The Efficacy of Microcredit in Promoting Business Growth and Alleviating PovertyIn several previous posts I've discussed microcredit. These posts have all looked at programs that combine provision of credit with training in managing a small business and the revenue it generates. The key issue is how much impact these programs have on business size and on the standard of living of the people and communities involved.
Now some further research on the efficacy of microcredit in alleviating poverty and promoting business growth has come to my attention, thanks to The Economist, which published a one-page article on the subject in their July 18 issue. Two studies are described:
- An investigation of the impact of access to microfinance in Hyderabad, India. The study compared low-income neighborhoods that were added to a bank's microfinance market area with low-income neighborhoods that were left out of the market area. Assignment of neighborhoods to the treatment and control groups was random.1
- An investigation of the impact of access to microfinance in the Philippine provinces of Rizal and Cavite and in the Manila area. As in the Indian study, this Philippine study used randomizing to address the problem of self-selection, i.e., the problem that the most entrepreneurial individuals are the ones most likely to take advantage of microcredit, and providers of microcredit favor markets where such individuals are concentrated.
In the Philippine case, it was individual credit applicants who were assigned randomly to the treatment and control groups. Those in the treatment group received loans, while those in the control group did not. All of the applicants in question were of marginal creditworthiness, so bank loan officers, not privy to the nature of the experiment, accepted (with a few exceptions) their computer system's decree as to whether or not a particular applicant should be approved, even though the decision was, in fact, random.2
The Hyderabad study's findings, based on a survey done 15 to 18 months after the launch of the program, suggest that
microcredit does have important effects on business outcomes and the composition of household expenditure. Moreover, these effects differ for different households, in a way consistent with the fact that a household wishing to start a new business must pay a fixed cost to do so. Existing business owners appear to use microcredit to expand their businesses: durables spending (i.e., investment) and business profits increase. Among households who did not own a business when the program began, those households with low predicted propensity to start a business do not increase durables spending, but do increase nondurable (e.g., food) consumption, consistent with using microcredit to pay down more expensive debt or borrow against future income. Those households with high predicted propensity to start a business, on the other hand, reduce nondurable spending, and in particular appear to cut back on "temptation goods," such as alcohol, tobacco, lottery tickets and snacks eaten outside the home, presumably in order to finance an even bigger initial investment than could be paid for with just the loan.3The authors of the study note that it is
somewhat hard to assess the long run impact of the program. For example, it is possible that in the longer run those people who are currently cutting back consumption to enable greater investment will become significantly richer and increase their consumption. On the other hand, the segment of the population that increased its consumption when it got the loan without starting a business may eventually become poorer because it is borrowing against the future, though it is also possible that they are just enjoying the "income effect" of having paid down their debt to the money-lender (in which case they are richer now and perhaps will continue to be richer in the future).Also
microcredit ... appears to have no discernible effect on [children's] education, health, or women's empowerment [decision-making concerning household spending, investment, savings, and education]. Of course, after a longer time, when the investment impacts (may) have translated into higher total expenditure for more households, it is possible that impacts on education, health, or women's empowerment would emerge. However, at least in the short term (within 15-18 months), microcredit does not appear to be a recipe for changing education, health or women's decision-making. Microcredit therefore may not be the "miracle" that is sometimes claimed on its behalf, but it does allow households to borrow, invest, and create and expand businesses.The Philippine study also used surveys to assess microcredit impacts. The surveys were conducted 11 to 22 months following an applicant's entrance into the experiment, and yielded these findings:
- Individuals assigned to the treatment group did borrow more than those in the control group.
- The marginally creditworthy microentrepreneurs who received credit shrank their businesses relative to the control group. The researchers suggest that this was a result of deciding to lay off employees who were not very productive. "[T]reated microentrepreneurs used credit to re-optimize business investment in a way that produced smaller, lower-cost, and more profitable businesses."
- A rise in business profit does not translate into income and consumption changes. E.g., there were no significant effects on two key measures of consumption: food quality, and the likelihood of not visiting a doctor due to financial constraints. This could be due to the combination of increased business profits and decreased outside employment (with an increase in school attendance and perhaps related expenditures), thus leading to no change in total household income or consumption.
- The treatment group reported increased access to informal credit to absorb shocks. This informal credit reduced the incentive to acquire formal and informal insurance.
- There was some evidence that expanding access to capital (credit in this case) increases profits for male, but not for female, microentrepreneurs. Males seem to use the increased profits to send children to school; there is a concomitant decrease in household members employed outside the family business.
- There was no evidence that increased access to credit improves subjective well-being optimism, calmness, lack of worry, life satisfaction, work satisfaction, lack of undue job stress, decision making power, and socio-economic status. To the contrary, there was some evidence of a small decrease.
"... increased access to microcredit leads to less investment in the targeted business, to substitution away from labor and into education, and to substitution away from insurance (both explicit/formal, and implicit/informal) even as overall access to risk-sharing mechanisms increases. Thus although microcredit does have important and potentially salutary economic effects in our setting, the effects are not those advertised by the "microfinance movement." Rather the effects seem to work through interactions between credit access and risk-sharing mechanisms [e.g., access to loans from family members] ... . At least in a second-generation setting [in which microcredit is provided by profit/sustainability-seeking institutions], microcredit seems to work broadly through risk management and investment at the household level, rather than directly through the targeted businesses. [emphasis added]Also:
... treatment effects [e.g., on business profits] are stronger for groups that are not typically targeted by microcredit initiatives: male, and relatively high-income, borrowers... The overall picture of our results also questions the wisdom of targeting microentrepreneurs to the exclusion of consumers/wage earners. ... [O]ur findings highlight that money is fungible. Entrepreneurs do not necessarily invest loan proceeds in their businesses. Limiting microcredit access to entrepreneurs may forgo opportunities to improve human capital and risk-sharing for non-microentrepreneurs.The Philippine researchers' concluding note is that "household financial arrangements in developing countries are complex ... [so] it is important to measure impacts on a broad set of behaviors, opportunity sets, and outcomes. Business outcomes are not a sufficient statistic for household welfare, nor even necessarily the locus of the biggest impacts of changing access to financial services."
1 "The Miracle of Microfinance? Evidence from a Randomized Evaluation" (pdf), Abhijit Banerjee, Esther Duflo, Rachel Glennerster, and Cynthia Kinnan, MIT Poverty Action Lab working paper, May 2009.
2 "Expanding Microenterprise Credit Access: Using Randomized Supply Decisions to Estimate the Impacts in Manila" (pdf), Dean Karlan and Jonathan Zinman, Review of Financial Studies, forthcoming.
3 "Among those who did not already own a business a year ago, the following characteristics predict the decision to become an entrepreneur: whether the wife of the household head is literate [a proxy for willingness to defer consumption], whether the wife of the household head works for a wage [which will reduce the return to opening a business], the number of prime-aged women in the household [also a proxy for willingness to defer consumption], and the amount of land owned by the household [a proxy for initial wealth]."