Poverty alleviation is increasingly about investing “patient” capital in promising individuals with powerful ideas. And, it's tied to economic growth.
January 25, 2016
To alleviate poverty, organizations should invest “patient capital” in a few game-changing entrepreneurs.
Poverty-reduction mechanisms like basic education and micro-loans help people in developing economies start and run sole proprietorships. However, sole proprietorships fail to create the economic growth that lifts those people – and others – out of abject poverty over the long term.
Those are the findings of researchers Sharon Alvarez (Daniels College of Business) and Jay Barney (David Eccles School of Business). Alvarez and Barney examined the conditions that encourage entrepreneurship among the abject poor. They also examined whether entrepreneurship leads to economic growth (i.e. jobs and the increased production of products and services).
Entrepreneurial Activities Are Not Created Equal
As the researchers observe, significant progress has been made in recent decades to encourage entrepreneurship. Governments, NGOs, and private organizations have worked to increase literacy rates, provide skills training, improve property protection rights, and provide greater access to financial capital in developing economies.
The researchers found these improvements in human capital, property protection, and financial capital have supported entrepreneurship; however, all entrepreneurial activity is not created equal.
Three Types of Entrepreneurial Activity
There are three types of entrepreneurial opportunities: Self-Employment, Discovery, and Creation. All three create economic activity, but only Discovery and Creation create long-term economic growth.
1. Self-Employment Opportunities
Self-employment opportunities include owning a small grocery shop, purchasing a cow or goat, or buying a rice paddy. They are the most common entrepreneurial activities, financed through microfinance institutions like Grameen Bank or Kiva.
Self-employment opportunities are typically low-risk. They require minimal education, training, problem-solving skills, and financial capital (loans average $125 to $350 USD). Criminals and corrupt government officials are less likely to target sole proprietors (good) because they generate low profits (not-so-good).
Low risk means low reward. As noted above, self-employment opportunities typically produce low returns. They rarely create more than one job and they are easily replicated by others.
As the authors state: “microfinance loans enable virtually anyone to enter the market through the formation of an easily imitable business.” Therefore, “Self-employment opportunities that are funded through microfinance opportunities are insufficient for economic growth.” Self-employment is not the key to reducing poverty.
Assumption/Goal of Current Poverty Alleviation Tactics
Reality of Current Poverty Alleviation Tactics
2. Discovery Opportunities
Discovery opportunities exploit a technology, government policy, or trend that is new to the market. For example, an enterprising mechanic builds a business repairing and certifying old taxis, introducing a business model from the large city of Cape Town to his small village of Ekurhuleni.
Discovery opportunities often create economic benefits for more than just the original entrepreneur. They hold promise for alleviating poverty through scalable products and services.
Discovery opportunities are often costly to discover and easy to imitate. If they have equal skills and equal access to capital, everyone has the ability to exploit a given opportunity. Therefore, discovery opportunities are also riskier to fund.
3. Creation Opportunities
Creation opportunities involve an entrepreneur creating a new market – and creating it with the members of the new market. A famous example of a creation opportunity is the Grameen Bank. When, in 1974, founder Muhammad Yunus loaned $27 to 42 families, he could never have imagined the new lending model he was about to create. Grameen became a new financial institution that issues small loans to individuals and requires family and friends to monitor and enforce repayment. Today, Grameen has disbursed more than $9 billion across 37 impoverished nations and employs more than 25,000 people.
Creation opportunities create true change. They are scalable, hard to imitate, and create economic conditions that alleviate poverty.
Creation opportunities require “sophisticated human capital, highly developed property rights, and sophisticated sources of financial capital,” observe the authors. “Those living in conditions of abject poverty rarely have these skills.”
What Business Should Do
Research-Based Poverty Alleviation Tactics (Suggested by Alvarez & Barney)
How can corporate philanthropy programs help alleviate poverty in developing economies? The researchers outline three routes to help guide poverty alleviation efforts.
Invest “patient capital.” Rather than issuing loans or expecting a quick return on your investment, support a promising entrepreneur with an industry-changing idea – and give them time to nurture that idea.
Focus on opportunities that create jobs for many people rather than encouraging individuals to seek self-employment.
Foster sophisticated skills in a few game-changing entrepreneurs. For example, rather than launching a program that teaches basic literacy skills to an entire village, help a few promising entrepreneurs become effective at industry scanning, planning, problem-solving, leading and organizing. If even one of entrepreneur creates the next Grameen, you will have helped more than 25,000 people escape poverty.
Alvarez, S. A. and Barney, J. B. (2014), "Entrepreneurial Opportunities and Poverty Alleviation." Entrepreneurship Theory and Practice. 38: 159–184.