Chinese President Hu Jintao is visiting Moscow today to discuss increasing petroleum exports to China. That’s if he doesn’t first blow his budget on a hotel room in Moscow. The Russian oil boom has propelled Moscow to the top of the list of most expensive cities in the world. But the concentration of wealth in the former USSR capital belies the truth about the true state of the former Soviet Union.

Today the fifteen countries that once constituted this superpower stand at odds with one another in terms of economic opportunity, human rights, and development. The Baltic states of Estonia, Latvia, and Lithuania are soaring as members of the European Union and NATO. Estonia was ranked top in the World Liberty Index, with its Baltic neighbors not far behind. Meanwhile Turkmenistan’s eccentric (and recently deceased) President Niyazov spent his country’s resources cultivating world class repression, bested only by North Korea.

Elsewhere, oil resources elsewhere combined with a bungled move to private markets after the fall of communism have produced a kleptocracy across the former Soviet states. Outside of the Baltics, all of the former Soviet states now rank amongst the most corrupt countries in the world. On the bright side, communism does seem to have some positive lasting effects when it comes to equality. Five of the top ten most equal countries are from the former USSR.

Having shed the planned economy, these countries have all taken wildly different paths. But what if the USSR existed today? Statastic used several different development indicators and weighted them for each country based on population (one caveat: Russia constitutes 50% of the population of the former USSR). These statistics were combined into a new rating for USSR based on the latest survey data for various development indicators.

Taken as a whole, the USSR is not a very nice place to live 16 years after the fall of communism. Corruption in the USSR is comparable to that in Libya or Rwanda. The countries of the USSR today have less economic and individual freedom than the Democratic Republic of Congo. Even the USSR’s crumbling socialized medicine contributes to a mediocre score in the United Nations Human Development Index. Today the USSR ranks at the same level as its long-forgotten communist friend, China.
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Last July I wrote about the inequity of prize money between women and men who play at Wimbledon. The twist is that women play the best of three sets, while men play best of five. So women champions spend much less time on the courts:

Over the past five years (2001-2005), Wimbledon Men’s Champions - usually Roger Federer - have played 53% more sets (and 66% more games) en route to the championship than the women’s champions during the same period. If the averages hold up for 2006, the Gentlemen’s Champion will have earned $51,376 per set played while the Ladies Champion would take home $75,126 per set played at Wimbledon. There you have it: women earn 46% more than men at Wimbledon.

Yesterday, Wimbledon announced that it will pay equal prize money to men and women. While I support equal pay for men and women, I also support equal play. Women should play best of five sets just as men do. It makes for some of the most exciting, suspenseful tennis matches on the men’s side. And too many women’s tennis matches are lopsided 45 minute affairs - hardly ideal for the TV ratings. Introducing the stamina factor might even out the women’s field.

There is no physiological reason that female tennis players couldn’t pull through a grueling five hour match as some men do. Women run the same marathons that men run, play on the same sized soccer fields, and work the same 40 hour week that men work.

But what if the Wimbledon standard were applied to life? What if equal pay could be earned by someone even though it only required 66% less work? Or put another way, what if women paid the same amount but received 51% more in services or products? Courts would be smaller, hoops wider, bank lines shorter, sandwiches more delicious. The world would certainly be easier (I especially support the new Wimbledon holidays and the longer Wimbledon hot dogs), but would it be fair?

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BBC World news was aflutter today over the results of the The United Nations Children’s Fund (UNICEF) report entitled, “Overview of child well-being in rich countries.” The Brits, it seems have taken over a place normally reserved for the United States: coming in dead last in child welfare.

The report takes a more inclusive approach to the measurement, and data quality varies widely across the rich nations that it surveyed, but the UK is at the bottom in many categories. Rest assured, America is still #1 in several categories, including: relative child poverty, percentage of single parent families, and the lack of overall health and safety for children. Paradoxically, while our children report getting plenty of exercise, they are also the second fattest (it seems that those pesky Maltese children edged us out).

Another seeming paradox is that one of the most tolerant countries on earth, the Netherlands, has many fewer children engaging in risky behavior than the United States. Of course, any Dutch person you ask will insist that this isn’t a paradox at all. The point of lax drug laws is to help demystify marijuana and other drugs for teenagers. Perhaps they have a point, about 50% more American 11 to 15 year-olds have smoked pot in the last 12 months compared to their Dutch counterparts. It might be worth listening to the Dutch - they came in first in the survey of child welfare among rich nations.

Below are some of the more interesting results from the report.

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President Bush’s 2008 budget hit the Hill yesterday to a frosty reception (so much for global warming). The budget is like having an accountant hold a mirror up to American society, and that society is simultaneously warlike and childish.

Almost half of your income taxes will be spent on national defense, and that doesn’t include the interest on debt from previous defense overspending. The Pentagon will spend 6% of its budget repairing and replacing equipment (mostly for Iraq), but it’s still more than the entire foreign affairs budget for 2008. Diplomacy from the barrel of a recently-repaired gun.

