How does it feel to be poor?

We are living in a world where finding contentment in living a simple life is becoming increasingly difficult. Inequality is on the rise; some are running an extravagant lifestyle while many are suffering from underconsumption. Today I found the following text about what being poor feels like on a friend's wall on Facebook. It is a really good read and tells us a lot about the poor and multi-dimensionality of poverty. It also makes us think about the expenditures we make, the ethics we subscribe to and the ends we work towards. 

 

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Late last year, two young men decided to live a month of their lives on the income of an average poor Indian. One of them, Tushar, the son of a police officer in Haryana, studied at the University of Pennsylvania and worked for three years as an investment banker in the US and Singapore. The other, Matt, migrated as a teenager to the States with his parents, and studied at MIT. Both decided at different points to return to India, joined the UID Project in Bengaluru, came to share a flat, and became close friends.

The idea suddenly struck them one day. Both had returned to India in the vague hope that they could be of use to their country. But they knew the people of this land so little. Tushar suggested one evening — “Let us try to understand an ‘average Indian', by living on an ‘average income'.” His friend Matt was immediately captured by the idea. They began a journey which would change them forever.

To begin with, what was the average income of an Indian? They calculated that India's Mean National Income was Rs. 4,500 a month, or Rs. 150 a day. Globally people spend about a third of their incomes on rent. Excluding rent, they decided to spend Rs. 100 each a day. They realised that this did not make them poor, only average. Seventy-five per cent Indians live on less than this average.

The young men moved into the tiny apartment of their domestic help, much to her bemusement. What changed for them was that they spent a large part of their day planning and organising their food. Eating out was out of the question; even dhabas were too expensive. Milk and yoghurt were expensive and therefore used sparingly, meat was out of bounds, as were processed food like bread. No ghee or butter, only a little refined oil. Both are passionate cooks with healthy appetites. They found soy nuggets a wonder food — affordable and high on proteins, and worked on many recipes. Parle G biscuits again were cheap: 25 paise for 27 calories! They innovated a dessert of fried banana on biscuits. It was their treat each day.

Restricted life

Living on Rs.100 made the circle of their life much smaller. They found that they could not afford to travel by bus more than five km in a day. If they needed to go further, they could only walk. They could afford electricity only five or six hours a day, therefore sparingly used lights and fans. They needed also to charge their mobiles and computers. One Lifebuoy soap cut into two. They passed by shops, gazing at things they could not buy. They could not afford the movies, and hoped they would not fall ill.

However, the bigger challenge remained. Could they live on Rs. 32, the official poverty line, which had become controversial after India's Planning Commission informed the Supreme Court that this was the poverty line for cities (for villages it was even lower, at Rs. 26 per person per day)?

Harrowing experience

For this, they decided to go to Matt's ancestral village Karucachal in Kerala, and live on Rs. 26. They ate parboiled rice, a tuber and banana and drank black tea: a balanced diet was impossible on the Rs. 18 a day which their briefly adopted ‘poverty' permitted. They found themselves thinking of food the whole day. They walked long distances, and saved money even on soap to wash their clothes. They could not afford communication, by mobile and internet. It would have been a disaster if they fell ill. For the two 26-year-olds, the experience of ‘official poverty' was harrowing.

Yet, when their experiment ended with Deepavali, they wrote to their friends: “Wish we could tell you that we are happy to have our ‘normal' lives back. Wish we could say that our sumptuous celebratory feast two nights ago was as satisfying as we had been hoping for throughout our experiment. It probably was one of the best meals we've ever had, packed with massive amounts of love from our hosts. However, each bite was a sad reminder of the harsh reality that there are 400 million people in our country for whom such a meal will remain a dream for quite some time. That we can move on to our comfortable life, but they remain in the battlefield of survival — a life of tough choices and tall constraints. A life where freedom means little and hunger is plenty...

Plenty of questions

It disturbs us to spend money on most of the things that we now consider excesses. Do we really need that hair product or that branded cologne? Is dining out at expensive restaurants necessary for a happy weekend? At a larger level, do we deserve all the riches we have around us? Is it just plain luck that we were born into circumstances that allowed us to build a life of comfort? What makes the other half any less deserving of many of these material possessions, (which many of us consider essential) or, more importantly, tools for self-development (education) or self-preservation (healthcare)?

We don't know the answers to these questions. But we do know the feeling of guilt that is with us now. Guilt that is compounded by the love and generosity we got from people who live on the other side, despite their tough lives. We may have treated them as strangers all our lives, but they surely didn't treat us as that way...”

