Helping the poor by selling them stuff; poverty alleviation through private enterprise

May 24, 2005

This year the United Nations announced a major push to deliver unprecedented amounts of aid to the world’s poorest countries. U2’s Bono has appealed to fans at rock concerts to support the One Campaign, which aims to persuade the U.S. government to spend an additional one percent of its budget to assist Africa and other struggling regions, while Tony Blair has called for a massive charitable package for Africa.

After last year’s devastating tsunami, relief pledges quickly turned into a bidding contest where nations did their best to out compete one another in their “generosity.” Despite this apparent renewed interest in charitable spirit, over the past generation aid to the developing world has met mixed reviews. Some of the largest recipients of aid are still some of the world’s poorest countries. What’s going on here? Have aid agencies just been throwing money into a hole?

Well to start, in many cases corrupt regimes have consumed massive amounts of aid. In the past aid — especially from America — was often tied to political agendas and went to supporting regimes that really had no business receiving aid. More money went to feeding strategic alliances with countries that were “poorly run, or not that poor,” as phrased by The Economist. Often, direct aid has not only bred corruption and the misallocation of resources away from those who need it most, but it has also fostered dependency and skewed the perceived value of goods and services.

So is there a better way to help the planet’s poorest people? C.K. Prahalad believes there is. In his book, The Fortune at the Bottom of the Pyramid: Eradicating Poverty Through Profits, Prahalad argues that by regarding the world’s masses, who he terms “the bottom of the pyramid,” as potential customers, businesses and the poor will be better off. Prahalad suggests that the private sector may do a better job eradicating poverty, building dignity and respect, encouraging entrepreneurship, and reducing dependency than handouts under traditional aid programs. Prahalad writes,

For more than 50 years, the World Bank, donor nations, various aid agencies, national governments, and lately, civil society organizations have all fought the good fight but have not eradicated poverty … If we stop thinking of the poor as victims or as a burden and start recognizing them as resilient and creative entrepreneurs and value-conscious consumers, a whole new world of opportunity will open up. Four billion poor can be the engine of the next round of global trade and prosperity … [and] a source of innovations.

As defined by Prahalad, the “bottom of the pyramid” consists of people living on less than $2 a day, or 4 to 5 billion people — around 80% of humanity. The sheer numbers of poor make them a valuable target for business.

Prahalad pegs the value of their purchasing power at around $13 trillion annually, an amount that exceeds the GDP of Japan, Germany, France, the United Kingdom, and Italy combined. As it exists today, the poor are essentially an under served market. Bringing them the products and services that they demand will not only be worthwhile to the companies providing these products and services, but will give the poor recognition that they lacked as a part of “the masses;” respect in the form of the dignity of attention and choices previously reserved for the middle-class and rich; and fair treatment in being freed from having to pay the “poverty penalty” whereby the poor have to pay a premium for the same products and services offered to the rich. Prahalad argues that “building self-esteem and entrepreneurial drive at the [bottom of the pyramid] is probably the most enduring contribution that the private sector can make” to poverty alleviation. Ignoring the poor does not help. Corporations and policy makers alike need to listen and respond to their needs instead of making assumptions about how they feel and what they require.

The Mystery of Capital: Why Capitalism Triumphs in the West and Fails Everywhere Else by Hernando de Soto

Reaching the poor is going to require more than just offering them “an existing portfolio of products and services,” writes Prahalad. “Because these product portfolios have been priced and developed for Western markets, they are often out of reach for potential customers in [bottom of the pyramid] markets. More important, the feature-function set has often been inappropriate.” Multi-national corporations are going to have to thoroughly re-engineer products to reflect both the very different needs of poor consumers and economics of the market — small unit packages, low margins, and high volume. Innovation in product development will be key and may reverse the flow of concepts, ideas, and methods to improve existing products offered in developed markets. The use of existing western products and methods will simply not cut it. Prahalad uses the example of resource usage to drive home this point:

The poor as a market are 5 billion strong. This means that solutions that we develop cannot be based on the same patterns of resource use that we expect to use in developed countries. Solutions must be sustainable and ecologically friendly… In the US each person generates 4.62 pounds of waste per day. If everyone is China adopted Western standards of waste per capita, there would be more than 5.5 billion pounds of waste per day. There are not enough places to dump this amount of garbage… With 5 billion potential users, per-capita consumption of all resources … can be crucial… Reducing resource intensity must be a critical principle in product development.

