Clay Christensen: Disruption and Innovation Can Solve Global Poverty

So there is a problem to be solved, beyond just sitting back and watching the miracle of self-sustaining growth unfold. (I am being only a little facetious.) Exhibit 1 shows the decline of per capita GDP in selected sub-Saharan African countries. The picture is not pretty. A good bit of improvement has taken place in the current decade, but before then the prevailing trend in this region has been, sadly, de-development.

Exhibit 1
Countries that had declining per capita GDP over 1965-2015

Source: Christensen et al., p. ix. Underlying source: IMF World Economic Outlook database. In current U.S. dollars, but not purchasing power parity adjusted. Data shown for “1960s” is an average over 1960-1969 and is likely to be representative of conditions in 1965.

Only three of the countries that have declined are not in sub-Saharan Africa: Afghanistan, which has had a series of destructive wars; Venezuela, mentioned earlier; and Kuwait, which is still rich despite declining oil prices. And, in a world where the overall GDP per capita in 2015 was $15,189, Burundi’s $315 is a pauper’s wage in the extreme. Losing ground – in some cases, a lot of ground – over 50 of the best years in world history is pitiable.

There are some problems with this analysis. When comparing standards of living, per capita GDP statistics should be reported using purchasing power parity (PPP), which adjusts for the cost of living in a given country.² Making this adjustment and updating to 2018, Burundi’s $315 becomes $733. The analysis also misdirects the eye by focusing only on economies that have declined: according to the Brookings Institution, “half of sub-Saharan Africa’s population [is] now in middle-income economies” as defined by the World Bank. In other words, there are some success stories.

When you make the PPP adjustment, Zambia, described by frontier-market investor Lawrence Speidell as having a “walking-around GDP” that is “not that bad,” rises from $1,576 to $4,120. Much better, and much more consistent with the handsome appearance of the capital city, Lusaka. But Zambia is only a bit more than half as prosperous as the poorest country in South America (which is Bolivia).³ Africa has a long way to go.

Go where, and how?

Creating prosperity, not eradicating poverty

The authors write,

Countries can reliably and sustainably overcome poverty and, indeed many have; however, they did not do it mainly by trying to eradicate poverty. They did it by focusing on creating prosperity. On the surface, the difference between the two strategies may seem like mere semantics, but that couldn’t be farther from the truth.

This sounds like business-school happy talk until you look at the results of efforts specifically designed to alleviate poverty. “Since 1960, we have spent more than $4.3 trillion in official development assistance trying to help poorer countries,” the authors write, yet the outcomes have been de-development in a significant number of countries. Lord Peter Bauer, the Hungarian-British economist, famously described the flood of aid money that has gone to Africa over the last half century as “taxing poor people in rich countries and passing it on to rich people in poor countries.” Experts as diverse as the Kenyan economist Dambisa Moyo, the hyper-prolific MIT economics professor Daron Acemoglu, and former U.K. Prime Minister David Cameron concur with this analysis and seek something better.

So do Christensen, Ojomo, and Dillon. As an example of trying to create prosperity instead of eradicate poverty, they hold up Singapore, which was poorer than Mexico in 1950 (and Mexico then was only about one-quarter as rich as it is today):

One of the main initiatives of [Singapore’s] government was to educate its citizens. But when Dr. Goh Keng Swee, one of Singapore’s ministers, would see hundreds of children streaming out of school at the end of the day, instead of being happy, he was heartbroken. He...understood that simply attending school wasn’t enough. What would the students do after they graduated? How would the economy create and sustain jobs for all these newly educated children? Those were the questions that Dr. Keng Swee was asking.

The authors continue,

Focusing on creating prosperity – in contrast to focusing on alleviating poverty – compelled Dr. Keng Swee and the government to ask entirely different questions, pursue different activities and emphasize different metrics. Instead of mostly focusing on the data, they focused on the deeper underlying phenomena. And so, instead of primarily building schools, Singapore prioritized investments and innovation and attracted companies that created jobs. This decision increased the need for education.