The budget also reveals that we are spending money like spoiled trust fund kids - but without the trust fund. Paying for the $261 billion in interest payments on our past indulgences takes up most (83%) of the revenue collected from corporate taxes. Lest you think that we should cut taxes to spur the economy, may I remind you that tax cuts still don’t pay for themselves no matter how many times Bush insists that they do. In fact, between 2008 and 2012, the Bush tax cuts will cost the Treasury Department more than one year of unemployment and welfare benefits combined.

Gift and inheritance taxes collect enough revenue to pay for nearly all of our national science and technology budget. So if you actually are a trust fund kid and think that so-called death taxes are unjust, consider that they might help keep grandma alive for a few more years. Or was that the point of cutting them?
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Source: Washington Post

Washington D.C. Public Library Case Study

Washington DC’s 37% rate of functional adult illiteracy reflects one of the most underfunded and underutilized library systems in the country. In 2004, former DC Mayor Anthony Williams launched a task force in 2004 to examine the DC Public Library (DCPL). In November 2006 the Mayor’s Task Force Report was released, envisioning that:

“Revitalized libraries will offer fresh collections of current books and media, useful standard publications, multilingual materials, GED and SAT practice books, historic documents and records, pertinent online databases, and digital content.”

Unfortunately, listing digital content last is symbolic of the vision for DC libraries. In the 370 page Technical Report, e-books are mentioned only seven times in reference to the future of DCPL collections. Here some of the few excerpts that lay out technology vision for the DCPL in 2010 and beyond:

“[Page 21]: The library should license digital content and make it available to registered borrowers whether they are in the library or using the collection from their home. E-books, digital audiobooks, videos-on-demand, and other digital content should be available for downloading to a customer’s personal computer, PDA,or MP3 player. …

[Page 60]: A ‘virtual branch’ is fast becoming a necessary facility for successful public libraries serving large populations. … A virtual branch can be a full-service location for searching licensed electronic databases, getting answers through an interactive reference service, downloading digital books and audiovisual content, using learning software, and participating in online programs such as presentations and discussions about books and topics of current interest. Also, items in the library’s physical collections can be reserved and, when available, shipped to the user – with any fees charged to the user’s account or credit card.”

It all sounds pretty high tech until you hit on idea of shipping books around the city. In any case, if you’ve lived in DC for long, the vision of a virtual branch probably sounds like science fiction. In fact, the 2010 vision for the DCPL is based on technology that has been used in public libraries around the country for years.
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Playing Catch Up

Several companies including NetLibrary, Overdrive, and Ebrary already have partnerships with public libraries around the world. All three offer a system for libraries to purchase e-books and popular audio book titles, though the technology is not cheap. NetLibrary has a rather shocking price structure. According to LibraryJournal.com:

“NetLibrary… now with more than 100,000 titles, has maintained its one book–one user access model. The company offers two primary purchase models based on title-by-title selection: libraries can subscribe to an ebook by paying the list price of the book, plus an annual access fee of 15 percent of the list price, or libraries can ‘own’ an ebook by paying the list price plus a one-time access fee of 55 percent of the list price.”

Unfortunately, the lack of a significant discount for subscriptions will encourage libraries to purchase e-books. If the library purchases a title, e-catalogs lose many of the advantages of digitization. For example, if econo-star Steven Levitt is heading to Seattle to talk about Freakonomics and 100 people want to read his e-book at the same time, they’ll have to wait. The King County Library System can only lend out 5 of his e-books at a time. E-books are made of 1s an 0s, not hardwoods and glue, so why not simply pay the publisher every time the virtual book is checked out?

Although the NetLibrary subscription model is extortionary, subscription e-books are the ideal model for libraries. E-books require few human resources: three weeks after you check out an e-book, it is automatically “returns” itself to the library by deleting itself (spooky, eh?). A subscription service ensures that libraries pay publishers only when e-books are checked out, so no dollars are wasted on lonely, unread books sitting on dusty shelves. Best of all, 10 of your best friends can check out a copy of the e-book at the same time, eliminating excuses in your book club.

While a subscription service might seem to favor the publishers of bestsellers, it also provides increased exposure to authors of obscure or out-of print books - the so-called long tail. If libraries pay only when e-books are loaned, then there is no reason to limit the size of their virtual catalog. A proper e-book subscription service that costs a public library no upfront fees also reduces guesswork in collections management, enabling a smooth transition in budgeting for a dedicated e-library.
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Leapfrog: DC Should Pursue the First True Virtual Public Library System

DC Public Libraries suffer from several problems that make them an ideal test case for launching a real virtual library: huge deferred maintenance costs, an aging central library, and a population disillusioned by years of neglect to local libraries.

