The rural poor as energy producers - a critique of the "bottom of the pyramid" development discourse
At Biopact, our original interest in the bioenergy sector stems from professional engagements in the (poor parts of) emerging economies and from working in the field of development economics. Simply put, it quickly became apparent to us that the potential for the production of biofuels in the South offers a genuine way to tackle poverty. The simple reasoning is that (1) energy prices and GHG emissions costs worldwide are rising sharply (oil prices tripled in under 3 years time with no serious declines in sight for the long-term; carbon-markets are being introduced on a planetary scale) (2) biofuels offer an immediate alternative to fossil fuels and there is an ever growing global demand for them; contrary to other renewables (like wind or solar), the energy and carbon-neutrality coming from bioenergy can be traded physically as a commodity as well as virtually in the form of carbon credits (this is important because it allows producers to play on two markets at the same time) (3) poor farmers in the South have a competitive advantage (land, labor, climate) and can thus boost their incomes by becoming energy producers who can sell to us competitively. A simple proposition. It is crucial that we stress this productive capacity of the poor and their ownership over it. Of the 3 billion people that live on less than two dollars a day, some 70% live in rural areas with more than half of them being farmers. With moderate capital interventions and basic knowledge and tech transfers, they can diversify into energy production over which they retain control.
Now over the past several years, there has been a new and some say offensive and even dangerous trend in the field of development economics which turns this logic on its head. The trend is called 'development through enterprise' and is highly successful amongst business leaders from the West, the World Bank and some political forces. It effectively comes down to the privatisation of poverty alleviation. Instead of stressing the productive capacities of the poor, this trend sees them as a huge pool of consumers to which companies can sell and make a profit by doing so. In this vision, consumerism is presented as a the better way to alleviate poverty, as follows:
- There is much untapped purchasing power at the bottom of the pyramid. Private companies can make significant profits by selling to the poor.
- By selling to the poor, private companies can bring prosperity to the poor, and thus can help eradicate poverty.
- Large multinational companies (MNCs) should play the leading role in this process of selling to the poor.
Recently, Professor Aneel Karnani, an influential development economist at the Ross School of Business (University of Michigan), looked carefully at this 'development through enterprise'-trend and his conclusions are devastating: the 'BOP'-discourse is riddled with fallacies, is a self-serving illusion, and may even result in increased poverty. Prof Karnani published his critique at a portal called 'NextBillion' (which is entirely devoted to the promotion of the 'BOP' proposition), where the discussion is ongoing. His main thesis is that the only real poverty alleviation strategy consists of increasing the real incomes of the poor by looking at them as producers, not as consumers.
Let's quickly add at this moment that this is exactly what we are aiming for at the Biopact. It is the most basic of our objectives to help farmers in the South to become energy producers who are able to sell to businesses and consumers on a global market. The bioenergy sector is one where the rural poor can be effectively looked at as producers, more so than in any other sector perhaps. Rather than approaching them as consumers to which we must sell, we look at them as producers (in this case of energy) who can sell to us. This all sounds very basic, but as Karnani indicates, the ideological framework behind this is more complex than it looks.
So how does Karnani deconstruct the neo-liberal 'bottom-of-the-pyramid'-proposition, and why is his stress on the productive capacities of the poor so important to us? Let's have a closer look:
bioenergy :: biofuels :: energy :: sustainability :: developing world :: poverty :: economic theory :: development economics ::
In order to understand the dangers posed by the increasingy successful 'development through enterprise' ideology, we must follow Karnani's arguments in detail. They will show why the Biopact stresses employment opportunities brought by bioenergy, and the need to strengthen the productive capacity and ownership of rural farmers.
Karnani himself illustrates his paper with many examples, amongst them several about the plantation sector and the energy sector, which we have retained because they are related to the biofuels sector as it is developing in the South.
The BOP-proposition and neo-liberal development economics exploit the poor
The BOP proposition suggests that the consumption choices available to the poor can be increased by targeting various products and services, such as shampoo, iodized salt and televisions, at the bottom of the pyramid. Holding the poor consumer’s income constant, the only way he can purchase the newly available product is to divert expenditure from some other product. Still, this increased choice will increase his welfare, assuming he is a ‘rational’ consumer. However, as a practical matter, this is unlikely to result in a significant change in his poverty situation. Additionally, if for some reason, the poor consumer is irrational in his resource allocation choice, the BOP initiative might even result in reducing his welfare. The BOP initiative could result in the poor spending money on products such as televisions and shampoo that would have been better spent on higher priority needs such as nutrition and education and health.