So what did these two friends learn from their brief encounter with poverty? That hunger can make you angry. That a food law that guarantees adequate nutrition to all is essential. That poverty does not allow you to realise even modest dreams. And above all — in Matt's words — that empathy is essential for democracy.

Should we worry about income divergence or not?

 

Charles Kenney, in his paper titled “Why to worry about income when other quality of life indicators are converging?” tries to show that quality of life variables other than income are all converging; so, there is no need to worry about inequalities. As far as the numbers and quantities of the indicators he is talking about are concerned, I can agree with him. However, when it comes to the quality of the indicators, I have some questions and concerns that make me worry about income divergence.

The quality of life variables that Kenny is talking about consist of average basic health indicators such life expectancy, infant mortality rates, literacy, civil rights, political rights, primary school enrollment, access to everyday communication technology, child labor, total education per capital and some other social indicators. As he has shown, basic indicators are converging. For example, the number of children getting enrolled every year in developing countries are increasing rapidly and hence getting closer and closer to those numbers of enrolment in the developed world. But, we can ask a valid question here: is the quality of primary education also converging? Take Afghanistan for example, the number of enrolment in primary, secondary and tertiary schools have drastically increased over the past 20 years. However, a very big portion of these number of students are having the following problems: no regular teacher, lack of books, no school building. Solving all these problems need a stronger income. Given this, should Afghanistanis worry about income or not? I think they should. The case of India, which comes second after China amongst developing countries, is not very different in terms of education quality from that of Afghanistan. The numbers of children enrolment are remarkably significant; but, the quality is still very low, and to improve the quality, India needs more money. Higher-income can help India improve the quality of education both through direct investment and through improving relevant institutions.

We can ask such valid questions almost about all those indicators that Kenny talks of convergence in them. For example, when it comes to civil rights and political rights, the quality of civil rights in the developed world is far more ahead of what we have in the developing countries. Civil institutions and political institutions are weak and may not grow to the level of developed nations if GDP and income of the global south are falling behind the global north. I strongly doubt such a possibility in the absence of high income. The basics, structures and models of such institutions can be imported from the developed countries, as has been the case in  Afghanistan, and some other third world nations; but, the quality cannot be imported. There is a need for more money, stronger income and GDP to improve and well-establish such institutions. As Ha-Joon Chang argues, there is a strong causality running from economic development to better institutions. He particularly stresses the point that economic development increases the demand for better institutions and more transparency. So, to have developed institutions such as those in the developed world income convergence matters.

In the face of Covid-19 pandemic, we see how the quality of institutions, the quality of the health-care system, and the quality of education (for covid-19 research) and the strength of income have increasingly become important. This pandemic has shown that even if all other indicators are converging, but income is not, then your vulnerability remains very high. What Charles Kenny is suggesting cannot explain how developing countries will ensure that they will converge to developed nations when it comes to technological researches. For technological researches and making advances in these areas, heavy investments are needed. Only high-income countries can bear it. One might not be wrong to say that tech advances are now the backbone of economic development and economic competition.

 To sum up, I can agree with Kenny to the extent that low-hanging indicators and indicators that have a higher bound on them are concerned. However, this does not suffice to stop me from worrying about the divergence of income. The income divergence may push for further inequality when it comes to the quality of “quality of life indicators”. Hence, income convergence is needed to have a real convergence rather than being delighted by somewhat superficial convergence.

 

Bibliography:

Kenny, C. (2005). Why Are We Worried About Income? Nearly Everything that Matters is Converging. World Development, 33(1), 1-19. doi: 10.1016/j.worlddev.2004.06.016

CHANG, H. (2010). Institutions and economic development: theory, policy and history. Journal Of Institutional Economics, 7(4), 473-498. doi: 10.1017/s1744137410000378

 

EXPLORING THE BENEFITS (IF ANY) OF FORMALIZATION DRIVE FOR INFORMAL FIRMS IN A DEVELOPING COUNTRY SETTING

1. Introduction

Informal sector constitutes a large part of a developing economy. It seems that the informal firms take a rational decision to exit from the formal domain by comparing the costs and benefits of formalization. (Suresh De Mel, David McKenzie, and Christopher Woodruff, 2013). De Mel and others found that formalization has a very limited impact on the profitability of the firms who exit the informal sector and join the formal one. Given this, we want to find out if the push for formalization of informal firms in a developing country is of any benefit. Here, I want to argue that any push for formalization in the developing countries will act as a double-edged sword. In other words, it is an act that has both favorable and unfavorable consequences. Still, I believe that the favorable consequences of formalization outweigh its unfordable outcomes.