Today, Singapore is the fourth richest nation in the world (third if you don’t count tiny Macau, which is effectively part of China) with a PPP-adjusted GDP per capita of $98,255. “And today,” conclude the authors, “not only do approximately 99% of people attend secondary school, but more than half go on to get a post-secondary school diploma.” They also have jobs, mostly high-paying ones.

Can the culture and economy of Singapore simply be transplanted to central Africa, 5,000 miles away with a radically different history and set of current circumstances? Of course not. But human nature is more or less the same everywhere. People respond to incentives, they are motivated to make their lives better, and if there is some guarantee that they can keep the lion’s share of what they produce and invest some of it with the realistic hope of later gain, they’re likely to do so. The business instinct is universal.

We now turn to the surprising ways in which Christensen and his colleagues seek to encourage disruptive innovation undertaken by some of the world’s poorest people. The motivated and creative people of Africa, India, Latin America, and other poor locales, not Silicon Valley engineers, will lead the way.

Pushmi-pullyu

The Singapore example highlights the difference between the “push” strategies favored by traditional aid and development agencies and the “pull” approach that the authors advocate. Like the pushmi-pullyu, the fanciful llama-like animal with a head at each end of its body in Hugh Lofting's Story of Doctor Dolittle, some developing countries are going nowhere because they are benefitting fully from neither approach. In Singapore, the push method was to build schools and hire teachers – a worthy endeavor, but with the risk of producing bored students and unemployed, restive graduates.

In contrast, the pull method, which succeeded in the case of Singapore, was to get people to want to go to school. This was accomplished through the opening of capital markets and the encouragement of trade, which in turn produced job opportunities. When the momentum for development comes from within instead of above, it is more likely to happen, argue Christensen and his co-authors.

Stalking the wild non-consumer

For entrepreneurs, innovators, and investors – one of the two groups of readers at which the book is aimed (the other is “those in the development industry”) – the key to success is identifying “non-consumers.” Why, in 2000, did only 2.5% of Africans have mobile phones? Why do a large proportion of Mexicans who need eyeglasses not have them?

The obvious, and wrong, answer is: Because they didn’t have the money. Through Christensen et al.’s lens, the correct answer is that they had some money, enough to buy some sort of mobile phone or pair of glasses, but the marketplace had not provided them with an affordable and accessible product. It fell to entrepreneurs, seeing an opportunity where others had not, to close that circle. In the case of Africa, Mo Ibrahim’s Celtel provided a cheap and tremendously beneficial set of mobile phone devices and services. In Mexico, Ópticas expanded rapidly as it made $17 prescription lenses available to people who can’t afford Oakleys and Ray-Bans.

The economy, as typically perceived, consists of the transactions that take place. Those are what GDP measures; they are what you can see. The opportunity, Christensen et al. propose, is in the transactions that do not take place. What you can’t see: non-consumption. Let’s look at Celtel and Ópticas in a little more detail.

Mo Ibrahim and Celtel

Mo Ibrahim, a Sudanese-British businessman and former British Telecom executive, said that people laughed at him and called him crazy (is this theme familiar?) when he said he wanted to start a mobile phone company in Africa. Skipping over the usual obstacles of poor infrastructure, greedy politicians, and uncomprehending investors, Christensen et al. show how Ibrahim knew there was a business opportunity in the first place:

‘If you live far away from the village where your mother lives and you want to talk to her, you might have to make a seven-day journey,’ Ibrahim recalls now. ‘If you could just pick up a device and speak to her instantly, what would be the value of that? How much money would you save? How much time?’ ...He focused on the struggle to accomplish something important for which there were few good solutions. For Ibrahim, struggle represented enormous potential.