DCPL is too far behind the technology curve to play catch up. Instead they should leapfrog technologies. Statastic proposes that new DC Mayor Adrian Fenty and DCPL Director Ginnie Cooper consider a bold experiment in virtual collections.

The DCPL should start phasing out the acquisition of new paper books in 2008, with the goal of e-books making up no less than 90% of new acquisitions 2013. By 2017, the DCPL should have digitized 90% of its existing collection and sold the millions of hardback books in its stacks to help generate revenue. This will reduce required square footage - and overhead costs - of neighborhood libraries, eliminate the frustration of missing books, and create more space for the computer terminals that are sorely lacking.

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Advantages to the DC Virtual Library

One of the most obvious advantages to a virtual library is the 24-hour access to books that might otherwise be checked out or unavailable. It could also expand the size of the DCPL available collection from 2.7 million volumes to as many as 32 million - every title in the WorldCat system. More titles mean more attention from residents, which increases reading and circulation.

In a city with 17% of its residents and 30% of its children living in poverty, it might seem that DC is not well-suited for e-books. After all, how would someone living in poverty afford a $300 e-reader? And how would they download a book with access to the Internet? Statastic expects the prices of e-readers featuring e-ink to drop to less than $75 within 5 years (we already have $100 laptops), and less than $40 by 2017.

Under this plan, the DCPL would phase in heavily subsidized or free e-readers for every low income DC resident. Children could also use these e-readers in the public schools where textbooks are in such short supply making it impossible to assign homework from textbooks. And assigning a hot new technology like e-readers to under-privileged citizens might just spark their interest in reading.

With the advent of Google Books, do we need a virtual public library? Many DC residents with their own e-readers and home Internet access will soon have access to millions of Google e-books. But the digital divide is real and if public libraries aren’t centrally involved in digitization of books, the gap will widen. As the high-income, early adopters turn toward e-books, wealthy taxpayers might see less value in funding the DC Public Library System (if this is even possible). This would exacerbate already grave funding shortfalls, leaving an underclass with an ignored and outmoded library system.

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E-book Public Library Budget

Free e-readers, millions of e-books… sounds expensive, doesn’t it? Actually it could save taxpayers millions of dollars. The DCPL proposed budget for 2007 is $43 million, of which $19 million is for reference and library collection services. Facilities make up another $9.4 million. All three of these categories will have enormous savings if transitioned to an e-books catalog:

• 1. Book Sale: Bound books would be liquidated, with proceeds dedicated to digitizing rare books and subscription to an e-books catalog.
• 2. Deferred Maintenance: Neighborhood libraries that have been already been closed or that suffer from huge deferred maintenance costs would be sold and replaced by an increased number of smaller, leaner e-libraries that offer better neighborhood access to computer workstations, distribution of e-reader and training and reading programs. Neighborhoods with little Internet access would be served by DCPL e-book kiosks (more on this below).
• 3. Staff reductions: With fewer books to re-shelve and a 24 hour virtual library online, collections and maintenance staff could be reduced. As D.C. Library Renaissance Project Director Robin Diener recently commented: “We have evidence of incredible abuses — people who work for [the library] and draw a salary and rarely come to work. It’s a no-work culture.”
• 4. Private Partners: The DCPL should pursue technology partners such as Google or Yahoo which will be naturally be drawn to the cutting edge, high-profile project of digitizing the library system of the nation’s capital.
• 5. Private & Public Grants: The DCPL’s innovative virtual library experiment will also attract attention from major donors such as the Bill & Melinda Gates Foundation as well as federal grants.

By 2017 when the DC Virtual Library System is in place, there will be some new expenses (2007 dollars):

• 1. New Staff: Tech savvy staff capable of managing a virtual catalog and training patrons on the use of e-books, e-readers, and online catalogs. The new, more expensive staff hired will be offset by staff reductions due to reduced maintenance and collections services (e.g. re-shelving). Reference librarians will still be necessary, though they may take on new roles dispensing valuable advice through online forums. It’s even easy to imagine 24 hour access to an online librarian.
• 2. Subsidized E-readers: Assume that students would be issued e-readers at school. The DCPL would purchase e-readers for any adult with a household income of less than $35,000 per year. Nearly one-third, or about 184,000, DC residents would qualify for free e-readers. If new e-readers are issued every 2 years and the price of e-readers averages $40 in 2017 (it is more likely to be about $15 to $20), it would cost the city about $3.7 million annually to supply free e-readers. Other ways to help defray these costs are to require a deposit or small co-payments from those above the poverty line.
• 3. E-book Subscriptions: Circulation in all DC public libraries is about 1.1 million books. If the DCPL can reach a circulation rate similar to Seattle’s, residents would be checking out 6 million e-books per year, or about 1 book per month for every reading-age citizen. If the DCPL cut a deal with publishers to pay $2 for every book checked out from its libraries, it would cost the DCPL $12 million per year to maintain its e-book collection.
• 4. E-book Kiosks: For residents in neighborhoods with limited home Internet access, DCPL could provide e-book kiosks near public areas like schools or community centers. Pre-distributed e-readers would have RFID technology that identifies the DCPL account. The customer would simply touch the e-reader to kisok to log in. After selecting a title, the user holds the e-reader next to the kiosk for a free wireless download of the e-book. Installation and maintenance could be covered by corporate advertising on the outside of the kiosk.

