The balance of payments and the importance of the flow of money through a community
We can borrow the term ‘balance of payments’ from economics to explain a major obstacle that extremely poor communities like Las Malvinas have in overcoming poverty. In short, poor communities ‘import’ most of the things the community needs, producing very little of these goods and services itself. The money it makes, usually working low-skilled jobs or producing low-value goods (the ‘exports’) is not enough to cover the basic costs the families have, making the families live in a constant state of deficit – meaning they cannot cover their basic living costs. The community hence acts like a country with a steep trade deficit and is placed in a precarious situation where the families have to either borrow with very bad terms just to get by and/or drastically cut their spending. Over time, this dynamic makes the situation of many families (and communities) get worse, not better. Starting companies that make products with high added value from within the community increases the flow of money towards the families (in terms of sales and wages) and improves their 'balance of payments'. This positive effect benefits not only for the people working for these startups, but also for all the services in the community they use.
Balance of payments applied to cities and communities
The balance of payments is a term used in macroeconomics to describe trade relations between countries – it is the systematic record of all the transactions that one nation has with another. We believe it can be applied to cities and communities to point to some concrete solutions to poverty.
Two countries that trade with each other will record their exports and imports. We’ll use two countries, ‘Mordor’ and ‘The Shire’. Mordor makes paperweights from volcanic rocks and sells it to the Shire. The Shire makes fine clothing and linens, furniture and smoking pipes it sells to Mordor. In this example, Mordor buys more goods from The Shire than it sells to it, that is, it imports from the Shire more than it exports to it. Mordor therefore has a trade deficit. Mordor has spent more money than it has made, and will have to make up the deficit with loans, savings, or selling off some of its assets. On the other hand, the Shire has a trade surplus. Because it sold more than it imported, it has a stash of extra cash that they can use to invest in new businesses, build better roads, bridges, schools and parks, or buy financial and capital assets from Mordor.
Mordor The Shire
Current Account Exports<Imports Exports>Imports
Trade deficit Trade Surplus
Mordor, or any country for that matter, can’t go on indefinitely trading at a deficit – it will either run out of savings and/or out of capital assets to sell, and will be eventually denied more loans to keep covering the gap. Mordor has to figure out how to generate revenue before its deficit becomes unmanageable. What are the options it has?
Mordor could start spending less by producing some of the goods it’s currently importing, like furniture or clothing, but The Shire might have a competitive advantage in producing some of these goods, that’s why Mordor started importing them to start. For instance, Mordor has little timber compared to the Shire, so making wooden furniture might be very expensive in Mordor and it’s cheaper to just buy it from The Shire.
Mordor can also try to export more, selling more paperweights to The Shire and looking for more markets for them. But it will run into 2 problems. First, people really don’t need more than one or two paperweights (if any at all), so the market can quickly become saturated. Second, a paperweight is very cheap, so even if it sold a ton more of them (by finding other uses for them – a doorstop? A fashion item?), it would still not generate a lot of revenue, compared to selling bigger ticket items like furniture. Mordor could also try to export something new – find a new product it can offer and try to export it. Hopefully this new product would have more added-value and produce substantial revenue for Mordor and allow it to balance its current account. It doesn’t have to choose only one alternative, but neither of them is a quick fix. Mordor will have to do some serious work and invest in research, training, education and infrastructure to turn its balance of payments around.
This example between countries applies to cities and neighborhoods also. A rich neighborhood of large houses, parks and nice paved roads will be full of people that earn much more than what they need to lead a good life. They have a valuable asset to export: a highly trained/educated population that sells their labor at a high price. The neighborhood attracts high-end stores and services that generate even more wealth in the community. Families of such a neighborhood can afford all the amenities for comfortable living, build beautiful surroundings, save and invest to keep growing their wealth. There will be a large chance that the children growing up in this neighborhood will be very well off, even better than their parents (1).
