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October 08, 2008

How Will the Financial Crisis Affect the Base of the Pyramid?

Luke Davenport ’09
Co-President, International Development Club
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This is the first in a series of blog posts from the International Development Club.

Much of the political discussion surrounding the $700 billion bailout passed by Congress last Friday has revolved around how the plan will affect ordinary “Main Street” Americans. Yet the financial crisis has had an impact world wide. Will the economic “base of the pyramid” — the three to four billion people in the developing world who earn under $3,000 per year — feel the pain?

It is estimated that large portions of many developing countries’ GDPs are held in the informal sector. In Nigeria, for example, it is estimated that two-thirds of the country’s economic output takes place outside of any economic and legal regulation. Unfortunately, this means that many people developing countries (90% in Nigeria, for example) have the dubious “advantage” of being unbanked. They draw income, pay expenses, and hold savings in cash and rarely engage with the formal capital markets in any direct way. While they may not be adversely affected by the financial crisis, people in developing countries are affected by other issues, such as the increase in food prices. That cost was up 40% in 2007 alone according to the UN Food and Agricultural Organization and it has effectively lowered the income of millions of people already living without a financial cushion.

The fact remains that an enormous swath of the world’s population has never had access to the wealth-generating power of capital markets that we, until recently, have taken for granted. This should prompt us to consider how we can best help the world’s poor access the wealth-magnifying capacity of well regulated formal financial markets without exposing them to the type of reckless behavior demonstrated by of some of the major American financial institutions in recent years.

Our upcoming Social Enterprise Conference will feature practitioners who have some interesting thoughts to contribute on this topic, especially in the areas of private equity and microfinance. What are your thoughts on how financial institutions can move into emerging markets safely? Please leave your comments.

The International Development Club is involved with projects as diverse as SME (Small and Medium Enterprise) development initiatives in emerging markets, the ongoing evolution of microcredit, and base-of-pyramid inclusive business strategies employed by multinationals. Last year the IDC spun off Microlumbia, the first student-run microfinance fund of its type. The IDC also offers consulting opportunities with enterprises throughout the developing world, a speaker series and an annual Washington DC careers trip.

Photo credit: Shubert Ciencia

Comments

by Kevin | October 08, 2008 at 1:27 PM

A little-known effect of this high inflation is that subsistence farmers can suddenly sell their staple crops as cash crops. As they do so, they can run down their seed stock for the next season. They may also sell high-value, high-protein foods, such as beans, and consume low-value, low-protein foods like cassava instead. Over time, this poor diet will exacerbate their poverty.

by Osifo A | October 08, 2008 at 5:45 PM

The best way for financial institutions to move into emerging markets especially though micro-finance and other similar concepts is to drop the "instant gratification" mindset i.e., these institutions should not seek extra-ordinary profits in the first few years of operation. This is not to say that the banks should not go in looking for a profit, instead I am advocating that they go to these communities and approach business with the mindset that the customer comes first, then the customer's community, then the shareholders. It's the win-win strategy in emerging markets with large rural populations.

by Ray Fisman | October 08, 2008 at 7:59 PM

There are a couple of secondary effects of the crisis that could have a first-order impact on the world's poor. First, commodity prices have gone haywire, and this volatility translates directly into volatility in farm incomes. And if a prolonged global slowdown leads to long-term price declines, some farmers will see some lean days ahead (though of course the urban poor will be better off). The other concern is that the unraveling of U.S. financial markets as a result of the free market run amok will cause a global backlash against liberalization. The last thing much of the developing world needs is more rigid oversight and control of its markets.

by Gaurav Maleri | November 01, 2008 at 9:50 PM

its absolutely certain that the bailout packages worldwide are going to have a negative impact on the billions of poor and underprivileged at the bottom of the pyramid. First of all is the lack of attention for these people on account of the current financial crisis.The attention and the resources needed for these people are going to shrink. Second is the existing resources meant for this section o fthe society.More often than less in such crisis times the corporates who have even an iota of commitment for such causes are likely to withdraw as such initiatives are not that well known to contribute to the bottomline or the topline. Third, the money lending institutions who have burnt their fingers in this collapse of the financial sector are likely to be more selective in their lending and it remains to be seen as to what impact it has on the lending to those at bottom of the pyramid,esp as this section might have lesser means and ability to pay.

by Damon Krytzer | March 09, 2009 at 1:45 PM

BUT there may be a positive for the proliferation of investment products among investors given the low-corr to developed financial markets. By offering products that are potentially low-risk based on historically low default rates, and uncorrelated to the global capital markets, there is potential to turn microfinance into a mainstream asset class, thus attracting sustainable and scalable funds. Of course the correlations are increasing somewhat, but still possess very unique variables that keep the cash flows unique.

by julien vallet | March 16, 2009 at 12:40 PM

Luke, Where can we find the minutes of the Social enterprise conference you organized in october? Thanks for your answer, Best Julien

by Shu Dar Yao | November 17, 2009 at 10:25 PM

IFC, the private sector arm of the World Bank, recently launched a slew of initiatives aimed at filling the gap of commercial financing, per the below link. I think the Bank Recap Fund is exactly the kind of response that you're talking about in this posting Luke. But certainly it is within the IFC's mandate to recapitalize local banks in dev markets. I'd be much more interested in seeing how banks, such as JPMorgan or Morgan Stanley, that were just starting to explore the bottom of the pyramid, are reacting in this capital constrained climate. Are they pulling back their experimental investments in microfinance funds or do they perhaps see it as an opportunity to diversify into "decoupled" economies? http://www.ifc.org/ifcext/media.nsf/content/SelectedPressRelease?OpenDocument&UNID=E915A6E933FD599E85257523007974CD

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