The total new expenses of subsidized e-readers plus e-book subscriptions is equal to about $15.6 million. Compare this to the $19 million being spent on collections and references this year alone.

It’s important to remember that not all books, documents and historical will be digitized, so there will be still be a need for a central library, whether it is the renovated Martin Luther King, Jr. Library in downtown DC or the new one proposed by the DC Mayor. Either of the central library proposals are would cost about $275 million according to city estimates. Statastic doesn’t prefer one proposal over another, but it is imperative to rethink the needs of a central library with e-books as the heart of the collection.

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Unknowns and Opportunities

There are two unknowns in creating the world’s first truly digital library: 1) are publishers willing to negotiate lower e-books subscription rates, and 2) will the DCPL create its own e-book collection or outsource it?

One major pre-condition for this proposal to succeed is that subscription e-book prices must be negotiated downward. Publishers and authors must be made to understand that low-priced e-book “rentals” in public libraries will increase readership. Publishers will sell higher volumes of e-books, and they can count on a reliable revenue stream.

It is not cost effective for the DCPL to digitize its collection from scratch. Google has already inserted themselves into the e-book value chain and Google is far and away the leader in the number of titles digitized. In fact, Google may be the only corporate partner for creating a virtual public library. According to Jeffrey Toobin in this week’s New Yorker, because of publishers’ lawsuits against Google, they might be the last company to digitize the world’s books:

Google’s advantage may well be cemented if the company settles its lawsuits with the publishers and authors. … [Lawrence Lessig , Professor at Stanford Law School said], “The publishers will get more than the law entitles them to, because Google needs to get this case behind it. And the settlement will create a huge barrier for any new entrants in this field.”

Google will complete digitization of the 6 million books at the University of Michigan by 2010 - the same target year for the DCPL’s modernization. The DCPL should approach Google immediately to negotiate a partnership for the DC Virtual Library.

Are DC residents feeling lucky?

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In the Saturday Op-eds, The Washington Post again called out the Bush administration for falsely claiming that tax cuts pay for themselves. Tax cuts pay for themselves in much the same way that a ten cent coupon pays for a can of soup. Yes, some tax cuts help stimulate the economy, but no study has found that tax cuts are self-funding.

Estimates range, but a sample of three non-partisan studies indicates that income tax cuts do not pay for themselves - not even close. Most studies indicate that tax cuts do increase personal income and consumption, resulting in a very moderate economic stimulus. But this minor boost in economic growth does not replenish government coffers. For every $100 lost to tax cuts, the government only recoups between 10% to 28% due to economic growth. Even former chairman of President Bush’s Council of Economic Advisors, Gregory Mankiw’s most rosy estimates demonstrate that tax cuts lose 50% of their value.

So tax cuts cost the government money. End of story. Unless you’re the president writing an op-ed in the Wall Street Journal:

It is also a fact that our tax cuts have fueled robust economic growth and record revenues. … The bottom line is tax relief and spending restraint are good for the American worker, good for the American taxpayer, and good for the federal budget. Now is not the time to raise taxes on the American people.

Tax relief has benefited the American worker - as long as you’re talking about the American worker in a household making more than $100,000 per year. According to a study by the non-partisan Tax Policy Center, last year’s tax “relief” amounted a whopping $68 to the 125 million households making less than $100,000. Meanwhile the 20 million earning more than $100,000 received an average of $2,861 per household, 42 times more tax relief than those at the bottom of the income scale.

Indeed, now is the time for Democrats to end Bush’s tax cuts for the rich.

And if you have to pour over tax policies in great depth, I would recommend Tim Hecker’s album Harmonies in Ultraviolet (number 14 on Pitchfork’s best of 2006): ambient static and dissonance for blogging in the middle of a rainy night.

*Mankiw: Income Tax Cut measured with dynamic scoring

Sources: Washington Post, Congressional Budget Office, Wikipedia, Tax Policy Center

Paternalism and the Mirage

Professor Karnani’s primary critique of Prahalad’s The Fortune at the Bottom of the Pyramid, is that it focuses multinationals on the extreme poor as consumers. Instead Karnani offers that “…we should emphasize buying from the poor. By far the best way to alleviate poverty is to raise the income of the poor.”