On the contrary, a poor neighborhood is like Mordor - it bleeds too much cash paying for ‘imports’ and ‘exports’ very little. In slums it’s typical that most of the community has little training and education and does not perform high-skilled high-valued work, so little comes into the community in the form of wages. Additionally, too little value is produced from within the community in terms of goods and services to sell to other communities (the wealthier Shires all around), so revenue trickles in but it’s not enough to cover for all the things families need to survive. Therefore, the balance of payments of a poor community is negative, meaning, it has a trade deficit.
Remember - a deficit implies you cannot cover your costs. So you have to find new ways to make more money and or drastically reduce your spending. What happens in a poor community is that families most of the time cannot make much more money – many are already working full time but make very little in wages performing menial jobs; they are not trained, do not have the soft skills and networks to get better jobs, and do not have the time or money to invest in getting educated. They typically have large families and cannot afford child care, so especially for women, they can’t even start to work. I’ve seen many cases where women could find work, but what they make would go directly to the babysitter, so why bother?
In light of this, most families go for the other alternative, to drastically cut their spending and ‘live within their means’. They start with housing - cheap land is what made them cluster into poor communities to begin with, usually on land-grabs or in undeveloped lots, cramping up in small quarters usually made with refuse materials. Cutting costs means eating less than 3 meals a day, not sending all your kids to school, skipping medical expenses. These measures, which are living ‘within their means’ for the poor, can cut their chances to progress over time because their children aren’t eating enough, aren’t going to school or getting proper medical attention when they get sick. Many send their children and teenagers out to work to help support the family (or give their young daughters into marriage) when they should be studying; instead, they are out on the streets working menial jobs that lock them into poor wages for a lifetime.
Families in slums have so little means their quality of life is below any standard of ‘a good life’. And time is not on the side of slums – without external help, over time families will only become more vulnerable. When you live on the edge any event can trigger a crisis: an accident, a sickness, a new baby - these events force families to part with assets or cut their spending even more to cover for the new event. Many families do not have the cash to make the basic investments to keep their assets in good standing and functioning, so houses deteriorate, cars get old and rusty, tools break, animals die. They deteriorate many times to a point they constitute a liability instead of an asset. And parting with what little assets they have left leaves them with even less ability to invest in their future.
I’ve witnessed this over and over again in slums across Latin America. In Las Malvinas, the families live on a land grab between a very contaminated river, an industrial zone and a wealthy community (the only land they could afford). Most families are underemployed; eat once or twice a day at best, and all the kids crowd into one tiny school where you can get by from grade to grade without properly learning how to read and write. In 2008 and 2009 we built several transitional houses for some of the poorest families thinking that by giving them more space, a dry floor and a proper roof, things would start to look up. Yes, families had more space, a more dignified, dry, safe living area, but they couldn’t hedge the house – in other words, we did nothing to help them reduce their deficit. Most of the houses we built in Las Malvinas 7 or 8 years ago, with a few exceptions, are either falling apart, abandoned or rented out. At best, the families that received the house and nothing but the house are just as poor (or even poorer) as 8 years ago, but they have a place to dwell. This is not to be looked down upon, but we can do better.
Entrepreneurship serving communities
To transform the balance of payments from negative to positive (go from deficit to surplus), slums needs more money flowing into it. What’s needed is a conscious, meticulous effort to produce more wealth from within the community. This can happen by two ways: either people find work in something that doesn’t feed on the residents of Las Malvinas and bring home bigger wages (which isn’t happening since the working population has little skills) or creating something using Las Malvinas’ capital and selling it to the city for a profit, hopefully a big one (“boosting exports”). This is where social entrepreneurship plays a unique role. By starting business in slums, hiring local people and selling our products out in the city, we can produce a stream of wealth that pours into slums. The effect would be similar to an economy that develops its local industry and starts to grow by exporting its production to other nations.
The catch is that building businesses from within slums requires we rethink most of what we know and expect when it comes to entrepreneurship because conditions, culture and resources in a slum are so different. But our experience with Esperanza is that this is not only possible but is a true alternative to building wealth and offering families real opportunities to lift themselves from poverty. In a future posts we’ll discuss at length how to produce wealth through entrepreneurship from within. Til then, soap up with Esperanza!