Reading time: 6 – 10 minutes

The Boston Globe released an article on September 20th that took a look at two recent studies on the efficacy of microcredit. The two studies were completed by researchers affiliated with MIT’s Jameel Poverty Action Lab and have not yet been published.  However, according to the Globe the studies are already being called the most thorough and careful studies that have been done on the topic (no sources were cited by the Globe to corroborate that claim). What did the studies find? Here is what the Globe had to say:

What [the studies] find is that, by most measures, microcredit does not offer a way out of poverty. It helps a few of the more entrepreneurial poor to start up businesses, and at the margins it may boost the profits of existing microenterprises, but that doesn’t translate into gains for the borrowers, as measured by indicators like income, spending, health, or education. In fact, most microcredit clients actually spend their borrowed money not on a business, but on household expenses, on paying off other debts or on a relatively big-ticket item like a TV or a daughter’s wedding. And while microcredit champions point to microloans as a tool for empowering women, the studies see no impact on gender roles, and find evidence that if any one group benefits more, it’s male entrepreneurs with existing businesses.

The team that completed the research for “Portfolios of the Poor” also found that a lot of loans aren’t actually used to start, or continue to build, businesses. A lot of the loans are used to pay off debt and to pay for expensive life milestones (like weddings in India and funerals in South Africa) among a myriad of other things. However, even if that is the case, microcredit, with its much lower interest rates, is a much needed alternative to the usurious local moneylenders.

The Globe article goes on to look at the microentrepreneurs that are created through microcredit programs and suggests that we may need to think more macro to solve the poverty issue. That is, we need to think of scale. While building a lot of microbusinesses is a good step toward alleviating poverty we need to recognize that microbusinesses, since they don’t have scale, won’t have as much impact as a growing a scalable business that, over time, will provide many new jobs. That is a completely valid point and one that deserves some more research.

Now that we have taken a look at some of the conclusions of the studies we should take some time to look at the methodology of the studies.  One of the main pieces of information I noticed was the time frame of the studies. The studies were completed over a 1.5 – 2 year time span.  It is debatable whether or not that was a long enough span of time to obtain meaningful results. One of the reasons that I really loved “Portfolios of the Poor” was that the studies were completed over a much longer time span and data was collected at closely spaced intervals. I do believe that to get solid data in the microfinance world you need more data points over a long period of time.  I am not ready to discount anything in the new MIT studies though since I have not even had that chance to read them.

The first study, completed by Dean Karlan (economics professor at Yale) and Jonathan Zinman (associate economics professor at Dartmouth), looked at a single bank in the Phillipines that offered microloans. They asked the bank to institute an algorithm that would approve some borderline people for a loan and deny others.  Then Karlan and Zinman followed up with both sets of subjects to see what the effect of the loans were. It turns out that, in this case, the loans didn’t seem to have much of an effect.

Neither household income nor spending rose for those who got microloans. And borrowers who did put the money into their businesses – instead of using it, as many did, for household expenses – actually shrank rather than grew their businesses. Karlan and Zinman suggest that this might be because the business owners were taking advantage of the loan to fire unproductive workers to whom they owed financial favors, and those firings seemed to explain the very small gains in profit Karlan and Zinman found. In addition, the gains accrued only to male entrepreneurs, not the women usually targeted by microcredit programs.

The second study, authored by Abhijit Banerjee and Esther Duflo (economics professors at MIT) along with Rachel Glennerster (executive director of the Poverty Action Lab) and an MIT economics doctoral student named Cynthia Kinnan, found a larger impact than the first study, albeit a selective one.

Working with a microcredit bank in India that was looking to expand in the city of Hyderabad, the researchers did find some small positive effects. Borrowers who already had a business did see some increase in profit. Households without businesses that the researchers judged more predisposed to start one were found to cut back on spending, suggesting they were saving to augment their loan for a capital business expense like a pushcart or a sewing machine. The researchers also found small but encouraging shifts in household spending across the board, with less money spent on “temptation goods” like alcohol, tobacco, and gambling.

However, overall household spending stayed about the same and the authors found no effect on children’s health or education levels.

Duflo thinks that those results only look disappointing since the expectations for microcredit are so high.  She is probably right. However, it is hard to take too much away from these studies.

The studies were very limited in scope, both of them only looking at one specific bank and then at a subset of the bank’s loan recipients. Because of the limited time frame and scope I am not sure one can rely too heavily on the results of these studies. Of course, I think most rational microcredit enthusiasts and practitioners would agree that microcredit isn’t going to solve the poverty problem by itself. It is simply a new tool in the development arsenal and one that is arguably very potent and sustainable.

Tyler Cowen, an economics professor at George Mason University and one of my favorite bloggers, gave a quote in the Globe piece that lines up with part of my thinking on the issue:

“The fact that [microcredit] has survived commercially, I take that more seriously than any other piece of evidence.”

The commercial viability of microcredit is one of the things that gets me excited about it. Having an effective, and sustainable, development tool is a very powerful thing.

At the end of the day, what these studies do help us understand is that we need to do more. Focusing on building other financial services like savings and insurance will be an important part of the solution going forward. Also, funding enterprises that have graduated from the “micro” level could be another important innovation. It will help bridge the gap between microcredit and working with a standard bank, which, at this point, is quite large.

The Globe article mentions that the Grameen Bank is already looking at an initiative where they will create loans of up to $10,000 for what they call minibusinesses. Other NGOs are even investing in neglected medium-sized businesses and receiving equity stakes in return for their capital.

The future of microfinance and microcredit is bright. Of course there is still a lot we need to learn in order to make better financial products for the poor.  Studies like the ones discussed in this article are very important for that reason. When it comes to development (or really anything) we should always study the efficacy of programs to ensure that they are performing well.  If they aren’t performing well then innovation needs to happen but innovation can only happen when we know the truth.

(via Boston Globe Article by Drake Bennett)