This is not a new idea, nor is it at odds with the idea of marketing innovative products toward the poor. Karnani’s arguments against the poor as consumers often boil down to naked paternalism:

“Holding the poor consumer’s income constant, the only way he can purchase the newly available product is to divert expenditure from some other product. If he is a ‘rational’ consumer, this will increase his welfare. However, as a practical matter, this is unlikely to result in a significant change in his poverty situation. Additionally, if for some reason, the poor consumer is irrational in his resource allocation choice, the BOP initiative might even result in reducing his welfare.”

“The poor surely have a right to buy televisions; the issue is whether it is in their self interest to buy televisions.”

So if there is a risk that poor consumers might make irrational buying decisions, who should help guide them? The United Nations? The dictator of that poor country? A local tribal leader? Religious clerics? In an ideal market, consumer choice is best left to… the consumer.

Professor Karnani emphasizes that the government should be focused on consumer protection. But we have to remember that consumer protection laws in the West have taken a century to build. Should developing nations that can’t even deliver basic sanitation, infrastructure and public health shift their focus to developing consumer protection laws? Consumer protection is a worthy goal, but it is ultimately citizens who must hold their own governments accountable when the forces in the free market are perceived as harmful to their society or environment.

Karnanai also takes issue with Prahalad’s example of a skin whitening cream that was marketed to women in India by international giant Unilever. Karnani blames it for it entrenching women’s disempowerment, writing that:

“The BOP proposition is not satisfied with just giving the company the right to sell skin lightening cream. It goes further and commends the company for empowering women and helping eradicate poverty. This is an intellectually and morally problematic position.”

He also notes that Unilver’s marketing campaign was failure:

“The All India Democratic Women’s Association campaigned against this and another advertisement as being racist, discriminatory, and an affront to women’s dignity.

“Ravi Shankar Prasad, minister of Information and Broadcasting, said ‘Fair & Lovely cannot be supported because the advertising is demeaning to women and women’s movement’. Unilever has since discontinued these two advertisements in India.”

Karanani advocates that we preemptively limit consumer choice because the poor might make economic decisions that seem irrational from a Western perspective.  But it was by giving consumers a choice in India that they considered the role of women in Indian society, and market forces ultimately drove Unilever to pull the ads. Would Karnani consider poor customers to have been rational economic actors in that case?
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Paternalism Meets Micro-Credit

Karnani also finds harm in Prahalad’s example of Casas Bahia. This Brazilian superstore facilitates the purchase of high-quality appliances by offering credit to poor consumers who have unpredictable income streams.

Karnani argues that:

“The BOP proposition again falls prey to a fallacy: providing credit does not change the affordability of a product. The finance term for Casas Bahia ranges from four months to one year, with an average of six months. All that the financing scheme does is provide instant gratification at a price. For the privilege of this instant gratification, he pays an interest rate of over 4% per month. People with ‘low and unpredictable income’ would be well advised to save and pay in cash; this will enable them to do a better job of comparison shopping too. It is not surprising that many of Casas Bahia’s customers do not understand well how to unbundle the purchase price and the interest cost and instead focus on the monthly installment payment.”

Using credit in a developing nation is rarely about instant gratification. Village groups in West Africa without access to micro-credit schemes organized themselves and made small loans to group members for the monthly interest rate of about 10%. These loans helped fund medicine for sick children or seeds for cash crops. Poverty tends to produce desperately pragmatic people. Would Mr. Karnani advocate saving money throughout the rainy season only to buy seeds for a cash crop to be planted the next year? Doesn’t it depend on the rate of return? And who is best able to judge when to extend credit?

If a poor Brazilian consumer buys an appliance on credit, isn’t it possible that this person might become more productive as a result? Washing machines liberate people from having to spend the day washing by hand. Gas stoves are more efficient that searching for firewood.

You don’t have to question whether someone will make the right rational economic choices just because they are poor. I agree that government regulation is needed, but we should not discourage the private sector from extending credit just because poor consumers might buy something they don’t need. If someone defaults on the loan at Casas Bahia, I’m guessing they won’t be issued more credit.
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Corruption - Total instances found: 0

Unfortunately this heading applies to a search for the word “corruption” in the PDF of Professor Karnani’s paper, not to the situation the facing the world’s poor. Transparency International recognizes that this is one of the gravest problems facing the poor. Corruption hurts the poor both as consumers (by distorting prices) and producers (by discouraging investment). Neither Karnani and Prahalad offer much insight into how to remedy this.

In fact, Karnani hardly even acknowledges the difficulty hurdle that corruption presents in establishing well-functioning institutions needed to turn the poor into producers. In attacking Prahalad, he seems to lose sight of the fact that billions of the world’s poor live in countries with failed governments.

“By emphatically focusing on the private sector, the BOP proposition detracts from the imperative to correct the failure of the government to fulfill its traditional and accepted functions such as public safety, basic education, public health, and infra-structure.”

