The people inside our markets – part I
I recently had a very interesting conversation with the Harvard economist Dr. Sendhil Mullainathan. Economists have recently been looking at how large a role human behaviour and incentives play when it comes to markets, and how people treat money; this is a big part of Sendhil’s work.
Sendhil’s particular interest is in how the poor, especially in rural India, respond to the lending and savings solutions that banks offer them. Sendhil points out to me, that what the financial sector typically does is take the banking solutions they have for the middle class and offer it to the poor. This does not work well because the way the poor earn their incomes is very different from the salaried class. Indian farmers for example, typically earn a chunk of income every six months or so, after harvesting and selling their crops.
For these farmers, paying loans on monthly installments, and saving money becomes an extremely difficult thing to do. ‘Its difficult for people to spend a large amount of money they suddenly receive, very carefully,’ Sendhil points out. Its human nature – people who get rare windfalls of cash find it difficult to plan and spend the money in small amounts. The impulse is then to celebrate - what money they receive they splurge, spending on weddings, family events and ‘conspicuous consumption’. Such consumption is especially important for the poor. As recent work on low income communities points out:
“Conspicuous consumption…. is not an unambiguous signal of personal affluence. It’s a sign of belonging to a relatively poor group. Visible luxury thus serves less to establish the owner’s positive status as affluent than to fend off the negative perception that the owner is poor. ”
As a result, the poor often have little money leftover for monthly expenditures such as schooling for their children, and even food and clothing.
Sendhil and other economists have been trying to devise specific banking solutions, which for example, allow rural workers to pay out big chunks of their loans at the end of the harvesting season. They are also working on other solutions which help them manage their money better, through micro-insurance schemes and savings accounts that allow large deposits and automated monthly payouts.
This new focus on human behavior– and tailoring market solutions accordingly – has become a focus for economists across different fields. They argue that people don’t always keep a complete hold on the real value of an asset when they are buying or selling in a market. The truth of that is pretty apparent when I look at our everyday purchase decisions. My friend hankers after the newest mobile phone or PDA - even though he (and many other likely buyers) feel that a part of the high price comes from the hype, and that ten months later once the next version is out, this one is relatively worthless, both to him and on eBay. We are rarely completely rational in our purchases — whether that’s a house, the latest gizmo, or a car loan.
So new theories around real estate and credit bubbles – which is the root of the global downtown we are now facing– have focused on how people in real life react to regulation, easy credit, and speculative prices in real estate and the stock market, and how the collective mood, rather than any fundamental numbers, works in sending economies into upswings and downturns.
Tying our individual and collective behavior to economic theory is not going to be an exact science. But I am still betting that it will give us some new, powerful insights.
Tags: banking solutions for rural India, collective behaviour and economic theory, conspicuous consumption, lending and savings, micro-insurance, Sendhil Mullainathan
December 20th, 2008 at 8:11 pm
Sir, why didn’t you just call it by its name - behavioral economics/finance
December 21st, 2008 at 2:46 pm
But economics has always been about collective behavior. “Value” has never been a physical property (like weight, color, hardness, etc), but the collective demand for a thing. Thus the “value” of gold is just what people in modern societies ascribe to it. For example, it has zero value in a remote, non-integrated tribe in the Andamans.
And once modern economies ditched the gold standard (where quantities of the stuff were limited due to its physical nature), the value of anything has become subject to easy swings w.r.t. mass belief in the same (tech companies, houses, oil, whatever). Physical gold cannot disappear overnight, but “value” of modern currencies, stocks, etc can. Since a) it is virtual and b) only exists in the collective consciousness of modern societies.
And once money stopped being tied to a physical substance, governments could much easily just “print” it, or basically create it out of thin air. Which is what Obama and all governments are promising now. Of course, the “value” of the newly printed dollars will be less, or in other words, inflation goes up.