Mo Ibrahim, founder of Africa’s Celtel mobile phone company
Source: https://upload.wikimedia.org/wikipedia/commons/a/a9/Mo_Ibrahim.jpg

The benefits extend well beyond calling your mother. The Economist estimates that M-PESA, a mobile phone-based banking system, lifted 2% of Kenyan households out of poverty between 2008 and 2014. While 2% in six years sounds like slow progress, the alternative was no progress, and only some who benefited from mobile telephony were on the line between poverty and non-poverty. Everyone benefited.

Why is it so beneficial for Africans to have access to banking? In Kenya, it’s common for poor entrepreneurs to earn money by making a large number of very small sales. The alternatives to M-PESA are to carry cash, which can be stolen, to only sell to buyers who pay cash, and to sell within a small geographic area. A banking system is not a convenience but a lifeline, vastly expanding your market and also allowing you to comparison shop for supplies, assess the competition, and make deals.

Ópticas Ver de Verdad: “Opticians, to Truly See”

In Mexico, as elsewhere, about 43% of the population needs eyeglasses to see properly. Fewer have them. Eyeglasses are expensive and many poorer Mexicans can’t afford them or choose to spend their meager discretionary funds on something else, so they just make do with poor eyesight.

But why are eyeglasses expensive? It is the frames? The prescription? The custom-ground lenses? Marketing and logistics?

It turns out the answer is “none of the above.” It is possible to make a perfectly serviceable pair of prescription glasses and sell them for about $17, eye exam included. That is what Ópticas Ver de Verdad (Ópticas for short), founded in 2011, does in Mexico, and 330 stores in that country are slated to be open by 2020.

The reason nobody was selling affordable prescription eyeglasses in Mexico is that nobody had bothered to try. The need was real but not obvious. Poor Mexicans were not protesting in the streets about the high price of eyeglasses; they were just doing without. The result of Ópticas was higher productivity and better lives among Mexicans: “How might a new pair of glasses,” the authors ask, “impact the life of an electrician, or a plumber, or a nurse? How might affordable glasses affect the life of a brilliant 12-year-old girl who is unable to see clearly what she reads, and as a result is doing poorly in school?”

Non-consumption and enterprise in U.S. history

Addressing non-consumption through enterprise has a long and honorable history. When George Eastman founded Kodak in 1888, everybody knew what a photograph was. They just didn’t take them. That was a job for professionals: Cameras were expensive, processing was inconvenient (requiring skill in chemistry), and film was sold in plates (one photo at a time) rather than rolls. By selling affordable cameras, manufacturing rolls of film, and developing photos through the mail, Eastman turned photography into a cheap, popular mania.

Isaac Singer’s 1851 sewing machine enabled an amateur seamstress to sew 900 stitches per minute, compared with the 40 that a professional could manage by hand. The story of Henry Ford rolling out the Model T, making a rich man’s toy into the backbone of American life, is too well-known to repeat; what is not as widely appreciated is the set of knock-on benefits, shown in Exhibit 2.

Exhibit 2
Impact of Ford Model T on existing industries, new industries, and jobs

Source: Redrawn by the author from Christensen, Ojomo, and Dillon [2019], Figure 5 on page 33.

Talk about a multiplier effect!

These American examples all come from a period when the United States was itself a developing country. Necessity drove invention, and just as we could expect the most profound innovations to originate in the countries that were developing in the nineteenth century, they will probably come from Africa, India, and Latin America in the twenty-first.

Non-consumption: Summary

To sum up, what benefits consumers and entrepreneurs most, especially in poor countries, are market-creating innovations. They create a market for mobile phones or eyeglasses, or cameras or sewing machines, where there was no market before. The follow-on effects include jobs, tax revenues, and capital accumulation (saving). This is the central thesis of The Prosperity Paradox, and it is plausible.

Market-creating innovations in developing countries, then, tend not to be new high-tech gadgets, but “a change in the processes by which an organization transforms labor, capital, materials, and information into products and services of greater value.” This is very close to the economist’s formal definition of technology: whatever skills and knowledge make it possible to do more with less. And doing more with less is what turns poor societies into prosperous ones.