Karnani and BOP advocates both want to see improvements in governance. Both want to improve the conditions facing the poor. It’s only a question of how to reach that noble goal. Making a market at the BOP gives multinationals a stake in the improvement. Surely sophisticated market analysts at the world’s corporations would recognize that a well-educated, healthy population of consumers purchases more goods?

We could, of course, step back and try to figure out what is going wrong in the failed states of the world. We just need to fix the infrastructure, education, eliminate AIDS, and end epidemic corruption. This is not a novel idea. The World Bank, UN and countless other academics, advisors and NGOs have been trying to achieve this for decades. As soon as we have that all figured out, will Karanani let companies sell approved goods to the poor?

Karnani concludes that:

Private companies should try to pursue marketing to the poor. However, the profit opportunities are modest at best and we suggest a cautious approach. Large companies that require scale economies should be even more hesitant.

Why ward off large companies? Free market innovation is an invaluable tool. Companies should try to earn a profit in developing nations. Many will fail as thousands of companies before have failed in rich nations. Just don’t wave off the LifeStraws and PlayPumps of the world while we wait for developing nations to create consumer protection laws up to our standard.

Karnani is correct to focus on establishing institutions that will help the poor earn more income. But while we wait, why not try the BOP approach?

Yesterday I wrote about the shortcomings of Prahalad’s book, The Fortune at the Bottom of the Pyramid. We left with the question of whether there was even a market to discuss. Several factors make it difficult to estimate disposable income at the bottom of the pyramid (BOP). Even if it is not a fortune, there is likely much more than a nickel a day of disposable income amongst the world’s 4 billion poor.

Most people in extreme poverty live in rural areas and derive much of their diet from subsistence farming. This means that relatively little of their income is spent of food. In family or tribe-oriented societies, there is also an income smoothing effect. Kinship networks, for example, mean that if one person in a family has a high-paying position in the government, many in the family will benefit. In addition, income such as flows from non-governmental aid, international transfers from foreign nationals living abroad, and the grey economy may be under-reported in GNP figures.

In response to Karnani’s paper, the WRI’s NextBillion.net noted that:

BOP households collectively spend money, lots of it, on a wide variety of goods and services, and are clearly willing to pay for services such as connectivity, clean water, financial services, energy, health care, and education for their children, as well as food, housing, and consumer goods. The BOP is already an economic actor, not just a passive, dependent group, and its collective actions define a market.

So there let’s assume that there is indeed a market of billions at the bottom of the pyramid. Should companies try to reach it? Karnani cautions that viewing the BOP as a vast market of micro-consumers is “potentially a dangerous delusion.” Let’s look more closely at his argument.
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Distribution and Economies of Scale

Concerned about the apparent gullibility of multinational corporations (MNCs), Karnani warns that:

“Not only is the BOP market quite small, it is unlikely to be very profitable, especially for a large company. The costs of serving the markets at the bottom of the pyramid are very high…. This increases distribution and marketing costs and makes it difficult to exploit economies of scale. Weak infrastructure (transportation, communication, media, and legal) further increases cost of doing business.”

Two words: Coke and Guinness. Both have very deep penetration in West Africa. Granted these are not going to improve the health and well-being of the BOP (though Guinness bottles do read, “Guinness is Good for You“). Somehow these MNCs have overcome the challenge of distributing and marketing their products across a large geographic area.

Regardless of infrastructure and marketing costs, the market will help align buyers and sellers if the price is right for each.
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Reducing Prices at the Bottom of the Pyramid

Prahalad’s thesis hinges on the idea that attracting more competition to the BOP will drive down product prices, thus freeing up their disposable income for other purchases. This is basically how Wal-Mart has made low-income Americans feel richer even as real income has stagnated over the last decade. But Karnani takes issue with Prahalad’s assertion that the private sector can deliver high quality goods to the world’s desperately poor at competitive prices:

“There are only three ways to reduce prices: 1) reduce profits, 2) reduce costs without reducing quality, and 3) reduce costs by reducing quality…. the only realistic way to reduce price is to reduce cost. The BOP proposition is adamant that we should not reduce quality in this process.

“Unless all the current producers are grossly inefficient, the only way to reduce cost… without reducing quality will always require a significant improvement in technology. Good examples of this are found in the areas of computers, telecommunications and various electronic products. It is difficult to find examples of such dramatic cost reduction in other product categories. It is not surprising that the BOP proposition repeatedly uses these same examples. We should also note that the ultimate impact on the real income of the poor due to these major price reductions is quite low because the poor spend only a small part of their income on such electronic products. The poor spend over 80% of their income on food, clothing and fuel – products that have not benefited from such dramatic technological changes in a long time.”

Let’s evaluate that last statement and have a look at how technology might help deliver improved food, clothing, fuel, and public health.

Food: There are constant improvements in pest-resistant crops, hybrid seeds, or high volume animal husbandry. Many famers in Africa still till individual family farms by hand. Certainly technology could help them improve efficiency which would lead to lower prices.

