Thursday 27 January 2022

Vimes's boots is a good explanation of poverty: just not in the way you might think

Jack Monroe has recently highlighted how the rise in inflation can hit the poorest in the economy hardest by looking at the recent rise in food costs. Given that we all consume a different mix of things, inflation will hit us in different ways (depending on where the price rises are coming from). So it is possible that this is a real issue.

Saying this, the current inflation data does seem to suggest that current inflation rates are similar across all levels of incomes. Arguably though, even if the inflation rate were the same across incomes, poorer individuals will be hurt more by inflation. Those on lower incomes spend a larger proportion of their income on necessities, things you cannot live without.

As oa consequence, Jack Monroe is seeking to create a “Vimes’s boots index” to capture the costs of poverty. Vimes’s boots refers to a character in a Terry Pratchett novel who claimed it was more expensive to be poor: rather than being able to afford good quality boots that will last a long time, you have to continually buy bad quality boots because they break so often. The total cost of the bad quality boots will eventually exceed those of the good quality boots.

I have seen people challenge this by focussing on whether higher prices for the same thing reflect quality. Could it not simply be fashion? Would a Jimmy Choo stiletto last longer than your bog-standard, stilted shoe?

Whether this is true or not is pretty much irrelevant to what we should be learning from Vimes’s story. Vimes can actually afford to pay for these better quality shoes. The issue he is facing is credit constraints, one of the most important concepts in poverty.

Vimes needs boots now, so he cannot simply save up to buy the better quality boots. What he needs is someone to lend him the money to buy the better quality boots and then pay off the loan over time. Understanding why no one is willing to lend to him is key to understanding his destitution.

Have you ever actually thought about why you need a deposit to obtain a loan? Why it is you get a better rate on your mortgage the higher your deposit? It is probably easier to think about it from the perspective of the person supplying the loan, rather than the borrower.

Let’s say someone you don’t know well asks to borrow £100. Lending someone the full £100 is quite risky. If they don’t pay it back, you are down a full £100. But what if they were to pay you a £30 deposit to secure that £100. Well in the worst case scenario you would be down £70 if they didn’t pay you back, as you get to keep their £30 deposit. As a result you may not want to lend to the person without a deposit (or charge them a very large interest rate) because you are taking a bigger risk in lending to them.

The reason why credit constraints exist is because you cannot commit ex ante to pay for the loan. That is, I cannot guarantee that I will definitely repay all of the loan in the future. I may lose my job and be unable to keep up with payments etc. In fact, I even have an incentive to run off with your loan and not pay you back!

What you want is some way to align the borrowers and lenders incentives. This is why we create all sorts of laws around things like bankruptcy and credit checks (it is also why loan sharks will break your thumbs if you do not pay up in time). Greater assurance that lenders will get their money back is good for borrowers (well, those borrowers who do not default on their loans). This is because you are more likely to obtain a loan and get a better deal if the person lending the money has greater confidence they will get their money back.

Being poor means you lack enough cash or assets to be able to put down a deposit. What makes matters worse is that low-income countries often lack the institutions and enforcement that make it less risky for lenders to lend. So any investment that would make you richer, from a tractor that would let you farm the land more efficiently to a university education to obtain a higher paying job, becomes unobtainable.

The worst thing about not being able to access credit is not that it is more expensive to be poor, but that you cannot escape poverty at all.

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