2. The unfavorable consequences of formalization drive

2.1 Government might waste its budget on firms that cannot stand in the competing world of formal sector.

Firms which are in the informal sector can easily compete with formal sector firms and even have an edge over them due to lower wages, non-existence of taxes and other types of costs that are related to activity in the formal sector. In the informal sector, they can survive even if they do not make a profit. This is what makes activity in the informal sector favorable to informal firms.

The firms that can survive in the informal sector might not survive once they enter the formal sector unless there is enough financial support from the government. If we assume that the government will support them with subsidies, then there will not be much room to argue that formalization is good because it adds to the income of the government. If subsidies or financial amounts are paid to induce informal firms to become formal, then one would argue that letting informal firms in the informal sector is better because they will not be a burden on the budget of the government. If we argue that incentives should be paid only for a short time, then one would counter us that the firms might return to the informal sector as soon as the government cut its financial support. Therefore, we can say that one unfavorable consequence of push for formalization through financial incentives is that government might waste its budget on firms that cannot stand in the competing world of formal sector.

2.2 A large section of people might not be able to survive.

Another somewhat obvious consequence of push for formalization is that a lot of firms might completely die out and disappear after a while when they enter the formal sector without any financial support from the government. Of course, here we are assuming that the government is using force to turn the informal sector formal. This means that a large part of people who could previously survive working in the informal sector now even might not be able to survive.

3. The favorable consequences of formalization drive

3.1 Tax and efficient allocation of resources

Research has shown that informality and lower tax collection are related – a phenomenon that reduces the ability of the government to finance public services (Levy, 2008). Hence, one favorable consequence of formalization is higher tax collection that will enable the government to better finance public services and even invest in the development projects. However, taking our discussions in the previous paragraph into consideration, we should cautiously optimistic about this consequence of formalization.

The coexistence of formal and informal firms leads to an inefficient allocation of resources in the economy through the different marginal production costs (Chang-Tai Hsieh and Peter J. Klenow, 2009). Therefore, formalization will lead to efficient allocation of resources which is another favorable consequence.

3.2 Profitability for the firms and contribution to economic growth and development

In addition to the above, another favorable consequence of formalization is access to formal business infrastructure including credit, technological support and access to more markets which ultimately lead to higher productivity and output of the firms. This favorable consequence can be viewed from the perspective of firms, because firms which are active in the informal sector have no or very limited access to what we just pointed out. Similarly, the firms will no longer be subject to harassments and bullying of government authorities asking for bribes.

We said that formalization opens access to formal business infrastructure including credit, technological support and access to more markets which ultimately lead to higher productivity and output of the firms. Higher productivity means, for the firm, higher profits and for the entire economy higher growth. Through this channel, formalization helps an economy with its growth and development.

3.3 Impacts on the quality of life of laborers

Apart from the above, I believe formalization will have positive impacts on the quality of life of labor force. When informal firms are formalized, they are required to follow labor laws set by relevant authorities. Wages of laborers will increase and some form of protection will be provided to employees/laborers. This is while in the informal sector, firm owner is restricted by no law and he/she can set any wages and can hire/fire on the spot. Of course the problems that informal sector laborers are facing are not limited to wage and instant firing. Inhumane working conditions are another big issue.

4. Conclusion and my take 

As discussed above, in the case of financially incentivizing informal firms to join the formal sector, the government might waste its budget on firms that cannot stand in the competing world of formal sector. However, there are chances that the firms stand on their own feet and become competitive profit-maximizing firms. If governments, backed by the use of force, coerce informal firms to go formal, there is a risk that a large section of people might not be able to survive when the informal sector disappears. This is firstly impossible. Even if we assume its possibility, due to inefficient and ineffective outcomes, it is not recommended.

Apart from the above undesired possible outcomes under certain conditions, I believe that formalization drive for informal firms in a developing country setting has various benefits. It can improve the quality of life of laborers employed by the informal sector, it can make survivalist firms profit-maximizing which contribute to the economic growth and development, it can improve the allocation of resources throughout the economy, and finally it adds to the income of the government. Hence, as stated at the opening paragraph of this writing, I believe the favorable consequences of formalization outweigh its unfordable outcomes.

References

Chang-Tai Hsieh and Peter J. Klenow. (2009). Misallocation and Manufacturing TFP In China and India . Quarterly Jouranl of Economics.

Levy, S. (2008). Good Intentions, Bad Outcomes: Social Policy, Informality and Economic Growth in Mexico. Brookings Institution Press.

Suresh De Mel, David McKenzie, and Christopher Woodruff. (2013). The Demand for, and Consequences of, Formalization among Informal Firms in Sri Lanka. American Economic Journal: Applied Economics.