A study in contrasts: Japan and Mexico

Non-consumption is far from the only theme of The Prosperity Paradox. As one might expect of a Harvard Business School professor, the book resembles a collection of case studies, linked by discussions of theory. Two of those cover the development of Japan and Mexico since World War II. They have followed very different paths.

After World War II, Mexico was richer than Japan. Today, Japan is more than twice as rich as Mexico. What happened? According to Christensen, Ojomo, and Dillon, Japan focused on innovation while Mexico concentrated on efficiency. Efficiency sounds good; why doesn’t it pay well?

In Knowledge@Wharton, Christensen wrote:

[E]fficiency innovation... helps companies make good products cheaper. They’re important in our economy because they help maximize free cash flow...but cause...you to minimize growth and job creation... Such innovations don’t create growth; they eliminate growth. [italics mine]

Thus, while Mexico had an almost ideal recipe for success – an export industry dominated by high-value items such as automotive and electrical equipment, a skilled and famously hardworking labor force, and proximity to the United States – Mexican incomes have grown at a snail’s pace when compared to Japan, the Asian Tigers, and many other emerging-market success stories.

Meanwhile, Japan pursued market-creating innovations. Were Americans crying out for transistor radios? No, they were huddled around the large family radio, each wishing they could choose a program to their liking. In 1955, Sony came out with its first pocket transistor radio (building on a technology developed in the United States), and revolutionized the industry. Honda, observing non-consumption of motorcycles in America – seeing that the “hogs” were perceived as large, dangerous vehicles ridden by large, dangerous people – designed a cute little cycle and attached the advertising slogan, “You meet the nicest people on a Honda.”

The culture in Japan is different from that of the U.S., the U.K., or Germany, so these market-creating innovations were mostly developed by large corporations rather than tinkerers and adventurers. But the idea of creating markets where none existed before is very much a part of the Japanese economic miracle. I hope they get their magic back.

“If you build it, they may not come”

All this talk about creating new markets does not mean that “if you build it, they will come.” In fact, the authors devote a whole chapter to debunking that idea, entitled, “If you build it, they may not come.” This is why “push” ideas for development, imposed from outside by “development experts,” rarely accomplish much. Business often engage in the same folly: products designed to fulfill a need that doesn’t really exist will fail. The idea is to identify non-consumption of something valuable and important, like phones or eyeglasses.

The authors sum up:

Market-creating innovations do exactly what the name implies, they create new markets. But not just any new markets, new markets that serve people for whom either no products existed or existing products were neither affordable nor accessible for a variety of reasons. [italics mine]

The role of institutions

Christensen, Ojomo, and Dillon also devote considerable time and space to the role of institutions in development. Some of their conclusions will come as a surprise to those, like me, who’ve been taught that good laws, reliable enforcement of laws and contracts, and honesty in government are (along with freedom of enterprise) necessary and sufficient conditions for people to make the best of their situation.

Good laws are not enough

It’s easy to observe that, as the authors write, “[i]n general, poor countries are overwhelmed with bad institutions, while prosperous countries are filled with good ones, or at least much better ones.” This observation, the authors contend, leads to a post hoc ergo propter hoc fallacy: “that countries that want to tackle poverty must first establish rule of law, fix their institutions, and adopt Western-style systems before they can make progress toward prosperity.”

Instead, the authors suggest that “the institutions of a society reflect its values rather than create them... Institutions are not something that can be pushed in by virtue of good intentions.” Instead, they “believe that if we begin by helping people make progress in their local economies, then change in their culture and institutions will follow. History has born this out, time and again.” They contrast the example of Venice, an intensely commercial society that developed good institutions over the centuries out of necessity, with that of Georgia, the little country in the Caucasus, imposing substantial institutional reform from above in the hope of growing the economy, and mostly failing. The Georgians put the “cart before the horse.”

