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Friday, October 02, 2009

Too Many or Too Few Choices? The Dilemma of Expanding Financial Access to Underserved Markets

By Suzi Sosa

Andr?s Velasco

In a recent BusinessWeek article, Economics Editor Peter Coy weighs the merits and risks of financial innovation. "The big problem:" he writes, "it's hard to tell the beneficial ideas from the ones that are self-serving or dangerous." Though concern over the potential harm of poorly understood financial products may lead us toward over-regulation, one benefit of these ongoing conversations is the attention it is drawing to the long-ignored problem of financial exclusion. Currently, an estimated two billion people around the world lack access to appropriate, affordable and safe financial products and services. 

Such was the focus of the second annual Global Empowerment Meeting, a one-day invitation-only gathering of global leaders from business, government, non-profit and academic worlds hosted earlier this month by the Center for International Development at Harvard University. With a focus on expanding the reach of markets the presentations and discussions of the event centered on the question of financial access and how to create long-term financial empowerment for underserved communities. Among the key topics were both the questions of financial innovation and appropriate regulation.

Launching the discussion, Ricardo Hausmann, Professor of the Practice of Economic Development at Harvard University, presented research that supports a new framework for understanding why some economies stagnate, remaining perpetually mired in poverty. Through detailed comparisons of countries worldwide, he has identified that a country's prosperity is directly correlated to its ability to create products of increasing complexity. In addition, as a country's capacity to produce products increases, so does the complexity of products that it produces, and this ultimately leads to increased opportunities for growth. As we think about the possible corollaries in financial services, it is impossible not to wonder whether the same product sophistication that caused millions of honest citizens to be "duped" into transactions whose complexity was beyond their comprehension also enabled the voracious growth of the recent past?

At the same time, the expanding range of available products and services, which should ostensibly be improving consumers' lives, may actually be causing them greater distress. These are the findings of detailed research presented by Dean Karlan, Professor of Economics at Yale University and founder of the non-profit Innovations for Poverty Action. Karlan's research has shown that oftentimes consumers prefer to have fewer choices, and they will actively seek products that force restraint. For example in India, Karlan and his research team discovered that despite being given the opportunity to pay off very high-interest debt owed to a moneylender, many poor people chose not to. These individuals were using ongoing debt as a way of negotiating the complex dynamics of household finance by "pre-allocating" their spending. In the United States, Karlan and his team created www.stickk.com, a website where individuals can sign up to "put a contract on yourself." Through hundreds of voluntary participants, Karlan has observed in practice that people want to limit their own choices and force consequences for their own "bad" behavior.

And at the root of this ongoing public discussion about setting limits for both businesses and ourselves we are all wondering: who should make that call?  Should the government develop those constraints for us, or must we take that responsibility ourselves? Many advocates for government intervention, including those who support Obama's proposal for a Consumer Financial Protection Agency, worry that consumers don't have the tools needed to make informed decisions about which products will benefit them. At the same time, in many countries (including the United States) regulations create unnecessary barriers to expanding access for consumers who would like to have more. At the Global Empowerment Meeting, an expert panel of international regulators engaged the group in a heated conversation about the challenges of reforming financial regulations. Andrés Velasco, Chile's Finance Minister who has been recognized for the most effective macroeconomic stabilization program in Latin America, urged the divorcing of law from regulation.  Laws, he suggested, should be simple and focus on intent with long-term relevance. Regulations, on the other hand, should be more detailed but also structured to adjust quickly as products, services and market conditions evolve.

The potential harm of over-regulation was deeply underscored by the luncheon keynote presented by Lant Pritchett, Professor of the Practice of International Development at Harvard. His remarks, titled "Capitalism without Capitalization," illustrated how excessive and/or inappropriate regulation in many countries has not only caused many entrepreneurs to go underground to work "informally" outside of the legal system, but that this phenomenon has endured for so long and spread so pervasively that countries risk being unable to escape it.  When regulation is so rigid that it prevents the natural flow of market forces, both suppliers and consumers circumvent the official system and, according to Pritchett, a world of "deals" replaces the one of "rules." The long-term consequence, of course, is that entrepreneurs and businesses working in the informal economy are unable to leverage their income for investment or growth. 

In the United States we don't worry so much about an underground black market of financial services. However, the ongoing appearance of "non-bank financial services" demonstrates that demand can and will drive innovation despite regulation, and if consumers want access to products that even the government may have determined are not good for them, the private sector will find ways to provide them. As such it begs the question of whether, like the "illegal" high-rise buildings of Cairo, we are simply avoiding the obvious and prolonging the inevitable? Or, perhaps more harmfully, of whether our regulations perpetuate market exclusion that prevents individuals from capitalizing on their financial success?

The complex question of consumer well-being is anchored in a fundamental tension between the freedom and danger of choice. On the one hand, as billions of individuals still lack the opportunity to choose products and services that may enable them to improve their financial well-being, millions of other consumers suffer from too many choices that they cannot navigate successfully. While one set of governments must throw off the vestiges of paternalistic regulation, ours now contemplates adding further layers for "consumer protection." What we all seek is a market that efficiently provides in an environment of minimal harm, though what we debate is how much responsibility an individual can and should bear and what tools we can best give him to become truly empowered.

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