And technology improvements in computers and telecommunications do not exist in a vacuum. There are numerous positive spillover effects that affect the BOP as producers. The Washington Post recently reported that cell phones in Congo have enabled farmers and fishermen to “…use text messaging to check market prices, eliminating middlemen and increasing profits — and preventing long trips to the market on days it is canceled.” So a technology unrelated to agriculture has helped farmers saved on input prices (transport to the market on days when it’s canceled) and output prices.

Clothes: Apparel prices have tumbled over the past decade. Much of this is due to reduced quotas on Chinese apparel imports in the U.S. and Europe. Thus, the assertion that “the only way to reduce cost… without reducing quality will always require a significant improvement in technology” is inaccurate. Clothing prices have dropped as a result of trade policy, not an improvement in technology. This does have a trickle-down effect for the world’s poor.

Fuel: Fuel has indeed become more expensive. Women have to scavenge farther for firewood. Oil prices lead Nigerians into the deadly practice of siphoning off crude oil from pipelines running through their villages. But technology can improve access to energy sources. Military applications such as SkyBuilt mobile solar power could find a market at the BOP helping medical centers or providing a short term power source for harvesting and processing crops.

Public Health: As patents expire on novel drugs, cheaper generic drugs will enter these markets. Playpump is an innovative approach to water delivery. LifeStraw promises to exploit economies of scale in order to drive down prices for its personal water filtration device.

Technology: Last week, the Wall Street Journal ran a front-page story about an American entrepreneur, Greg Wyler, who was building an Internet infrastructure in Rwanda. The focus of Terracom is to first focus on market access, then profits. Mr. Wyler might disagree with Karanani’s ideas about providing a quality product at reasonable prices for the poor. He is quoted as saying, “We’re on a mission here to see what happens when we drive prices down and quality up.”

And lest you think that Rwanda is an obvious market for an outside investor, have a look at the graph at the right.

As WRI writes in response to Karnani’s critique:

The pertinent development question is whether the BOP is well served by the present (often informal) markets, and whether there are unmet needs that could be better served by more competitive markets and broader participation by the legitimate private sector.

I believe that private sector innovation help can drive prices lower, maintain or increase quality, and help deliver goods that result in better livelihoods for those at the bottom of the pyramid. But what if multinationals start marketing products that the poor don’t need? Are BOP consumers rational economic actors? Or is Karnani correct when he says that, “The problem is that the poor often make choices that are not in their own self interest.”

More on that soon…

In 2004, C.K. Prahalad, a professor at University of Michigan’s Ross School of Business published the groundbreaking book “The Fortune at the Bottom of the Pyramid.” The basic thesis is that multinational corporations (MNCs) have concentrated their sales and marketing efforts on the richest citizens of the world while ignoring the 4 billion consumers who live on less than $2 per day at the Bottom of the Pyramid (BOP).

He asserts that introducing market choice to the poor will free villagers from local monopolists, creating a virtuous cycle of consumer access and improved product quality. MNCs that sell products in this enormous, underserved market stand to make hefty profit. And, as more and more companies turn their attention to the BOP, competition will drive private sector innovations that address the needs of the poor. By giving MNCs an economic stake in this market, they in turn will draw the attention to problems of governance.

Although the work is primarily empirical and draws too heavily from examples in India, the BOP argument is an intriguing one. It eschews the notion that concentrating on the poor should be relegated to a secondary “corporate social responsibility” initiative and takes an integrative approach to the private sector achieving what non-governmental institutions and multi-lateral lenders such as the World Bank have not: pulling billions out of poverty.

We should applaud the BOP adherents for their novel approach, an approach that too closely resembles the idealism typical of a first-year Peace Corps volunteer. It is only after the corruption, complacency, intestinal ailments, and constant economic opacity have wrung out the initial naiveté that the discussion becomes interesting.

And a dose of cynicism is exactly what Professor Aneel Karnani - also of the Michigan School of Business - introduces in a recently-released working paper, “Fortune at the Bottom of the Pyramid: A Mirage.” He asserts that:

“Rather than focusing on the poor as consumers, we need to view the poor as producers. The only way to alleviate poverty is to raise the real income of the poor.”

Professor Karnani’s basic thesis is that BOP de-emphasizes the role of government in providing basic services and that we must focus on building the capacity of the world’s poor by focusing on government failures in education, health, and infrastructure.

Unfortunately, non-governmental organizations have been focusing on failures of government for decades. Billions of dollars have been spent flying experts around the world to bolster child immunization rates, build water delivery systems, and advise on bankruptcy reform. As you can see from the map above, the last 27 years have been lean ones for many in the bottom of the pyramid. This is not to diminish individuals’ efforts or passion. It is only to acknowledge that it is a very difficult goal and multi-lateral institutions do not have a recipe, much less a consensus, of how to foster economic growth.

