What is a Poverty Trap? Understanding Causes and Solutions

Poverty-traps keep people poor not because they do not work hard, but because the obstacles they face are too great to overcome alone - Abhijeet Banerjee, Esther Duflo

Ramadan is a month of spiritual reflection and fasting, which also encourages people to consider their social responsibilities. The Holy Quran places great emphasis on charity, urging and mandating those with the means, to support the poor, orphans, and less fortunate members of society. In light of this, we present this post to deepen our understanding of poverty and, in particular, the structural barriers that trap individuals and communities in cycles of deprivation. Our aim here is not to bring readers to emotional tears but to objectively present the concept of poverty traps and explore potential solutions to break free from them. We hope that after reading this post, you will develop insights on how to help the poor and make the best use of the resources you intend to donate.

Poverty trap, often used casually in conversation, has a well-defined meaning in the fields of economics and social sciences. It refers to a situation in which individuals or countries remain poor because they lack the resources to invest in opportunities that would allow them to escape poverty.

Think about a farmer who cannot afford fertilizer—he constantly produces low yields, which results in fewer savings for buying seedlings for the next harvest (or worse, forces him into a high-interest loan). Now, imagine a wealthy family from Kuwait decides to help this farmer by buying him a year’s supply of fertilizer. With this application, his yield shoots up by 80%. The farmer now has much more savings, which he can use to buy better-quality seeds and fertilizer for the next year. This further improvement leads to an additional 30% increase in yield. In just two years, the farmer starts producing 2.5 times what he was producing before receiving the aid.

The book Poor Economics, written by Abhijit Banerjee and Esther Duflo, co-founders of the Abdul Latif Jameel Poverty Action Lab (JPAL) at MIT delves into the concept. We highly recommend our subscribers read it to gauge the rigor of their work. It highlights that the relationship between income today and future income can be S-shaped, leading to a zone where the very poor become progressively poorer.

This graph is explained in detail in the reference section of this post, but the broad idea is that (a) people in the poverty-trap zone have very low income, and (b) their expected future income is lower than their already low current income. This occurs because their low current income limits their ability to invest in essential areas like nutrition, health, education, and business ventures, thereby keeping them stuck in an impoverished state. The concept of a poverty trap suggests that there is a threshold of resources or opportunities below which it becomes exceedingly difficult to initiate a path toward sustained future improvement, as in the case of the farmer without fertilizer.

Cycle of Poverty Trap

However, if poor people are given a little help that brings them to point P in the graph, their growth potential increases significantly, giving them the opportunity to break away from the factors that further diminish their future income to below their already low current income (i.e., bringing them out of the poverty trap). Once a poor person moves past point P, the potential for fast growth becomes feasible. At some point, their growth slows down as they become relatively rich, but they will not fall back into the poverty trap again.

There are several factors that leads to a Poverty trap:

• Nutrition-based poverty trap: Although famines and severe food shortages for extended periods of time are very uncommon in the 21st century, there are still parts of the world where people do not get enough food or the necessary nutrients to develop the physical ability to work and earn a sufficient livelihood. Another common problem among the poor in many regions is child malnourishment, which affects their health throughout adulthood and reduces their productivity. In such situations, the poor cannot work enough to earn sufficient income to properly nourish themselves, ultimately trapping them in a cycle of poverty.

• Health-based poverty trap: Poor health can lead to missed workdays, reduced productivity, and educational setbacks, hindering economic progress. Jeffrey Sachs argues that countries burdened by diseases like malaria can become trapped in poverty because the illness weakens the labor force, making it difficult to afford preventative measures and thus perpetuating the cycle. Factors such as lack of information, procrastination, and underestimation of benefits play a significant role. Simple solutions, such as the availability of bed nets (to prevent mosquito bites), deworming pills for children, chlorine for sanitizing water, and a functioning drainage system, can have a major impact. Additionally, providing effective medical treatment ensures that those afflicted with disease can recover quickly without depleting their already limited savings on medical expenses.

• Lack of Savings: The inability to save can prevent the poor from investing in income-generating activities or buffering against economic shocks. Contrary to common perception, poor people are not dumb. They have ingenious ways of saving money, but despite their ingenuity in finding informal ways to save, the poor often lack access to formal savings institutions and face challenges in exercising self-control. They also encounter inevitable economic shocks, such as the sickness of a family member or crop failure due to bad weather, heavy rain, etc. There is always a temptation to spend small amounts, which seemingly doesn’t make much difference but makes saving difficult. By temptation, we are not talking about a restaurant meal every weekend, but people in a poverty trap are in such dire situations that cutting daily tea will also make a big difference in their state. The S-shaped relationship between wealth today and wealth tomorrow illustrates how those with minimal savings may not be able to accumulate enough to escape poverty.

