Wednesday, April 22, 2015

The flawed wisdom on microfinance

The conventional wisdom that underpins the micro-finance and self-help group movement is based on three assumptions about poor people
  1. They need money.
  2. They are willing to borrow if they have access to credit.
  3. They can use borrowed money to enhance their livelihoods. 
Now, a closer analysis would reveal that neither of these assumptions are as axiomatic as they would appear. Consider the first assumption. A recent J-PAL policy paper that summarizes findings from RCTs on micro-finance uptake among beneficiaries in Ethiopia, India, Mexico, and Morocco who were provided easier access to micro-credit, find modest demand for credit. A more plausible assumption is that poor people need money at certain times, when faced with certain unavoidable requirements.

As regards the second assumption, again the story may be complicated. Consider a society where debt comes attached with a stigma. If this were to hold, then families are unlikely to borrow even when plentiful credit is available. They would borrow to meet unavoidable consumption requirements - festival or marriage expenses, medical treatments etc. But they would not do so to meet avoidable consumption (eg. buy consumer durables) or investment (eg. expand business) requirements.  

Finally, the idea that poor people, in general, can work their way out of poverty through entrepreneurship is not only ahistorical (which society has escaped poverty by entrepreneurship?) but also simply an inversion of the conventional wisdom on risk allocation - risks should be assumed by those best able to bear it. Most business activities, however small, carries considerable commercial risks. Expecting poor people, who just about manage to make ends meet, to bear those risks appears a case of risk-burdening those with the least ability to assume commercial risks.

Incidentally, the J-PAL paper is a great read, with several interesting insights - micro-credit access did not lead to substantial increases in income; micro-credit driven business investments rarely resulted in profit increases;  none of the seven studies found a significant impact on average household income for borrowers; and there is little evidence that micro-credit access had substantial effects on women’s empowerment or investment in children’s schooling. 

Update 1 (01.10.2015)

Evidence that questions the utility of microfinance. David Roodman of CGDEV has a book where he writes, "The best estimate of the average impact of micro-credit on the poverty of clients is zero". A comprehensive DFID-funded review finds that the microfinance craze has been built on “foundations of sand” because “no clear evidence yet exists that microfinance programmes have positive impacts.”

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