Why the poor are poorer in poor countries
As a student, I used to hitchhike from the Netherlands to Mediterranean countries like Greece and Turkey during the summer holidays. Each time, I was surprised to see the highways in that direction overcrowded with cars, vans and trucks filled up with all kinds of household assets and equipment, including big items like refrigerators and washing machines.
It was in the 1970s, the glory days of the so-called ‘guest workers’, who were brought over from the rural areas of countries like Turkey and Morocco to keep the North-Western European manufacturing industry running. In the summer holiday, many of them went back to their families by car bringing those items to their villages.
At that time, I did not much think about what I was seeing. However, recently I started wondering why these families did not simply take their money to Turkey or Morocco to buy these goods there. I then realized that at that time there was no second hand market for these goods in those countries. Or in any case no second hand market that could compete with the ones in Western Europe.
This realization was surprising, as what I observed was clearly an economic phenomenon, people buying goods and transporting them over a long distance. However, this phenomenon is hardly mentioned in contemporary economic literature and completely lacking from welfare and poverty measurement debates.
This is regrettable, as second hand markets are of great importance for the material living standard of the poor. Adam Smith already noticed that durable goods bought by the rich are, over time, taken over by the poorer segments of society, and in this way contribute to the affluence of a nation1. The durables mentioned by Smith were houses, furniture and clothes. These are currently still important but have been supplemented with many other items that make life easier or more comfortable like TVs, refrigerators, washing machines, (motor)bikes, and cars.
These durables typically keep their use value (do what they were made for) over a longer period. However, their value as a status good quickly declines, which means that in countries with mature second hand markets their prices go down rapidly. After five years they cost less than half of the new price and after ten years hardly anything. Households lacking the money to buy these items new, thus have the opportunity to buy them second hand and enjoy their services at much lower costs. The fact that in countries like the USA or Britain three times more second hand cars are being sold than new cars, makes it clear that second hand markets are a non-negligible economic phenomenon.
For second hand markets to effectively function, there must be a regular supply of ‘new’ second hand goods. That supply depends to a large extend on the purchase of new, first hand durables by households who can afford this. In rich countries, there are enough wealthy households that are able and willing to buy new durables to guarantee a regular supply to the second hand market. In poor countries, there are much less of such households.
In the poorest countries of our world, like Ethiopia, Tanzania, or Niger less than 25 percent of the households owns a TV and even much less have a refrigerator, washing machine, or car. With so few households owning these items, there is very little supply to the second hand market. This means that households that would have enough money to buy a second hand TV or refrigerator in a wealthy country cannot satisfy their demand for these goods in their local context. These households are thus deprived in comparison to households with exactly the same income in a wealthier country, as they need more money to satisfy their material needs.
This economic problem has consequences if we want to study poverty throughout the world. To compare the wealth of people across the globe, we have to adjust their incomes for differences in cost of living using Purchasing Power Parities (PPPs). PPPs address the fact that people in poor countries are wealthier than the exchange rate of their currency suggests, because manual labor is cheaper in those countries.
However, PPPs do not address the fact that those people are also poorer because they have to pay more for durables than people in wealthier countries. This means that the purchasing power of people in poor countries is rated too high and that the international poverty lines for these countries are drawn at a too low level. That is why the poor in poor countries are poorer than we think.
1 Adam Smith (1776). Wealth of Nations, II.iii.38-39.
Once a month there will be published an article written by one of our teachers economics at the Radboud University. We really appreciate the contribution of the economics department a lot. This month we may thank Jeroen Smits, professor of International Economics, for his article about why the poor are poorer in poor countries.