theories we hold about the poor. In a developing world, everybody is undergoing a transformation, with the poor transforming at a faster rate at the margin. Thus, we not only need to ask the right questions but also revisit the existing answers to update our understanding of poverty. Each piece of evidence gives us insights into the lives of the poor and incorporating these insights helps us create better poverty alleviation policies.

The views expressed in the post are those of the author and in no way reflect those of the ISPP Policy Review or the Indian School of Public Policy. Images via open source.