The Hidden Lives of America’s Poor and Middle Class
The Hidden Lives of America’s Poor and Middle Class
This series explores how current programs and policies for helping families escape poverty, build stability, move up the ladder, and invest in the future need to change.

Until a few years ago, I spent my career focused on the challenges of poverty and financial inclusion in places far poorer than the United States, mostly in Asia. As a result, I didn’t pay close attention to work on poverty and finance in the United States. It seems like people interested in similar challenges in different countries should actively share ideas and approaches, but in practice, conversations are often walled off by region.

That’s all changed for me. For the past five years, I’ve helped lead the US Financial Diaries study of low- and middle-income families in the United States, and I’ve seen the other side of the wall. The biggest surprise was finding that researchers in the United States are only now catching up to ideas that international development economists have seen as central to understanding poverty for decades. At the same time, there are ample lessons that go in the other direction.

The barriers between domestic and global poverty work are falling fast. Partly that’s because the rest of the world has been closing the gap on the developed world. It’s arguably the great good-news story of our time (and too often ignored). Huge gains in communications, transportation, and other technologies have shrunk both the physical and mental distance between wealthier and poorer countries, making commonalities easier to see. Researchers also have been learning a lot more about the way human beings think and behave, and concepts from behavioral economics—such as present bias, loss aversion, and reactions to scarcity—seem true of people no matter where they live. The basic concept of how financial products that create discipline help us save more, for instance, applies equally to a person in Beijing, Bamako, Buenos Aires, or Birmingham. Much of what we know about financial inclusion in the developing world applies to the United States, and vice versa.

Learning from financial inclusion initiatives in the United States

Few people working to advance financial inclusion in developing economies imagine that the end goal is a financial landscape that looks like ours in the United States. After all, the US financial services market, particularly in poorer communities, is hardly a runaway success; most adults have access to financial services of some kind, but services are often expensive and unreliable. Despite this, most developing markets will likely evolve similarly at least in the medium-term, which means poorer customers will mainly get access to lower-quality financial products, and there will be plenty of financial services providers ready to take advantage of customers who are already squeezed. That doesn’t mean that we should necessarily rein in financial inclusion in poorer countries, but if the US is a guide, financial inclusion funders and practitioners should emphasize consumer protection, and worry about moneylenders, pawn shops, payday loans, and discriminatory practices at the same time that they promote mobile money and broader inclusion.  

Learning from developing countries

First among the lessons we can learn from research in less-wealthy countries is the importance of understanding financial volatility. Volatility is a huge drain on households. Unmanaged volatility makes it difficult if not impossible to budget, save, or invest consistently for the medium or long-term. The prevalence and impact of financial volatility was a central finding of the original Portfolios of the Poor financial diaries work in India, Bangladesh, and South Africa. In all locations, the amount of income and expense volatility that lower-income households cope with is much greater than conventional data showed. Managing short-term volatility requires different tools and policies than those needed to climb the ladder with an eye to the long-term. Understanding households’ need to manage volatility has reshaped how many practitioners in the microfinance community understand the value of their products and how to make those products better.

Financial volatility, it turns out, is not just an issue for poor households in poor countries. The US Financial Diaries found a great deal of income and expense volatility even among solidly middle-class households in the United States. US policy and the products that flow from it have focused on the big stuff (helping families save for retirement or buy a home). But that leaves families on their own to cope with the near-term challenges (like months when paying for a car repair makes it hard to pay the rent). The financial diaries research makes it evident that the tradeoffs families face in dealing with short-run needs continually undermine progress on long-run goals. To help people succeed in the long run, policy-makers and product designers need to focus more on the short-run.

Another similarity between households in the United States and less-wealthy countries is that in the absence of appealing banking services, communities create their own informal financial systems. The US Financial Diaries project provides many examples showing the importance of informal finance—such as informal loans between family and friends—as a coping mechanism.

This suggests the need for humility when it comes to the expected impacts of new financial products and policies. The global microcredit movement offers two insights:

First, microcredit was built around the unexamined idea that households that lacked access to formal credit didn’t have access to credit at all (except perhaps at truly extortionate rates from loan sharks). That assumption led us to expect too much from microcredit. It was natural to think that we would see a big impact when we introduced microcredit into an environment where credit was unavailable. But with a better understanding of the variety of informal financial tools that households are actively using (including informal mechanisms for credit, saving, and insurance), it’s easy to see why microcredit hasn’t made nearly as big of an impact as expected. The same goes for new financial products in the United States. The competition isn’t “nothing,” nor is it just predatory lenders. To make a measurable difference, innovative products will have to be a meaningful addition to the existing informal financial landscape.

The second insight is wrapped around a puzzle of microfinance’s growth. Why were so many households so excited to get microcredit if it wasn’t transformative? There are many reasons, but one is that households value a reliable and rule-based partner in financial dealings. Informal financial arrangements are very valuable for households, but they also have serious limitations. In places where poor households lack access to formal credit, there are often deep networks of informal lending between family members, neighbors, or local shopkeepers. And while these networks are vitally important to households, they are not always reliable. There is no guarantee that a neighbor will have money to lend when you need it; nor is it always possible to say no to a sister’s request for a loan, even when you know it is not likely she’ll repay it. In contrast, microcredit institutions mostly operate with transparent and reliable rules. Weekly meetings will always happen. If you pay back a loan, you can borrow again in an amount and at a cost that you can count on. The structure, reliability, and transparency of microcredit are a huge boon to poor households that may not interact with any other institution—public or private—with anything like a similar degree of rigor.

The lesson for the United States is not that formal services are much better than informal ones. It’s to recognize that for many poor households, the “formal” services are not always transparent and reliable. The fees and restrictions hidden in fine print can make the banking experience feel very arbitrary. While it’s easy to get excited about innovations in FinTech, for example, in the end what will make a meaningful difference in people’s financial lives is less a new piece of technology than having access to mechanisms that meet decidedly old-fashioned virtues like transparency and reliability.

It’s clear we have a long way to go to make financial services work better for poor households. The sooner we tear down the walls and recognize the similarity of challenges people face around the world, the more progress we’ll make.