I continue discussing the findings of a research project I conducted on Filipino migrants in Paris, to understand how migration is being used as an investment strategy. This led me to dig deeper into the literature of financial strategies of the poor, which is often the demographic that most migrants come from. I needed to understand in a broader way, why is it that people must migrate? Why is it that they cannot simply invest their wealth at home or become good entrepreneurs, study hard to get better jobs to lift themselves out of poverty? Are they lacking in skillsets when it comes to saving and investing? What is the bottleneck? Finally, why is it that they manage to obtain financial stability elsewhere and what does that say about the financial strategies of the poor?
There is a general idea that for one to have become rich, then she or he would have had to be intelligent with money. And that if one is poor, then it is because of negligence or lack of prudence in money matters. This idea gets extended to — anyone who is rich is smart with money and anyone who is poor is financially illiterate. But this is often not the case. Many rich people simply inherited their wealth and may appear rich when they are actually deeply indebted, whereas many poor people are born into poverty with no way to get out of it no matter how skilled. We make assumptions because we only observe the rich and their success stories.
In addition to a host of socio-economic problems, the poor suffer what authors Collins et al. (2009)* refer to as a “triple whammy”: low incomes, unpredictability in these incomes, and lack of access to good and appropriate financial services. Whereas the first two issues are significantly difficult to deter, the third issue is something that can still be addressed. Financial inclusion is the buzzword for this — it is the delivery of financial services at affordable costs to sections of disadvantaged and low-income segments of society. Financial inclusion is measured through access to financial services, which provides the separation between people who are “bankable” (that is, credit-worthy enough to maintain an account) and those who are “unbankable.”
Understanding the financial strategies of the poor has become more and more possible with the growing research on Microfinance. Further, a ground-breaking project that led to the book Portfolios of the Poor have largely extended these findings by shedding light as to how the “bottom billion” manage their daily lives — looking at cash flow rather than balance sheets. The authors systematically tracked 250 poor households in Bangladesh, India, and South Africa over the course of one year. I reviewed this literature which uncovered that the poor are among some of the best money managers! First, the poor use group lending and borrowing in a way that would make economists proud; second, they leave money-related decision-making to women; third, because they have a diversity of financial needs, they are pushed to create complex portfolios and relationships to manage these. And, finally, and most surprisingly: the poor hate indebtedness and constantly save. Interestingly these are all characteristics that the migrants in my study possessed. Let us discuss the first characteristic today.
Group lending and borrowing is effective for the poor. This method was one of the main innovations microfinance brought to the banking sector. The group lending method consists in self-formed groups of borrowers (generally composed of between three and 10 members) who know each other that assume a joint liability for the repayment of loans given by microfinance institutions (MFIs) to group members. The idea is that because they know each other, they will avoid forming a group with individuals that have higher risk profiles, thus mitigating information asymmetry problems between the MFI and the borrower and resulting in a lower probability of default. The formation of a group also increases peer pressure, which is the substitute for collateral in a situation where they had no physical or monetary assets. Plus, there is a reputation issue — when members participate in meetings, they feel that they must illustrate their trustworthiness. This feature was also important in savings. Being able to save in a group provided more accountability and social pressures and made saving more salient. This illustrates that the poor are able, in their own ways, to replicate even the most sophisticated theories of investment involving moral hazard and adverse selection. Do not discount their sophistication.
(To be continued)
*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 IÉSEG School of Management in Paris and maintains teaching affiliations at IÉSEG 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.