C.K. Prahalad, the biggest proponent of the BOP-idea, dismisses such arguments as patronizing and arrogant; how can anybody else decide what is best for the poor? He argues that the poor have the right to determine how they spend their limited income and are in fact value-conscious consumers; the poor themselves are the best judge of how to maximize their utility. This is free market ideology taken to an extreme, and is a potentially dangerous aspect of the BOP proposition.
The poor in fact are vulnerable by virtue of lack of education (often they are illiterate), lack of information, and economic, cultural and social deprivations. A person’s utility preferences are malleable and shaped by his background and experience, especially so if he has been disadvantaged. We need to look beyond the expressed preferences and focus on people’s capabilities to choose the lives they have reason to value.
The problem is that the poor often make choices that are not in their own self interest. (The rich also often make choices not in their self interest, but the consequences are not as severe in their case.)
Raising real incomes
Not only is there no fortune, there is not even glory at the 'bottom of the pyramid'. It is a fallacy to claim that there is much ‘untapped’ purchasing power at the BOP. The poor, in fact, obviously consume most of what they earn, and as a consequence have a low savings rate. Contrary to the BOP argument, getting the poor to consume more will not solve their problem. Their problem is that they cannot afford to consume more.
The only way to help the poor and alleviate poverty is to raise the real income of the poor. There are only two ways to do this: 1) lower prices by appropriately lowering the quality of the goods that the poor buy, which will in effect raise their income, and 2) raise the income that the poor earn. The BOP proposition eschews the first approach because it insists on not lowering quality. It deemphasizes the second approach because it views the poor primarily as consumers rather than as producers.
Lowering prices of products
One way to alleviate poverty is to reduce the prices of the goods and services the poor buy (or would buy), thus increasing their effective income. To have a significant impact on the purchasing behavior of the poor, the BOP proposition calls for price reductions of over 90%. This is too ambitious a target and rarely achieved; let us consider instead price reductions of at least, say, 50%.
There are only three ways to reduce prices: 1) reduce profits, 2) reduce costs without reducing quality, and 3) reduce costs by reducing quality. If it is true that the average profit margin in a market is well over 50%, we should certainly endeavor to make the market more ‘efficient’ and reduce monopoly profits resulting in significant price reduction. Even allowing for the fact that the poor are often subject to local monopolies, this must be a rare situation. Therefore, the only realistic way to reduce price is to reduce cost. The BOP proposition is adamant that we should not reduce quality in this process.
Unless all current producers are grossly inefficient, the only way to reduce cost by over 50% without reducing quality will always require a significant improvement in
technology. Good examples of this are found in the areas of computers, telecommunications and various electronic products. It is difficult to find examples of such dramatic cost reduction in other product categories. Thus it is not surprising that the BOP proposition repeatedly uses the same examples. Note that the ultimate impact on the real income of the poor due to these major price reductions is quite low because the poor spend only a small part of their income on such electronic products. Rather they spend over 80% of their income on food, clothing and fuel – products that have not benefited from such dramatic technological changes in a long time.
Contrary to the BOP proposition, it is often necessary to reduce quality in order to reduce costs; the challenge is to do this in such a way that the cost-quality trade-off is acceptable to poor consumers. A good example of this logic is the low-price detergent introduced by Nirma in India. In 1969 Karsanbhai Patel started a small business to sell a cheap detergent powder he had formulated in his kitchen. The quality of Nirma was clearly inferior to that of Surf, the product marketed by Hindustan Lever, the Indian subsidiary of Unilever. “Nirma contained no ‘active detergent’, whitener, perfume, or softener.
Indeed tests performed on Nirma confirmed that it was hard on the skin and could cause blisters” (Ahmad and Mead, 2004). Largely because of this Nirma sold at a price about one-third the price of Surf. Nirma rapidly became a success. In 1977, Surf had a market share of 31 % compared to 12% for Nirma. Ten years later in 1987, the market share of Surf had come down to 7% while that of Nirma had gone up to 62%. Contrary to the BOP proposition, the poor do like inexpensive, low-quality products! This is not because they cannot appreciate or do not want good quality. They simply cannot afford the same quality products as the rich; so, they have a different price-quality trade-off. They are even willing to put up with a detergent that sometimes causes blisters!
Most often, reducing costs while reducing quality does not require a major technological advance. Prahalad and Hart (2002) admire the R&D prowess of Unilever to harness state-of-the-art technology to serve the poor. Yet in this famous example of Nirma, it was a lone chemist who formulated the product in his kitchen.