Corruption can be a solution, not a problem

Christensen et al. have a kind word for corruption, in that it can enable entrepreneurs and customers to circumvent bad laws or customs. This idea crops up in the economic development literature from time to time, and is basically correct. If I buy a piece of land with the intent of building a house, and the government’s official position is that I must pay $50,000 for permits but a local official will allow me to build if I contribute $5,000 to his kids’ education fund, the obstructionist official rip-off loses its power. It all sounds terribly unfair to people raised on the idea that governments will be reasonable and accountable, but in many places that is a pipedream.

Corruption is a symptom of bad laws, not a moral failing, the authors argue. People will risk fines and imprisonment to circumvent laws that seriously impair their ability to live and do business as they please, but they will not do so to avoid minor inconveniences or fees that are perceived as reasonable. The lesson is that governments should not be so intrusive as to force both sides into a conspiracy to cheat the authorities so they can function.

Find the Mormon missionaries

In a surprising turn toward the end of the book (less surprising since Christensen is a Mormon and was a missionary as a very young man), the authors advise us to “find the Mormon missionaries.” Not because there is something about Mormonism that makes money for its adherents or helps the poor become prosperous – although one could make that argument – but because such missionaries are typically in touch with the needs and struggles of the common man and woman in the countries where they serve. The authors write,

I often tell people that one of the best ways to identify non-consumption opportunities is to visit a country, find the Mormon missionaries, and simply experience life with them. They are usually in some of the poorest parts of the countries and in most circumstances, live like the average person in that society. As a result, many of their struggles can point to market-creating opportunities.

The authors learned from a Mormon missionary that mattresses are scarce among the poor in Cambodia:

Most people... slept on bamboo mats or on the hard floor. ...On the surface, it might seem like an inexpensive mattress would do the trick. But considering the fact that many [Cambodians]...live in small single-room homes, it is clear that isn’t likely going to work. What if an innovator developed a low-cost, easy-to-assemble-disassemble-and-store mattress? ...It turns out that there might just be vast non-consumption of a “good night’s sleep” in the world.

With the right innovation, that could become near-universal consumption of a good night’s sleep in the world.

Recommendations for investors

When the authors say they are writing for investors, as well as for entrepreneurs and innovators, I think they mean “investors in the real economy” – that is, businesses making direct investments, private equity firms, and the like. From this book, portfolio investors can only gain an appreciation of how the rest of the world is gradually (too gradually!) becoming more like the First World, and how convergence between countries’ economic fortunes has replaced divergence (which prevailed before about 1948) as the great trend of today.

This means investing in emerging and frontier markets. Unfortunately, I’ve been bullish on these markets forever, and they’ve underperformed for more than a decade. Fortunately, that means the stock prices are still reasonable in many countries, so investors who have not yet gotten in to these markets can do so at prices less inflated than those in the U.S.

The Prosperity Paradox is an eminently readable book about a topic of paramount importance. Commendably, Clayton Christensen has, somewhat late in his career, put his understanding of the business world to a use more important than documenting how established firms often are disrupted by innovators rumbling around at the bottom of the market (although that knowledge is worth having too). He has brought two skilled co-authors along with him on this journey, on which I strongly recommend readers embark. And I fervently hope his guarded optimism about the future of poor countries turns out to be correct.

Larry Siegel is the Gary P. Brinson Director of Research for the CFA Research Foundation and an independent consultant. Prior to that, he was director of research in the investment division of the Ford Foundation. His book, Fewer, Richer, Greener will be published by Wiley in 2019. He may be reached at [email protected] and his web site. Larry thanks Stephen Sexauer, CIO of the San Diego County Retirement Employees Association, for his valuable comments and suggestions.

¹ South Africa, Botswana, and Namibia.

² I use IMF data, accessed here on March 27, 2019. My $15,189 world average for 2015 is PPP-adjusted. The corresponding number for 2018 is $18,120, the increase reflecting both real economic growth and inflation.

³ PPP-adjusting the 1965 or 1960-1969 numbers would raise them also. De-development in the countries in Exhibit 1 is a reality.

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