For a variety of reasons, therefore, micro-insurance may not become the next billionaire market opportunity. There seems to be a deep reason that most people don’t yet feel very comfortable with certain kinds of insurance products that the market is willing to offer. On the other hand, the poor clearly bear unacceptable levels of risk. There is, thus, a clear role for government action. Private companies could continue to sell exactly the kinds of insurance they are currently willing to sell, but for the time being, the government should pay a part of insurance premiums for the poor.

Subsidizing insurance could pay for itself in terms of higher incomes for the poor. It is possible that over time, as people start to see how insurance works and the market starts to grow, that the subsidy could be phased out. A social safety net could, thus, be the key. A minimum income support that people would be entitled to if their income fell below a certain range could free them from having to worry about finding money to survive. This sense of security that any of these would provide would encourage savings for two reasons: by creating a sense that the future holds promises, and by lowering the stress level, which directly impedes decision making.

One other way for poor people to expand their asset base is to borrow. On an average, in countries like India, the poor borrow mainly from moneylenders, followed by friends and family. Only about five per cent of the poor are able to borrow through formal financial channels because information and monitoring costs of lending to the poor people prohibitively high. This has always been the challenge of the micro-credit movement for lending to the poor people at reasonable rates of interest. The poor continue to borrow from money-lenders at exorbitant rates of interest because of the rigid rules and time costs imposed on micro-credit borrowers.

This year’s Nobel Laureates have concluded that there is a tension between the spirit of micro-credit and true entrepreneurship, but ‘there are very few programmes targeted at the poor that have managed to reach so many people’. They recommend the immediate expansion of the micro-credit movement, notwithstanding some of the recent controversies surrounding it. The alternative to borrowing for investment is prior saving, but poor people find it hard to save partly because of the natural preference for present rather than future consumption (even though returns on present savings can be high e.g. investment in fertilisers), and partly because the formal banking system is not interested in encouraging small savings or dealing with small accounts.

The high cost of collecting information on a borrower also help explain why even when there are several moneylenders in each village, competition does not drive the price of credit down. Once a lender has paid the cost of vetting a borrower, and the borrower has established a good reputation with him, leaving becomes difficult. Borrowers are somewhat bound to the moneylender they know already. And the latter often exploit this advantage to raise the interest rates. The typical micro-finance institution (MFI) contract involves loans to a group of borrowers, who are liable for each other’s loans and, hence, have a reason to try and make sure that the others repay.

MFIs threaten to cut off all future lending to anyone who defaults. The loan options at MFIs are not nearly as flexible as with moneylenders who make it difficult for the MFIs to organize the payments and lower the cost of doing so. Microcredit has, however, earned its rightful place as one of the key instruments in the fight against poverty. However, the equivalent of the microfinance revolution for small and medium firms is still a long way away. Nobody has yet figured out how to do it profitably on a large scale. Changes in the business environment, such as improvements in the functioning of courts, may well make the difference. Finding ways to finance medium-scale enterprises is the next major challenge for finance in developing countries.

In an attempt to reduce risk, microfinance institutions have experimented with offering health insurance, but the extreme poor may not be willing to pay the required premiums at the cost of tying up cash. Subsidized insurance from governments could reduce risk exposure while also dropping premiums to a level that the poor are willing and are able to pay. Micro-credit offers better interest rates than moneylenders, but in comparison, its rigid borrower repayment structure means less flexibility with future cash. Microcredit has reached hundreds of millions, and while its effect has not been dramatcally transformative, it has demonstrated positive gains. Enterprises that receive microcredit loans rarely grow beyond one employee.

There is currently a funding gap for medium-scale enterprises that are still too small for banks, but too large for money-lenders. The reason why most poor people run a business in the first place (approximately twenty per cent of the rural poor operate a non-agricultural business) is that they want a job to supplement a meagre income. The problem is that most poor countries don’t generate enough ‘regular’ jobs in the private sector or government which is the job that most would prefer. To make life easier for the poor, the Banerjee and Duflo suggest subsidized migration of rural workers to the cities. However, given the grim conditions of urban life, it surely makes more sense to take work to the workers. This is the paradox of the poor and their businesses. They are energetic and resourceful and manage to make a lot out of very little.

But most of this energy is spent on businesses that are too small and utterly undifferentiated from the many others around them. In order for a small business to scale, they must either be on the cutting edge of some new product or have to invest enough to get a production technology that allows your business to operate on a large scale. A sense of stability may be necessary for people to be able to take the longterm view. While the marginal returns (return per dollar of investment) of microenterprise investments can exceed 50 per cent, the businesses themselves are very small and overall returns are quite small. In many cases, these businesses do not last more than five years and rarely grow beyond one employee.

Additionally, this means that it may be decades of steady reinvestment before one accrues the necessary funds to purchase a technology that might significantly expand production or business. Knowing this, it can be almost impossible for the extreme poor to believe they will be able to change their circumstances and, therefore, attempt to venture down the path of growth. The Nobel Laureates believe that India is at the risk of falling into the ‘middle-income trap’, which means that countries grow to a point where they do not grow any further.

With the quality of our human capital, infrastructure and environment being poor, we can’t continue growing beyond a point. Our economic growth would start petering out once the structural weaknesses in our economy including the opportunities created by the inherent misallocations and distortions wear thin for our entrepreneurial class, as already visible all around us. Hence, if we wish to keep growing, we surely need to fix our economic structures and institutions while also making some suitable changes at the policy level.

(Concluded)

(The writer is an IAS officer, presently posted as the Commissioner of School Education, West Bengal. Views are personal)