Chapter Four - Poverty and Inefficiency Traps
What stops companies doing business with poor people? If it is all so obvious, why doesn’t it happen already? Why do we need a book to tell us what to do?
This chapter is all about identifying the subtle systems that stop people making mutually beneficial agreements. Most of the work on this has been done by development economists who look at it from the perspective of poor people—what traps them into unemployment, lack of business opportunities, insufficient credit to operate at efficient scale? We look at this from the other perspective and so we call them ‘inefficiency traps’ rather than poverty traps—systems that prevent companies from doing business efficiently with poor people. The solutions to these traps rarely involve money and often depend simply on increasing one’s ability to form trusting relationships and to commit to agreements.
One of the apparent mysteries about the process of opening up to free markets and foreign investment is that the process tends to reinforce rather than undermine the status quo. You would expect that the old elites of people who got rich from land or political power would be replaced by entrepreneurs with business skills. But the evidence from South-East Asia and Russia is that old political and aristocratic elites thrive on the new opportunities. The poor might get slightly richer, but rarely change places with the old rich.
This is a dangerous situation for international companies, who quite unwittingly find themselves tarred by the sometimes disappointing results of capitalism. It’s bad for their reputation because it associates them with propping up privileged classes or ethnic groups and delivering few benefits for the poor. And it’s bad for profits because it restricts the number of people they can deal with as suppliers, distributors or customers. Poverty/inefficiency traps are the key to explaining much of this, and a company that understands them can increase its bargaining power and improve its reputation with local people, governments and development agencies.
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Chapter 4 – links and resources
‘Strategies that Fit Emerging Markets’ by Tarun Khanna, Krishna Palepu and Jayant Sinha, in the June 2005 issue of Harvard Business Review provides an excellent account of how companies need to understand and adapt to ‘institutional voids’ in developing counties either by changing their business model or by helping the country to fill the gap. It is written purely from a strategy perspective rather than a poverty alleviation point of view, but reaches similar conclusions to ours. You can pay to download a copy of the article from http://harvardbusinessonline.hbsp.harvard.edu
The Mystery of Capital
Opportunity International and Grameen Bank are fine examples of microfinance organisations that welcome links to multinational corporations.
The Enterprise Centre in Baku is a good example of multinational companies overcoming inefficiency traps and increasing local sourcing. INSEAD Innovasia works to connect multinational companies with Asian entrepreneurs.
UNCTAD's World Investment Report 2001 discusses the value of establishing better backward linkages with local companies.
"Poverty Traps and Development" by Professor Stefan Dercon of Oxford University gives an excellent technical account of the role that poverty traps play in constraining pro-poor growth.
"Lack of Investment is the Problem in Africa" describes The Shell Foundation's attempts to help poor people overcome poverty traps and gain access to credit.