In coming up with a better approach to helping the poor through such consumer-driven market processes, they will need to overcome being cash-poor with a low level on income. Market development initiatives will need to focus on giving bottom of the pyramid innovators capital to innovate and bottom of the pyramid customers a greater capacity to consume, but not through the traditional approach of doling out products or service frees of charge. While “charity might feel good … it rarely solves the problem in a scalable and sustainable fashion” argues Prahalad. Access to fair and reliable micro-credit facilities can both increase the capacity to consume and stimulate entrepreneurship among the poor. For example, in Bangladesh women have used micro-loans to acquire cell phones which they then lease out to villagers for personal and business-related calls. Studies have shown default rates among these debtors are typically quite low, sometimes even lower than those among middle class debtors.

Also crucial to creating wealth at the bottom of the pyramid is rooting out corruption and implementing the rule of law. Prahalad argues that “most developing countries do not fully recognize the real costs of corruption and its impact on private sector development and poverty alleviation. The capacity to facilitate commercial transactions though a system of laws fairly enforced is critical to the development of the private sector.” He sees two major areas where developing economies can improve:

1. Under-developed legal structure. In many countries the absence of enforceable contract law means that private sector commerce is conducted through black markets which neither attract capital or are particularly efficient. Further, a lack of clear legal title means that much of some countries’ economic potential is tied up as trapped resources, or “assets that cannot be converted into capital because of underdeveloped legal frameworks and institutions” (a concept coined by Henardo De Soto in The Mystery of Capital).
2. Inability to enforce existing laws. The implementation of existing laws is critical to the development of a thriving private sector. Inconsistencies in enforcing laws, through bureaucratic interpretation of rules, opaque legal processes, and microregulations, can result in corruption that significantly hinders the private sector. “Corruption is a market mechanism for privileged access,” says Prahalad.

Prahalad proposes a concept he calls Transaction Governance Capacity, or TGC, for addressing corruption in developing economies. The idea of TGC is to make economic transactions and legal processes as transparent and consistently enforced as possible. TGC, through “clearly developed laws, transparent microregulations, social norms, and timely and uniform enforcement,” reduce transaction costs, clarify ownership and the transfer of ownership, and allow citizens to better understand the economic and legal processes.

Prahalad’s book, while controversial, has not gone unnoticed. It has won praise from the likes of Bill Gates, Madeleine Albright — the former U.S. Secretary of State under Bill Clinton, and various executives and administrators in both private industry and with international development organizations. Further, The Fortune at the Bottom of the Pyramid comes at a time when the United States government has recently restructured of its aid philosophy through a new program, the Millennium Challenge Account (MCA) which gives grants to countries committed to respecting the rule of law and reducing corruption. On the surface, the MCA appears to embrace some of the very same concepts presented in Prahalad’s book and may help promote the development of the conditions necessary for the growth of an efficient private sector.

According to The Economist the MCA “takes its inspiration from a group of World Bank economists, principally Craig Burnside and David Dollar, who argued that aid only works in countries pursuing sound economic policies.” The MCA uses “no fewer than 16 different indicators of a country’s honesty and soundness, including its credit rating, its treatment of civil liberties, its spending on health and education, and how long it takes to start a business.”

Madagascar

The first recipient of aid under the MCA was the Indian ocean island nation of Madagascar, one of the poorest countries on Earth. Under the agreement signed April 18, 2005, the country will receive $110 million over four years, money that Madagascar will use for supporting projects of its own design. The MCA asks only that projects be novel and deliver measurable impact on economic growth. Madagascar, where the average person lives on about $1 a day, certainly qualifies as a place where wealth creation for the “bottom of the pyramid” is needed.

Just four years ago, Madagascar probably would have been a long shot for aid under the MCA. The country was run by a military strongman, Didier Ratsiraka, under whose four decades of rule the economy stagnated, the quality of life plunged, and civil liberties were often trampled. Change was brought about in 2002 with the election of the capital city’s mayor, Marc Ravalomanana as president, though the regime change did not come easily. Former president Ratsiraka’s challenge of the election result nearly brought the country to civil war before he fled into exile.

President Ravalomanana has thus far proved to be a capable reformer who grades his ministers on their performance while cracking down on corruption and courting western business interests. The United States liked the way his government was running the country and a year ago notified Ravalomanana that Madagascar could apply for a Millennium Challenge grant.