Nirma is a perfect example of a win-win situation. The company has created a large market and made significant profits. The poor are better off now that they can buy an affordable detergent. In a real sense they are economically better off. We need more products like Nirma. Unfortunately, examples like Nirma are not common. Selling inexpensive, low-quality products does not hurt the poor. Insisting on not lowering the quality actually hurts the poor by depriving them of a product they could afford and would like to buy. The BOP proposition argues that selling low quality products to the poor is disrespectful. Quite the contrary, imposing our price-quality trade-off on the poor is disrespectful of their preferences. The myth is that low-quality implies terrible, shoddy, or dangerous products. It is better to think of quality as a relative concept.
Quality broadly defined
Garvin (1987) develops a framework for analyzing quality by considering eight dimensions of quality: performance, features, reliability, conformance, durability, serviceability, aesthetics, and perceived quality. To further expand this concept, other dimensions might be added such as availability, timeliness, convenience, and
customization. The customer takes into account all these dimensions and arrives at a subjective judgment of the overall quality of the product (or service), and is, by definition, willing to pay a higher price for a product with higher quality – this is the price-quality trade-off. Holding technology and firm capabilities constant, it costs more to produce higher quality products – this is the cost-quality trade-off. To profitably serve the poor, the firm needs to make the cost-quality trade-off in a manner consistent with the price-quality trade-off made by the target customer.
The Poor as Producers
The BOP proposition focuses on the poor as consumers. To the contrary, we argue for the need to view the poor primarily as producers, not as consumers. Rather than emphasizing selling to the poor, we should emphasize buying from the poor. By far the best way to alleviate poverty is to raise the income of the poor. Even though the BOP proposition conceptually focuses on the poor as consumers, it sometimes cites examples of successful organizations that treat the poor primarily as producers. We agree with these examples and will highlight some of them below. In discussing solutions to poverty, it is useful to conceptually separate the role of the poor as
consumers and producers.
Create Efficient Markets: a successful farmers' cooperative
The poor often sell their products and services into inefficient markets and do not capture the full value of their output. Any attempt to improve the efficiency of these markets will raise the income of the poor. Amul, a large dairy cooperative in India, is a great example of this approach. Amul collects milk from 12 million farmers twice a day from 100,000 villages. It started by selling milk, but has since forward integrated into more value added products such as butter, milk powder, cheese, ice cream, and pizza. More recently it has even entered direct retailing through franchising parlors. Amul is owned by the poor (it is a cooperative), and buys from the poor (the farmers, who are its members); however, its customers are mostly from the middle and upper income groups, and export markets.
Soybean farmers in India
Another example along similar lines is e-Choupal, an initiative of ITC in India (Prahalad, 2004). Based on an innovative business model, e-Choupal has brought efficiency to the system for moving soybeans from the individual farmer to oil processing plants. It has reduced dramatically the role of, and the rents captured by middlemen in this process. ITC views the poor farmers not as consumers, but rather as producers. “Our e-Choupal is fostering inclusive growth and enhancing the wealth creation capability of marginal farmers” (emphasis added) says Y.C. Deveshwar, Chairman of ITC (The Hindu, 2006).
Ventures such as Amul and e-Choupal are commendable because they improve the productivity of poor individual farmers and help create micro-enterprises.
The Role of the State
Governments need to facilitate the creation and growth of private (small, medium and large) enterprises in labor intensive sectors of the economy, through appropriate policies (such as de-regulation), infrastructure (such as transportation), and institutions (such as capital markets). Small and medium sized enterprises need financing options – both debt and equity -- in the range of $10,000 to $1 million that are almost non-existent in developing countries (Shell Foundation, 2005). Lack of good infrastructure results in geographically fragmented markets and firms that are too small to exploit scale economies.
Some see the best antidote to poverty in economic growth. There is much evidence linking poverty reduction to economic growth – the so called ‘trickle down’ or ‘multiplier effect’. But, there are two problems with this argument. First, the trickle down effect may be too little and too slow. We need to target programs specifically at poverty reduction rather than just wait for the general multiplier effect to kick in. The recent political changes disillusionment with market liberalization and a drift to the populist left - in several South American countries (such as Venezuela, Bolivia, and Peru) support such an emphasis on poverty reduction.
Second, poverty cannot be defined only in economic terms; it is about a much broader set of needs that permit well being. Development can be seen as a “process of expanding the real freedoms that people enjoy” (Sen, 2000). "The point is not the irrelevance of economic variables such as personal incomes, but their severe inadequacy in measuring many of the causal influences on the quality of life and survival chances of people". The BOP proposition focuses on companies, marketing and prosperity; it sees the social, cultural and political benefits at best as by-products of economic gains. In contrast, we think that social, cultural and political freedoms are desirable in and of themselves, and also enablers of individual income growth. We should emphasize the role of the government and public policy in cultivating and safeguarding these other (non-economic) freedoms.