Coming back to bubbles, since a) modern markets are electronic and b) money is not linked to a physical substance, bubbles are pretty much a given. Wall street, with all its brains, thrived on them. Just move the virtual money from one bubble to another and keep going. Tech bubble, real estate bubble and shortest of them all - the commodities bubble. And all these bubbles were never a function of livelihood linked demand and supply. They were speculation linked demand and supply.
But, finally, it looks like reality is catching up. But, I would still not put it past Wall Street to cook up something new.
December 21st, 2008 at 11:17 pm
Indian Banking Industry has many schemes that is tailored to suit farmer’s requirement. for e.g. the crop loan is designed to finance during the sowing season and repayment is aligned with the harvest (Rabi and Kharif crops). It is not lack of suitable schemes that is the reason but the conservative/cautious approach of the Banking system that pushes the farmer to knock on the door of private money lender. It is very difficult for a marginal farmer without proper acrage to borrow from Bank due to minimum land holding required and other securities needed to secure a loan. Bank’s reach to remote villages is also limited. It is highly necessary to ensure the schemes reaches the needy farmer.
The tendency to splurge whenever one has some liquidity is in human nature. However in rural India such expenses especially for weddings of daughers or family events is also driven by social beliefs and needs. Even today it is not easy to marry off a not so educated and financially dependent girl without spending good amount of money in the marriage. So between repayment of loan and the expenses for family functions or marriages they have to choose the later as they have no other choice.
December 23rd, 2008 at 8:37 pm
The ground level realities of various projects should be judged by the end result of reaching various demographics of India. The truth is that a Mirage of success on various projects is being projected, which does not reach the poor. It’s not the poor who should be blamed for those. Every person cannot be a Kshatriya, nor a Chanakya. You should not expect everyone to do everthing evertime:-(
December 26th, 2008 at 11:32 pm
The cooperative movement in Maharashtra understood banking needs of the farmers; they easily replaced traditional traders as ‘providers of financial solutions’. Their structures were more equitable and democratic; they were ’social entrepreneurs’ on forefront of Maharashtra’s development. They did everything from investment to marketing. Most importantly, their banks were designed for the functions of their socio-political movement; they went on to achieve much higher purpose of establishing cooperation as a community value- than mere branch operations meeting customer demands. Though they operated in different business environment, what matters is they really performed and came to be known as “Sugar Lobby”. They dominated the state politics for decades.
But now co-operative sector is falling short to meet challenges of modern times (globalization is one key factor), the co-operative politics has gone morally bankrupt, and farmers have no leaders. Sharad Pawar shifted quickly from sugarcane (food) to cricket (media), but farmers are hardly able to change their ‘profiles’. The rural youth also plays cricket (reflecting his aspiration to become urban) but no one will ever get equity in BCCI.
The financial institutions need to be entrenched in process of change while working with any part of our market, especially the backward ones. The developmental solution may be anything- ranging from urbanization to reviving the agriculture to employment guarantee scheme, we need to have more bankers understanding the basics of change economics and create the products-services for catalyzing the socio-economic change. They need to design products-services not just for transactions – investment is perhaps the most important. Community development was inherent in co-op banking but only way for modern banks (ICICIs, HDFCs) to have effective societal penetration is to walk on the shoulders of cutting edge innovative social movements – both technological and organizational innovations on forefront.
Since everyone values money, financial sector has huge role and responsibility in creating what we can call as reform enterprises. We, unfortunately, have history of ‘them’ waiting forever. No ventures and no angels. They will talk about microfinance, but refuse the responsibility of acting on several levels between micro and macro or moving along several angles between horizontal and vertical processes of development. They only change when changing societal values (or ‘change in value perception’ as business describes it) bring the total catastrophe on wall streets. People in our markets need financial institutions for change resulting into market expansion and benefiting everyone.
December 30th, 2008 at 8:23 pm
On a tangential note, check this out - http://bookoutlines.pbwiki.com/Predictably-Irrational - A list of experiments on people’s irrational behavior under different circumstances.