Because roughly 75% of Madagascar’s population lives in rural areas, initiatives for stimulating growth while alleviating poverty differ from strategies used in other parts of the world. As Emma Ralijohn, the director of the MCA effort in Madagascar, put it in an interview with The Wall Street Journal, “We can’t just build factories in the cities — there would be economic growth, but not poverty reduction.” Instead, relying on feedback from the Malagasy themselves, government officials came up with a plan that will use funds from the MCA to address two of the most critical bottlenecks in achieving broad-based economic growth and poverty alleviation — the archaic system for land ownership and the banking system.

Land titles

The Fortune at the Bottom of the Pyramid: Eradicating Poverty Through Profits by C.K. Prahalad

The Mystery of Capital: Why Capitalism Triumphs in the West and Fails Everywhere Else by Hernando de Soto

As it exists today, the opaque nature of acquiring title to land makes it extremely difficult for most Malagasy to gain legal rights to their land. Without legal title to land, Malagasy have little incentive to improve their living quarters or sustainably manage their holdings. As a result, today most of Madagascar is treeless scrubland from generations of poor land management. Through MCA-funded improvements in the land title office, government officials hope to reduce corruption since in the past, virtually the only way to get through the formal titling process was using well-placed bribes. As a side benefit, the streamlining of the land title process may result in improved land management which in turn would help the largely agricultural-based economy which current suffers from severe soil degradation and erosion.

Banking reform

In banking, Madagascar has been long plagued with a system that encourages banks not to lend money to the general population. Banks can earn lucrative revenue simply by holding government bonds that pay around 18% interest and floating checks for weeks on end. With MCA funding, the government aims to make bonds available to individual investors who will then have more reason to save their earnings in bank accounts (currently only 200,000 of Madagascar’s 18 million have bank accounts). Banks would need to look elsewhere for revenue, something which help pave the way towards a banking system that would enable small entrepreneurs to take out microloans to grow their businesses and stimulate the economy. In The Fortune at the Bottom of the Pyramid, Prahalad has argued that such credit facilities are key to reducing poverty through wealth creation at the bottom of the pyramid.

Facing criticism

While Madagascar is still a long way from seeing whether these reforms are successful or even possible, the MCA has brought the country a great deal of hope. Back in America, there is debate over whether the MCA’s conditions are too strict. Critics argue that in the three years since its inception the program has granted funds only to Madagascar, totaling a mere $110 million out of the $2.6 billion budget for 2004-2005 (already scaled back from $5 billion). There is also concern that the MCA could exacerbate a phenomenon recently documented by the World Bank’s Monitoring Report whereby poor countries are “dividing into ‘aid orphans,’ bereft of any patron, and ‘aid darlings,’ doted on by competing agencies. The danger is that the MCA’s all-or-nothing, in-or-out criteria might make this polarization worse,” according to The Economist.

Poverty alleviation through profits

There is little doubt that creating wealth among the world’s poor is a noble endeavor that would generate immediate benefits in terms of health, the economy, and even the environment. Whether or not this is an attainable goal rests on the shoulders of many parties from local and national governments to international development organizations to private enterprises, and requires innovations in product development, marketing, and distribution. The MCA and other reformed aid programs may serve as a carrot to spur change in otherwise inept and corrupt governments. As Prahalad puts it, “The development of markets and effective business models at the BOP can transform the poverty alleviation task from one of constant struggle with subsides and aid to entrepreneurship and the generation of wealth. When the poor at the BOP are treated as consumers, they can reap the benefits of respect, choice, and self-esteem and have an opportunity to climb out of the poverty trap.”

References

This article used information and, in some cases, quotations from the following:

• Prahalad, C. K. The Fortune at the Bottom of the Pyramid: Eradicating Poverty Through Profits. Wharton School Publishing (2004)
• de Soto, Hernando The Mystery of Capital: Why Capitalism Triumphs in the West and Fails Everywhere Else. Basic Books (2003)
• Phillips, Michael M. “New Bush Strategy On Aid Faces Test In Madagascar,” THE WALL STREET JOURNAL (April 18, 2005)
• — “A choosier approach to aid.” The Economist (Apr 21st 2005)
• — “C. K. Prahalad, profits and poverty.” The Economist (Aug 19th 2004)

Other links of interest

• Microcredit helps women entrepreneurs in India: With Loans, Poor South Asian Women Turn Entrepreneurial, excerpt from WSJ.com
• NextBillion.net: Development Through Enterprise; Eradicating Poverty through Profit

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Rhett Butler Editor

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