Virmani (2006), an economist with the elite Planning Commission of the Government of India, concedes that the improvement in social indicators in India has not kept pace with economic growth and poverty decline. This is the result of government failure to “fulfill the traditional, accepted functions of the government like public safety and security, universal literacy and primary education, public health education, provision of drinkable water, sanitation drains and sewage facilities, public health (infectious and epidemic diseases), building road, and creating and disseminating agricultural technology.” While there has been a distinct shift in political ideology of the world towards an increasing role of the market (as opposed to the government), providing the above functions still needs to be in the public domain, especially in the context of helping the poor.
Downsides of the BOP Proposition in a Nutshell
Even if not intentional, a by-product of the BOP proposition is its de-emphasis of the role of the state in providing basic services and infrastructure. Actually, the BOP proposition goes even further. Prahalad is quoted as saying “if people have no sewage and drinking water, should we also deny them televisions and cell phones? … It is absolutely possible to do well while doing good” (Time, 2005). The poor surely have a right to buy televisions; the issue is whether it is in their self interest to buy televisions. Prahalad (2002) argues that the poor accept that access to running water is not a “realistic option” and therefore spend their income on things that they can get now that improve the quality of their lives.
Why do the poor accept that access to running water is not a realistic option? Even if they do, why should we all accept this bleak view? Instead, we should emphasize the failure of government and attempt to correct it. Giving a ‘voice’ to the poor is a central aspect of the development process.
Prahalad (2002) describes the impressive extent of business activity in the slums of
Dharavi (in Mumbai). “The seeds of vibrant commercial sector have been sown.” But, we should be cautious about celebrating this entrepreneurship too much. Sharma (2000) in her emotive book about Dharavi states that while enterprise in the midst of deprivation is to be admired, there is absolutely “nothing to celebrate about living in a cramped 150 sq. ft. house with no natural light or ventilation, without running water or sanitation.” The UN-Habitat estimates that in Dharavi there is one public toilet for every 800 people. This poses a bigger problem for women because of obvious reasons of anatomy, modesty and susceptibility to attack. Televisions are not an adequate substitute for lack of sanitation. Even if we concede that televisions help the poor to escape the burden of their bleak lives and thus provide some value, how do they help eradicate poverty?
To truly solve the problem of poverty, we need to go beyond increasing the income of the poor; we need to improve their capabilities and freedoms along social, cultural, and political dimensions as well. The role of the government is critical in some of these dimensions. By emphatically focusing on the private sector, the BOP proposition
detracts from the imperative to correct the failure of government to fulfill its traditional and accepted functions such as public safety, basic education, public health, and infrastructure, all of which increase the productivity and employability of the poor, and thus their income and well-being. Reform of capital markets will also enable many more local entrepreneurs to create jobs that employ as well as serve the poor.
Beyond the Hype
The BOP proposition is characterized by much hyperbole and very weak research methodology. The fortune and glory at the bottom of the pyramid are a mirage. The fallacy of the BOP proposition is exacerbated by its hubris. Prahalad (2004, page 45) states that all the examples used in his book challenge the current paradigm. Selling appliances on credit – as does Casas Bahia – is not even a novel idea, let alone a new paradigm.
The Millennium Development Goals adopted by the United Nations member states target the halving of extreme poverty in 25 years. Finding this pace too slow, Prahalad (2004, page 112) states “I have no doubt that the elimination of poverty and deprivation is possible by 2020.” But why be satisfied with only poverty eradication when so many other problems plague the world? Prahalad and Hammond (2002) argue that the BOP initiative will not only eradicate poverty, but also cure economic stagnation, deflation, governmental collapse, civil wars, and terrorism. And all this in 15 years!
Walsh et al (2005) are awed by Prahalad’s (2004) ambition: “he is trying to eradicate worldwide poverty in 15 years for goodness sake!” They argue for cutting Prahalad some slack; “we cannot let people suffer and die while we pause to clarify the logic”. We think exactly the opposite. It is precisely because poverty is such a serious issue that we should be careful to validate the logic and demand much rigor.
Solving the crisis of poverty requires recommendations supported by logical analysis rooted in data, not exhortations based on unsupported assertions and hyperbole. The poor deserve no less.
Aneel Karnani, Fortune at the Bottom of the Pyramid: A Mirage, [*.pdf] Stephen M. Ross School of Business at the University of Michigan, Ross School of Business Working Paper Series Working Paper No. 1035 September 2006. [Other download options].
New Economics Foundation, Growth isn’t working: the uneven distribution of benefits and costs from economic growth [*pdf] January, 23, 2006. [Abstract here.]