One of the positive side effects of the BOP argument is that it makes MNCs stakeholders in a new and underserved market. To be sure, there are fatal flaws in the logic and research initiated by Prahalad. But MBAs are new to development and we should embrace that wide-eyed optimism even as we critique shakey methodology.

Is there a Market at the Bottom of the Pyramid?

Karnani points out one inexcusable fallacy in Prahalad’s work: market definition.

Prahalad used the World Bank’s estimates for the number of people living on an income of $2 a day or less (poverty), and $1 a day or less (extreme poverty). Both poverty measures are at purchasing power parity (PPP).

Why is PPP important? Because no matter where in the world you spend $1 PPP it buys the exact same goods, regardless of local price. So that $1 PPP that the extreme poor earn in a day will buy you one loaf of bread in the U.S. Actual prices are much lower in developing countries, so that same loaf of bread might only cost $.10. The market at the bottom of the pyramid will not pay MNCs in PPP dollars; it will pay them in local currency, as Karnani explains:

“[Prahalad] claims that the BOP potential market is $13 trillion at PPP. This grossly over-estimates the BOP market size. The average consumption of poor people is $1.25 per day and assuming there are 2.7 billion poor people, which implies a BOP market size of $1.2 trillion, at PPP in 2002.

“From the perspective of a multi-national company from a rich country, profits will be repatriated at the financial exchange rates, not at PPP rates. In that case, the global BOP market is less than $0.3 trillion, compared to $11 trillion economy in the US alone – making the BOP a difficult place to look or a fortune.”

Another problem is that the poor spend about 80% of their income on food, clothing and fuel. Suddenly the $300 billion market at the bottom of the pyramid shrinks to $60 billion of disposable income at current exchange rates. Spread amongst 2.7 billion people, that’s about a nickel a day for disposable income.

Karnani also takes issue with the number of poor:

“Prahalad states that there are more than 4 billion people with per capita income below $2 per day at purchasing power parity (PPP) rates…. Most researchers argue that the World Bank already over-estimates the number of poor people, with some researchers estimating the poor at 600 million (The Economist, 2004).”

There’s no shortage of poor, I’m afraid. Sanjay Reddy and Thomas Pogge of Columbia University have written a persuasive paper that critiques World Bank calculation of the number of poor in the world. While they give no new estimate, it’s likely that the world’s poor have been undercounted:

“There is some reason to think that the distortion is in the direction of understating the extent of income poverty.”

So the bottom of the pyramid is left with billions of poor who have no money. Does this invalidate Prahalad’s entire thesis? More on that tomorrow.

Yesterday Foreign Policy and the Center for Global Development released their 4th annual Commitment to Development Index (CDI). This index attempts to quantify how well rich countries “help poor countries build prosperity, good government, and security.” The index measures seven policy areas: aid (per capita and quality), trade, investment, migration, environment, security, and technology.

Many countries’ own policies stand in direct contradiction to one another showing, perhaps, that internal politics are primary, and policies affecting the poorest countries on earth are secondary. Andrew Natsios, the former head of the U.S. Agency for International Development (USAID), pointed out some of these contradictions before resigning in January, 2006. As Foreign Policy notes:

“Natsios criticized a law that requires the U.S. government to buy food from U.S. farmers, ship it on American boats, and deliver it to famine-stricken regions via U.S.-based organizations. The U.S. government must deliver food aid this way even when it depresses local food prices, pushing more farmers into poverty, and even when it could buy food from farmers just outside a famine zone for much less. Some nongovernmental organizations that get a large fraction of their funding from the program defended the status quo, arguing that dropping the ‘made in America’ requirement would undermine the program’s support among American farmers and shippers. Congress quickly axed Natsios’s proposal for reform. That the U.S. government must pay off American interests to feed the starving is a sad commentary on how low the commitment to development may still be.”

In an unrelated but equally interesting measure, Transparency International has for several years been publishing the Corruption Perceptions Index (CPI) in order to draw attention to the role of corruption in stifling economic development. When we look at corruption in rich countries, there appears to be a parallel between increased corruption and decreased effectiveness at helping poor countries. To be fair, the 21 rich countries ranked in the Corruptions Perceptions Index are squeaky-clean relative to the countries they are trying to help (with the exceptions of Italy and Greece).

Is there a link? Perhaps pandering at home - the constant political pressure from competing interests - creates economic inefficiencies that hurt poor countries. These policies could come in the form of unfair trade policies (e.g. Switzerland’s $987.58 per-cow subsidy) or environmental indifference (the United States’ ultra-low gas taxes).

Then again, it’s also easy to be small. The 5 countries “most committed to development” have an average population of 7.9 million whereas the bottom five have an average population 53.7 million. Similar ratios hold for corruption: the most transparent rich countries have smaller average populations.

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Sources: Statastic research; Foreign Policy; Center for Global Development; Wikipedia