Inductivism is an important complement to the formal deductive models that prevail in the Economics profession. This is certainly the case with developing countries where observing how the real world functions could result in insights that might be useful to policymakers. This book is a major breakthrough in understanding how the masses of poor developing countries manage not only to survive, but even to improve their lot.
The authors interviewed two hundred and fifty poor households in three countries (Bangladesh, India, and South Africa) twice a month for a period of one year, and from the data collected they constructed "financial diaries, showing how the poor manage their money. Through the analysis of the diaries," interspersed with individual stories, they found that physical assets changed very little, [End Page 182] while most of the action was with financial assets. Poor people need financial services more than any other group. Poor households with a pressing need to intermediate goods have to manage a collection of relationships and transactions with others—family, neighbors, money lenders, and savings clubs, constituting a set of formal, semiformal, and informal financial providers—that can fairly be described as a portfolio" (p. 14). In the three countries studied, the cash turnover with use of these instruments amounted to 75–300 percent of annual income in Bangladesh and India, and 500 percent for some households in South Africa.
The authors found that many households paid interest huge rates—amounting to 200 percent on an annualized basis. However, most loans are never held for a year, but rather for short periods (less than a month, or for just a week) and thus interest paid on very short duration loans should be considered as a fee. And thus when "research annualize all interest rates, they may be following standard accounting practices but distorting the real picture" (p. 22).
They point out that the well-known Grameen Bank focused on microcredit. Gradually this has become inadequate, as poor households do not only want to borrow, but also to save and insure, and thus the emphasis has been increasingly on the need for microfinance. This is clearly shown by the financial diaries on which this book is based as "demand for microcredit extends well beyond the need for most microenterprise credit. The poor households in the study seek loans for a multitude of uses besides business investment: to cope with emergencies, acquire household assets, pay schooling and health fees, and, in general, to manage complicated lives" (p. 25).
Not only the low returns of work, but also the uncertainty of work opportunities led the poor to patch livelihoods together from different sources. Poor households are found to employ financial tools not despite being poor but because they are poor. All poor households were found to attempt to save, using savings accounts to patch gaps in their cash flows: "saving small sums when they could, and drawing down the balance when they needed to for food, travel costs, medicine and the like" (p. 47). Loans were used to stock up with rice, buy a wooden cupboard, etc.
Most households conduct their saving and borrowing activities on their own or with informal partners, as this offers flexibility, but this lacks reliability, flexibility, privacy, and transparency and "rely too heavily on kindness, goodwill and norms of mutual obligation" (p. 57).
The diaries show that poor household incomes are not only low but also irregular, and financial services to deal with this problem are [End Page 183] imperfect. The authors observe that in the rich world the portfolio of a household is managed on the basis of risk and return. But the portfolios of poor households "are instead managed to ensure that money can be obtained in the desired amounts at the desired times" (p. 61). Thus the way to understand the lives of the poor is to analyze cash-flow analysis rather than balance-sheet analysis.
The diaries show that...