Tuesday, September 15, 2009

Microcredit – not a silver bullet, but still a tool.

Microcredit, or small loans to poor people, was made most famous by Mohammad Yunus who founded Grameen Bank in Bangladesh in 1983 and made group lending and village banking household terms in international development. The field grew to microfinance, which applies to not only loans, but a wider set of financial products including microinsurance and savings products. For decades now, microfinance was seen as a silver bullet in fighting poverty, improving gender equality, and even decreasing children’s school drop out rate. The field grew from a few established organizations such as Grameen Bank, FINCA International, ACCION, and Opportunity International, to numerous organizations both international and local providing similar services to low-income populations globally. Microfinance received accolades from nearly everybody: international organizations, development workers, governments, and academics. With only occasional critiques regarding the high interest rates, the field grew exponentially. Yet, only recently have the true effects of microfinance been tested.

Thus far two randomized studies critically examined the impact of microfinance on poverty alleviation:
The miracle of microfinance? Evidence from a randomized evaluation by MIT’s Poverty Lab
Expanding Microenterprise Credit Access: Using Randomized Supply Decisions to estimate the Impacts in Manila by Dean Karlan and Jonathan Zinman at Yale and Dartmouth.

The overall results were disappointing at best. Bloggers actively discussed the results, and microfinance quickly fell off the pedestal it sat upon for decades. Essentially, neither study found microcredit (the papers looked at microcredit specifically, not a broad range of financial services) to be all that effective in poverty alleviation, improving health, promoting gender equality or increasing access to education. However, these are not the ultimate findings, and as in all academic papers, it is worthwhile to delve into the details.

The first study showed that households that received loans increased their expenditure on durable goods, and decreased their expenditure on “temptation goods” such as alcohol or tobacco. The increase spending on durable goods was especially seen in households that already owned a business, or were likely to start a business. Households without a business did not increase spending on durable goods after receiving the loan. Likewise, households with the highest propensity to start a business or ones that already own businesses decreased their spending on temptation goods, while households without businesses increased their temptation spending. The claims that microfinance increases access to education, changes gender roles, and improves health were not supported by these findings.

The second study’s results by Dean Karlan and Jonathan Zinman indicate that microcredit is not an effective tool in helping the poorest of the poor escape poverty. Microcredit did increase overall borrowing of the household. However, the households that borrowed from the microfinance institution were more likely to borrow from the formal sector. The return on business profit was larger for the higher income borrowers than lower, and it was much higher for male borrowers than female. Because microfinance traditionally targets women, these results are not only surprising, but should be considered by MFIs in their lending schemes. The results of this paper included findings which were contradictory to the Poverty Lab’s paper. Karlan’s paper found an increase in school enrollment within the household, especially the households where the male received the loan, while the Poverty Lab’s study found no such effect on education. Also, Karlan’s paper found no observable changes in consumption patters, and no impact on capital inputs into the business, while the main finding of the Poverty Lab’s research was an increase in durable good expenditures. As with the first study, no positive changes in health were observed.

At the end of the day, both studies produced mixed results and neither of these studies discredited microcredit entirely. Intuitively, loans should not be distributed randomly, but to groups or individuals who have the greatest chance of repayment. Thus providing loans to individuals who have an entrepreneurial drive and who already own a business makes logical sense. Whether those individuals are considered the poorest of the poor is a different manner. Microcredit is not a silver bullet, nor should it be. However, based on the Poverty Lab’s analysis it does promote durable good expenditure and allows people to invest in their businesses leading to a healthier economy overall. Microcredit seems to be the most helpful to individuals who have an entrepreneurial personality, and that is not an all inclusive category. Its main role is to give credit where there was none to people who have the drive and ability to use it. So no, microcredit is not a silver bullet, but nevertheless it remains a useful tool in international development.

-Yulya Spantchak
Research Associate
Center for Global Prosperity

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