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Charting pathways to rural transformation: Financial inclusion as the catalyst function

Why rural transformation? Why must transformation, beyond development, be the goal for the country? Can financial inclusion catalyse rural transformation; to what extent? In this article, we pick up some of these questions. We try to identify the mechanisms underlying rural transformation at the level of household and individual decision-making. We argue that, unlike rural development, the transformation of rural economies and households is significantly related to organic changes in individual and household behaviour1. We propose that financial inclusion may have the potential to strongly incentivize micro-behavioural changes that shape rural transformation. We further argue that the pursuit of rural transformation through financial inclusion calls for a serious reorientation of the current policy framework around financial inclusion.

What is Rural Transformation? In 2016, the International Fund for Agricultural Development (IFAD), a specialized agency of the United Nations, identified India as an economy experiencing slow rural transformation (IFAD, 2016). The term ‘rural transformation’ comes from a long research lineage from around the world, and is generally regarded as distinct from, albeit related to and impacting rural development (e.g. see Berdegué et al, 2014).

Typically, rural transformation is seen as a complex and dynamic process of societal change that, at its core, entails modernization of agriculture and transition of rural labour to high-quality rural employment beyond agriculture. When steered efficiently, rural transformation improves livelihoods and standards of living, enhances welfare outcomes, embodies a transformation in people’s perspective on life and enables them to integrate with the larger world and markets on fair terms.

The manifestations of rural transformation are multi-layered and nuanced. It is commonly associated with higher agricultural productivity, commercialization, increase in marketable surpluses, diversification of production patterns and livelihoods, access to entrepreneurial opportunities, and better access to infrastructure (IFAD, 2016). However, we know little about the fundamental mechanisms that catalyse Rural Transformation. Rural Transformation through Households’ Allocative Efficiency In an economy that is transforming, households and individuals are known to make decisions that are “proactive” rather than “reactive”. Proactive individuals and households are likely to understand the nature of their resource constraints and make rational decisions based on these constraints. These decisions are varied including but not limited to the types and levels of consumption, choice of public goods, migration, employment, savings and savings instruments, crop types and timing of cultivation, sale of cropping outputs, etc. Expectedly, these decisions affect the individual’s and household’s welfare. Economies, where proactive individuals and households are increasing in numbers, are more likely to be transforming faster. This leads us to ask - are there ways to trigger proactive decision-making in households and individuals, so as to catalyse transformation in an economy? A necessary condition for households and individuals to be proactive is the ability to control, monitor and anticipate the flow of financial resources. Most importantly, they should at least have some agency in the generation and utilisation of financial resources. Framed from this perspective, rural transformation rather boils down to a problem of increasing ‘allocative efficiency’.2 The households’ ability to make choices, access and capability to process signals from both markets and governments and absence of coordination failures constitute the foundations of allocative efficiency. It thus follows that any intervention that either triggers or buffers the ability of a household or individual to make decisions reaching allocative efficiency, will catalyse rural transformation. As an immediate next step, we posit the question - how can individuals and households be incentivized and enabled towards allocative efficiency (i.e. being proactive) leading to welfare maximization? Policymaking must create incentives for households Over the years, governments and policymakers have implemented a number of programs and schemes aimed at rural development. Unfortunately, such programs and schemes were implemented in the absence of any meaningful structural reforms that would relax decision making constraints. As a result, households and individuals became and remained beneficiaries instead of productive decision-makers. Specifically, rural development policies lacked incentive mechanisms that could enable individuals and households to align their preferences with those of the policymakers. This was due to policy design being orthogonal to the preference structure of rural households. If policies on rural development had focussed on factors furthering allocative efficiency of households, then the demands and preferences of producers and consumers alike in the rural economy could have been revealed to the policymakers; the resultant resource allocation could have mirrored such preference patterns. Since this has not happened, there are mismatches in the rural labour market, missing markets for agricultural outputs and imperfect price formation of agricultural products, poor quality and frequent instances of deteriorating capital formation.

At present, the design of financial inclusion policies aimed at households is largely geared towards achieving convergence. Policies focus on issues of universal access to payment and banking systems, including access to digital channels. The discussions that surround such policies are more concerned with using financial inclusion to expand the efficiency of government outreach, particularly benefit transfers, and less to do with incentivising decision-making by those that are financially included. Instead of transferring the onus of resource allocation to the households, policies retain such activities with higher-level governments. Additionally, as a result of this type of single-point focus on access, policies of financial inclusion get designed in isolation, leading to policymakers operating in silos. Enabling agency in individuals and households may hold the key towards allocative efficiency, leading to welfare and hence rural transformation.

Evidence: Female agency impacts household welfare We know that financially included individuals have an incentive to understand factors governing the income-generation process, seek methods of enhancing income flows, understand savings, and search for related information. Further, financially included individuals also have an incentive to access information on the availability and quality of public goods, prices of consumption goods, and any other information that might have welfare implications. This implies that financial inclusion fosters the impulse to gain control over income generation and management of expenses. Available evidence suggests that these effects go beyond improved financial management. Consider the following example. In a recently completed report based on a large scale survey across 34 villages and a representative sample of households from Uttar Pradesh, Das et al. (2021)3 find that a 1% increase in the likelihood of owning and operating a bank account by women members of households will increase their share of participation in household decision-making by 34.2%. This has significant welfare effects at the household level. The monthly consumption expenditures in such households increase by 45.1% and per capita non-food expenditures go up by 77.3%. There is a clearly identifiable channel between ownership of bank accounts and welfare effects that occur at the household level - female agency in household decision making. When female agency is strengthened, welfare effects more than double; per capita monthly consumption expenditures increase by up to INR 3000. Even in the absence of triggers to female agency, the spillover effects of account access and ownership by women on per capita household consumption expenditures go up by INR 600. Findings such as the above are of significance to rural development policies in general and to policymaking for financial inclusion of rural households in particular. Case Study: Policymaking in Context Larsen and Toubro (L&T) as part of its CSR initiative distributed Lenovo tablets to 100 women from 60 villages in Vizhuppuram district of Tamil Nadu. These women were trained to use tablets to access financial services, make cashless transactions and look up information on markets, prices, farming practices, etc. Training was implemented through the Aurobindo Society, Pondicherry. One of the beneficiaries of this training, Lakshmi, was a marginal farmer from Poothurai village. She cultivated spinach in her small plot of land to sell locally within the village. She was also a member of a Self-help Group (SHG) supported by the Aurobindo Society (as a result she had access to a bank account). Post the training, Lakshmi was incentivised to both access information about organic farming of spinach, markets, types of spinach preferred, prices, quality control, etc., and borrow from the SHG. Using this line of credit she reorganised cultivation on her land and started selling her organically cultivated spinach to buyers in urban centres such as Vizhuppuram town and Pondicherry city. “I am now able to send my children to a school in a nearby town and can afford to buy books and other teaching materials as well as save money for future emergencies”, she later said.

Rethinking financial inclusion policy-making for rural transformation Holistic policy design geared to incentivize households and individual decision-making, and which embeds opportunities for financial inclusion will engender transformative outcomes, as in Lakshmi’s case. Top-down resource allocation policies, as are predominant now, are neither likely to be sustainable nor transformative.

Since financial inclusion relaxes the budget constraint for households and enables choices, policymakers and to an extent other stakeholders in policy design and implementation (including those from the banking sector and fintech), should be incentivised to design policies and products that enable households to make efficient decisions, which in turn would set rural transformation in motion. Since Independence, rural India has sustained economic development even in the absence of basic ingredients such as markets, technology, public goods and information about access and use of resources. Rural transformation is long overdue. A concerted effort to create data-backed policies for financial inclusion that enhance household agency and nudge them towards allocative efficiency will infuse new life into the goal. Notes: 1 Historically, the locus of transformation in villages has been the community. When a community transformed, individuals and households also benefited and became efficient decision-makers within these communities. However, with the breakdown of community-centric actions, it is important to focus on the next best entity viz., households and household preferences. 2 Allocative efficiency can be defined as resulting from or the ability of individuals and households to optimally allocate financial and other resources in response to their respective needs and wants. 3 From Das, A., Chopra, P., Kumar, D., Nagarajan, H.K., Pandey, V., Sharma, S., Tagat, A., Tripathy, A. (2021). Financial Inclusion and Economic Development: Do Institutions Matter? ICSSR IMPRESS Report.

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