Who is Poor? Defining Poverty

This was written for the Kiva Fellows blog.  Read the original here.

How do you define poverty?   A basic needs index looks at whether (and to what extent) fundamental needs are fulfilled – food, water, shelter, clothing – and whether people have access to critical services – education, information (newspapers, etc.), sanitation facilities, healthcare, financial services.  This is an absolute poverty calculation, which uses a standard threshold that can be compared across countries and continents.  Another method is to use a national poverty line, usually a percentage of median income.  For example, if the median income is $10,000 USD, and the poverty line is 60% of that, any family making below $6,000 is technically below the poverty line.  This is a relative poverty calculation, because it is country-specific.  Using this method, it doesn’t make sense to compare across countries, since the poverty line in wealthier countries with higher median incomes will allow for greater purchasing power than in much poorer countries.  In microfinance (and development in general), you often hear about the percentage of the population that lives on less than $1/day – the definition of extreme poverty – or $2/day, or some other defining statistic of poverty.

Statistics are important for microfinance institutions (MFIs).  When you know what you are dealing with, you can more effectively target the population with programs that are proven to work.  It is important for an MFI to understand its clients and where they exist on the spectrum of poverty.  This is actually more difficult to assess than you’d think.  It is not feasible to ask clients how many dollars a day they spend, or even try to determine their income relative to the rest of the population.   Instead, MFIs use social performance metrics – simple tools to help them to define exactly what they are as an organization and whom they are serving.  They are basically proxies, which, when examined in aggregate, give the MFIs a profile of the poverty level of their clients.

I am a Fellow with Negros Women for Tomorrow (NWTF), which uses a social performance measurement system called the Progress out of Poverty Index (PPI).  Originally developed for the Grameen Foundation, the PPI is based on the assumption that certain indicators are useful for assessing the poverty status of a client.  Each country has a PPI, and once a PPI has been established in a country, just about any MFI can implement the system and determine with a high degree of confidence just how poor their clients really are.  So how is a PPI for a country developed?

In the Philippines, the government performed a survey in 2002 called the Annual Poverty Indicator Survey, collecting data from more than 38,000 households.  Regression analysis was used to rank each of the indicators on the survey according to how well they predicted poverty.  Out of the hundreds of indicators included in the survey, they culled it down to ten.  Why did they decide to use only ten?  Any measurement of social performance certainly needs to be accurate; but, more importantly, it needs to be practical.  If a survey is too long, the incentive for participation on the part of both the loan officer and client goes down.  Quick-and-dirty is the modus operandi of the effective SPM tool.

So ten is the magic number.  There are other things that make one indicator more appealing than another – how easy it is to collect (i.e. roof material), whether it connotes something else (i.e. if the client has a radio, there is no reason to ask whether they have electricity).  The questions range from broad (“do any family members have salaried employment?) to specific and surprisingly mundane (“does the family own a washing machine?”).  Each of the answers to these questions is assigned a numerical value (see a copy of the survey below).  Once the survey is complete, you add up all the points and you get some number from 1 to 100.  Each of these scores is assigned a percentage, which indicates the likelihood that the client is above or below the poverty line.  For example, in the Philippines, someone with an overall score of 30-34 has a 59.6% chance of being below the national poverty line, and an 23.1% chance of being below the USAID “Extreme” Poverty Line (see corresponding lookup table below).   For an MFI, the last step in the process is to take a weighted average of the percentages for all of their clients, which gives the percentage of their portfolio that is at or below the poverty line.  It is a truly scintillating method of assessing the poverty level of your clients.

This kind of data is invaluable to MFIs.  It allows them to target specific groups with loan products that are most conducive to the corresponding level of poverty.  As an example, let’s consider the number of months per loan cycle.  Shorter loan cycles – let’s say three months – mean higher weekly payments.  For poorer clients, these higher payments can be onerous and difficult to make, increasing the likelihood of default.  If the MFI can identify poorer clients (using a PPI survey), then it can set a minimum loan cycle of 6 months for those clients specifically.   This helps the MFI to lower its default rate, decreases the likelihood of the poorer clients dropping out of the program, and makes it more attractive to potential investors.

NWTF is able to determine the poverty profile for clients at different loan cycles.

Another use for the PPI is improving the social mission of the organization.  NWTF, which was one of the first MFIs to pilot the program, has a target of 90% for the number of new clients below the poverty level.  When it rolled out the PPI a few years ago, the results were surprising: in fact, over 40% of new clients were actually above the poverty level.  The PPI program has allowed them to better manage that number, and they are fast approaching that 90% target.  Finally, and most importantly, something like the PPI allows an MFI to track progress.  After a few years, they can go back and look at the data and see just how many of their clients have crossed the poverty line.  It is a way of bringing together and better quantifying the double bottom line – social impact and financial performance.

This was a much heavier post than I intended to write, but I think it is something that is both important and interesting to understand.  We think of poverty as something that is easily defined, something that can be bucketed into neat categories that are as basic as right and left, up and down, paper or plastic.  It is actually much more complicated than that.  Understanding these delineations makes microfinance more effective, and it helps make your Kiva dollars go a lot further.

Please support the NWTF and their mission to reach the poorest families in the Philippines here.

One thought on “Who is Poor? Defining Poverty

  1. Francisco d'Anconia

    Superb post-not too complicated and gives a great understanding of micro-finance and what it is trying to do. The discussion of poverty and how it is measured is a great explanation. What percentage of the Philippines is under the poverty level and is how much higher is that in the rural areas?

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