• Reluctant Entrepreneurs: While many poor individuals operate small businesses, these ventures are often tiny and generate minimal profit. The lack of initial investment required for significant scaling, combined with limited access to credit and essential skills, can prevent these entrepreneurs from crossing the 'hump' needed for substantial growth. For many, these businesses serve as a means of survival rather than a pathway to significant wealth accumulation.

Bringing people out of the Poverty trap requires understanding the specific constraints they face and implementing targeted solutions. Possible ways of alleviating poverty traps include:

• Small, targeted interventions and "nudges": Providing timely information or a small push can sometimes have surprisingly large effects. For instance, placing chlorine dispensers at village wells makes water purification much easier and more likely. Reminders and small incentives can also improve the adoption of preventative health measures like immunization.

• Subsidies for essential goods and services: Making crucial items like insecticide-treated bed nets, fertilizer, and fortified food affordable or even free can overcome financial barriers and generate positive externalities.

• Improving access to savings: Facilitating access to safe and convenient savings accounts, even with commitment features, can help the poor accumulate funds for investments and manage financial shocks.

• Microfinance with realistic expectations: While microcredit provides access to small loans and can empower the poor, it is not a panacea for poverty. Its primary impact may be in providing a means to manage present needs and plan for the future rather than enabling a mass exit from poverty through rapid business growth.

• Comprehensive support for the "hard-core poor": Programs that provide a combination of temporary financial assistance, skills training, and ongoing support can help the most vulnerable individuals initiate income-generating activities and break out of extreme poverty.

• Creating a sense of possibility: The poor must have a world to believe that a better future is possible through improved education, secure employment opportunities, and reliable social safety nets. This belief will generate hope and encourage them to adopt a more positive attitude towards embracing steps for a better life.

With this information, one must reflect on the ways in which one can make a positive impact on people's lives and help them escape the poverty trap. For example, a financial reprieve of 150 Indian rupees (US $2), which is the amount a poor person in an Indian village might lose by missing a day of work, could prevent them from falling into the clutches of money lenders who charge exorbitant interest rates of around 20% per week (13,000% per year).

Apart from JPAL’s research, there are many other perspectives that conflict with these approach. This is especially true for political economists like Daron Acemoglu, whose institutional theory argues that the small steps advocated by JPAL will not bring sustained change if the country’s larger institutions are themselves pushing the population into poverty. JPAL, however, disagrees with Acemoglu’s emphasis on grand political and economic institutional change as a prerequisite for improving the lives of the poor. They argue that institutions are composed of smaller institutions, which can be reformed incrementally without revolutionary changes, making this a more practical path. In addition to this debate, there are other studies which focuses on:

• Behavioral and Psychological Aspects: Constant financial stress forces the poor into short-term thinking, impairing decision-making and long-term planning. Also, chronic poverty fosters hopelessness, reducing motivation to seek opportunities, though targeted interventions can help build aspirations.

• Environmental and Climate-related Poverty Traps: Environmental shocks like floods and droughts disproportionately affect the poor, worsening their economic vulnerability. Solutions like weather insurance and resilient infrastructure aim to mitigate climate-induced poverty traps.

• Globalization and Technological Change: Technological advancements can widen inequality by reducing demand for low-skilled labor, making it harder to escape poverty. On the positive, Mobile banking and digital payment systems expand financial access, helping the poor save and invest more effectively.

Islamic perspective: Unfortunately, Muslim thinkers have not developed such detailed strategies and analyses of poverty. However, one area where Islamic thinkers have placed great emphasis is the development of empathy for the poor. This stems from love for Allah and a sense of accountability (Taqwa), which motivates a person to be generous, regardless of external mandates. Adding a sense of personal responsibility to care for humanity, originating from divine love, can elevate the effectiveness of all proposed solutions. Without this, even the best analyses and solutions may have less than optimal impact. The moral dimension is an extremely valuable addition to the fight against poverty. Having said that, Muslim intellectuals should adopt more empirically driven, pragmatic approach instead of coasting purely on Normative mode of thinking.

In conclusion, the poverty trap is a multifaceted phenomenon driven by a combination of economic, social, and psychological factors. Breaking free from poverty traps often requires a combination of well-designed policies, small but impactful nudges, and a genuine understanding of the challenges and opportunities faced by the poor. The journey out of poverty is rarely a single leap but rather a series of small, hard-won steps facilitated by thoughtful and evidence-based support.

Reference:

[1] Poor Economics: A Radical Rethinking of the Way to Fight Global Poverty by Abhijeet Banerjee and Esther Dufflo

[2] Why Nations Fail: The Origins of Power, Prosperity, and Poverty by Daron Acemoglu, James Robinson

[2] Note on S-Shaped Curve: