Weekend reading links

1. FT has a long read on the challenges facing the global market for luxury goods. Asian shoppers accounted for more than 60% of the $300 bn (including cars) plus market in 2021.  

This is a stunning snippet

South Korea’s Shinsegae department store in the Gangnam district of Seoul recording sales of $2bn in 2021 — the highest turnover for a single store in the world.

Harrods in London had for long held the top spot.  

2. Another long read on the exploration for Lithium mining in the US, which may have the fifth highest reserves but very little of which is exploited. The search for efficiency and cost cutting, coupled with the dominance of environmental interests meant that there was little incentive to mine its own minerals.

The US’s willingness to allow its manufacturing to take place overseas has attracted criticism... “We outsource everything for slightly lower costs,” says Emily Hersh, an analyst at consultancy DBDC Group, and the chief executive of a company undertaking a lithium brine exploration project in Nevada. “We have punted the supply chains behind the technology we use and love to cheaper jurisdictions, or jurisdictions without stringent environmental policy, so that we can get them cheaper and faster.”

As the EVs market expands, the demand for battery minerals will grow dramatically

3. The rising interest rates have turned spotlight on housing markets in developed countries, which have experienced a sharp increase since the pandemic. The Economist has a good graphic which captures the health of housing market in western economies. 

As can be seen, outside of the Nordics, the western economies remain well placed to weather out the housing market bubble. 

4. It has long been an orthodoxy of management that financial incentives in the form of bonuses spur productivity growth in businesses. Notwithstanding serious doubts, it has endured as a narrative. In this context Pilita Clark points to a study of by Professor Klaus Möller of Switzerland’s University of St Gallen which refutes this conventional wisdom,

Professor Klaus Möller of Switzerland’s University of St Gallen co-authored a study of salespeople at the Lichtenstein-based Hilti group, a family-owned company that sells construction products and services in 120 countries and wanted advice on reforming its pay-for-performance schemes. In early 2019, 190 Hilti salespeople in eastern Europe were switched from a salary that was 65 per cent fixed and 35 per cent dependent on meeting performance targets to an almost entirely fixed salary. (Small, non-monetary rewards such as family dinner vouchers were paid to teams that won internal company competitions for their performance.) The results were impressive: the country group outperformed the market by a factor of 1.4 in 2019, double the rate of 2018. Staff turnover fell by more than 4 per cent and satisfaction with pay rose by 19 per cent, double the company-wide increase. Crucially, sales efforts did not drop off... Hilti teams in other countries have adopted similar systems...

In many countries, bonuses first emerged in factories during the previous century to spur people doing simple, repetitive tasks to work faster and harder. It was relatively easy to judge how many widgets an individual worker produced each day, and pay a bonus accordingly. Today, more office workers collaborate in teams on complex tasks requiring co-operation and creativity. That makes it harder to judge exactly who is hurting or helping performance, yet bonuses have persisted.

Clark also refers to another study done by a big German retail chain which wanted to know if an attendance bonus would reduce absenteeism, 

A study was duly done of apprentice employees in 232 stores who were offered either extra money or more vacation days if they came to work as planned each month. Alas, the time-off bonus had no effect on absenteeism and the cash incentive made it worse: absenteeism surged by about 45 per cent, the equivalent of more than five extra days of absence a year per worker... It turned out that paying people to turn up to work sent unintended signals. Some staff thought it meant bunking off was rife — otherwise why would the company be paying for attendance? So they felt less guilty about being absent themselves. Others thought it showed the work they were being asked to do was unpleasant and underpaid, so they stayed home too.

5.  The application by Finland and Sweden to enter NATO is truly a landmark turn. To put it in perspective,

Sweden and Finland judged neutrality to be in their interests when faced by the Soviet threat, and in the Swedish case for centuries before that. They did not alter course, although they did join the European Union, in the more than three decades since the Cold War’s end. The shift in sentiment in the two countries in the past several months has been dramatic, one measure of how Mr. Putin’s determination to push NATO back and weaken support for it has produced the opposite effect — the rebirth of an alliance that had been casting around for a generation for a convincing reason to exist. Where no more than a quarter of the population in Sweden and Finland supported joining NATO last year, that number has risen sharply today — hitting 76 percent in a recent poll in Finland. Sweden’s governing Social Democratic Party, the country’s largest party and long a bastion of nonalignment, has embraced NATO membership in an extraordinary turnabout... Germany, a generally pacifist nation since it emerged from the rubble of 1945, has embarked on a massive investment in its armed forces, as well as an attempt to wean itself of dependence on energy from a Russia it had judged as, if not innocuous, at least a reliable business partner.

6. Here is the long list of businesses which have paused or exited from Russia. The latest are McDonalds and Renault. 

7. Jeff Bezos, like Elon Musk, appears to have lost it in this spat between him and the White House on the issue of rich not paying enough taxes. It's natural for the richest to take the cover of libertarian ideology to justify tax evasion. 

8. Shyam Saran reads the tea leaves from Chinese policy statements and speeches of top leaders and finds circumspection

The overall impression one gets from reading these speeches and their further elaborations is that China sees that the “changes unseen in a lifetime”, which had provided a strategic opportunity to advance China’s geopolitical influence, are shifting in a more adverse direction. China senses it is confronted with greater vulnerabilities even as the more positive factors appear to be losing steam. Its economy has slowed down and the persistence of its zero-Covid policy is leading to prolonged economic disruptions. The manner in which Russia has been crippled by economic and financial sanctions has heightened China’s vulnerability especially since its economy is far more integrated with the still West-dominated trade and financial systems. China may have declared victory too early. There are signs of a more cautious external posture going forward.

9.  From Business Standard on the carbon emissions from different energy sources

And the decline in storage costs

10. Kudumbashree self-help groups in Kerala should count as a genuine development success. It could be seen as the social counterpart to the political movement to decentralise governance. 

11. Sri Lanka becomes the first country in Asia-Pacific region after Pakistan in 1999 to undergo a hard default on its sovereign bonds.

12. A good summary of all the recessionary headwinds facing the world economy. 

13. Even as the world grapples with an inflationary spiral, Japan seems to be facing much calmer inflationary situation - while consumer prices rise 2.5% in April over the year earlier, core inflation was up just 0.8% from a year earlier. FT points to an interesting dynamic at work,

In the US and Europe, companies usually respond to a rise in raw material and commodity prices by transferring those costs to consumers. In Japan, however, businesses fear a public backlash if they raise prices, while workers — beaten down by decades of stagnant pay — do not demand the higher wages that would let them afford higher prices in the shops. If companies must pay more for imports but cannot increase their retail prices, they will suffer a squeeze on profits. They often react by seeking to cut wage costs, ultimately creating deflationary and not inflationary pressure. 

It points to other factors contributing to the muted inflation response,

First, a big chunk of the April inflation number reflected the disappearance from annual comparisons of cuts in mobile phone tariffs engineered by the then prime minister Yoshihide Suga last year. That means underlying inflation is less than the numbers suggest. Second, Japan’s economy has yet to recover to pre-pandemic levels, even though the country has never imposed the strict lockdowns carried out in other parts of the world. While there were fewer restrictions on economic activity, people have continued to take precautionary measures, even after most of the elderly were vaccinated against Covid-19. Japan is still closed to tourists. That has hit consumer spending hard. Third, while weakness in the yen used to provide a big stimulus to the Japanese economy, that effect is more muted than in the past. Big Japanese companies have relocated much of their supply chain to China. Demand for the capital goods Japan does still export has been heavily hit by the weakness of the Chinese economy.

14. From an FT long read about long distance truckers, this snippet about cross-border restrictions due to Brexit,

... requiring trucks going into the Republic of Ireland from the UK to present 700 pages of documents that take eight hours to prepare. Archie Norman, chair of Marks and Spencer, said this week: “Some of the descriptors, particularly of animal products, have to be written in Latin and in a certain typeface.” Every sandwich containing butter, he said, requires an EU vet certificate, which means employing 13 vets and budgeting for 30 per cent more driver time... The metaphor of supply “chains” makes the process sound orderly and smooth, but from the first this journey along them was more like an adventure through a wild ecosystem in which we were a prey, dashing between safe habitats such as lorry parks and filling stations, hunted by authorities, legislation and customs rules that sought to charge, delay or stop us.

15. Chinese economy, an April 2022 status check,

Retail sales down 11 per cent from a year earlier, against an expected decline of less than 7 per cent. Industrial production dropped 2.9 per cent. Manufacturing was particularly weak, with auto production falling 41 per cent. Export growth was 4 per cent, a screeching slowdown from 15 per cent growth in March. Real estate activity collapsed, with construction starts falling 44 (!) per cent

  

Social protection programs and impact on poverty

A recent article in the Economist pointed to success of Ethiopia's social safety net programs. It said that social safety net programs formed 1.5% of GDP in Sub-Saharan Africa. It writes,

Ethiopia’s rural scheme is widely regarded as a success. It has reduced rural poverty and helped the poor buy food during a severe drought in 2016 that might have led to famine.

Now this is deceptive. What do we mean reduced poverty? Does it mean that people's lives have undergone a significant change? I guess all this goes back to the artificial minimalistic thresholds that we have constructed around per capita incomes to define poverty levels. 

The World Bank defines Social Protection (SP) programs as consisting of social insurance (mainly public pension schemes covering old age and disability), social assistance (cash and in-kind transfers and workfare schemes, often targeted to the poor), and labor market programs (training, entrepreneurship support, unemployment benefits).

Martin Ravallion and Co explore the impact of social protection programs on the poorest, the floor level of incomes,

The bulk of the impact of SP in developing countries is due to public pensions, which lift the floor by $0.38 a day. This too is below the mean spending on such pensions, which is $0.67 per day. Social assistance on its own only raised the floor by $0.015 per day on average—merely 8% of the (already low) level of average spending on social assistance. The bulk of the impact of SP on the headcount index (5% points) is also due to contributory pensions. Social assistance on its own reduced the poverty rate by 2% points. Countries that spend more on social protection tend to have a higher floor. The correlation coefficient is 0.751. Mechanically, this relationship reflects both differing levels of SP spending and differing transfer efficiencies. Transfer efficiency in reaching the poorest varies greatly. We see that very few countries attain a value of FTE of unity or more. (Recall that this is the ratio of the gain in the floor due to SP to mean spending.) For the bulk of countries (87% of the sample), the gain to the poorest is less than mean SP spending. FTE tends to be better for social assistance on its own, for which the median value is 0.934, as compared to a median of 0.630 for all SP; 43% of countries have FTE for social assistance greater than unity. In addition to FTE, we measure the efficacy of SP in reaching the poorest 20%, giving our second measure of transfer efficiency, GTE. The two measures are correlated (r = 0.505), but certainly not perfectly; some countries are better than others at reaching the poorest people given their efficacy in reaching the poorest 20%. GTE is positively correlated with spending per capita (r = 0.656), but that is not true for FTE (r = -0.021). As countries spend more on social protection, a larger share of that spending tends to reach the poorest 20% but not the poorest.

Now the takeaways in English. We need to make the distinction between poverty alleviation (allows people to have three meals a day compared to two) and poverty eradication (allows people to have meat twice a week, or a more dignified human existence). SP programs in almost all the developing countries help address the former. It will keep people meaningfully above the biological poverty line. It does little, on their own, to help the poorest transition to any meaningfully higher income level. This is just stating the obvious - social safety nets are for poverty alleviation, and not elimination.

If this is the case, then how appropriate is to use indicators like increase in savings or increase in aggregate consumption to measure the impact of social assistance programs like cash transfers? A more relevant measure of impact would be just the change in food consumption - having enough to eat three meals against the typical one or two, or eating meat once a week, or something like those.

This is a bit like the debate about the role of women self-help group movement. It is often confused as an instrument of economic empowerment, when its more relevant utility may be as a tool of social empowerment. 

The false dawn of micro-pensions

There is a disturbing irony in encouraging poor people, who barely manage to make ends meet just for physical survival, to save for old-age and insure themselves against diseases. Self-financed micro-pensions and micro-insurance, aided by the allure of modern technologies, are a fad in international development and impact investing. It is flawed on both philosophical and financial considerations.

The fundamental assumption with micro-pensions is that it is both desirable and possible for informal workers (or poor and lower middle-class) to save money from their current income to finance their pensions. 

The desirability condition is, at best, a benign paternalistic concern of outsiders for the welfare of the poor and informal workers during their retirement. I will leave this at that. The possibility condition is contingent on another assumption. These people have the incomes to save long-term for their pensions, and it is human behavioural and cognitive failings that prevent them from doing so. 

This assumption flies against the near universal evidence on the difficulty impossibility of long-term financial savings (pensions or insurance) among the poor. Forget the poorest, even the typical rural and urban informal worker in a low income country lives a virtual hand-to-mouth existence, barely surviving from month to month on their meagre wages. 

India, for example, has a pension and health insurance scheme for all formal sector workers which requires mandatory deductions from worker’s salaries. The mandatory deductions amount to slightly above 30% of the worker’s salaries, including the employer contributions. This is actually counter-productive because it deprives the badly stretched worker off money he badly needs today to meet daily needs and forces him to borrow at much higher cost from local money lenders for those needs, thereby likely making him more indebted. While the logic of making this voluntary at least for workers with monthly wages below Rs 15000-20000 is clearly understood, its politics very challenging.  

It is also for this reason that almost all developed countries have either lower mandatory deductions or higher government contributions for low income workers. In fact, this was a major component of the acclaimed 2004 Hartz IV reforms of Germany, often claimed as the cornerstone of Germany’s recent economic success. In case of the poor, it is almost always completely public funded social safety nets that provide pensions and health insurance. 

It is ironical that international development entities promote self-financed pensions and insurance for the informal workers even though it is an idea that is not even considered for their arguably far better off (both in relative and absolute terms compared to others in their respective countries) counterparts in developed countries. 

How many countries have self-financed pension schemes for informal workers? Is there any country at all that has this creature of innovation? In fact, how many examples of micro-pension business is there in any developing country? Is there any self-financing (or non-subsidised by governments) micro-pension company which has say, 100,000 regularly paying informal worker subscribers? Is there any micro-pension company in any country which has been in existence for even 10 years? Do we have entrepreneurs offering micro-pensions to the legions of part-time or contractually (hourly-wages) employed workers (say, McDonalds and Walmart workers), who form a very big share of the labour force in the US? Do we have impact investors offering financing for such entrepreneurs? If not, why?

This is a bit like Lant Pritchett’s example of women in rural India asking him how the women Self Help Groups were in the US! 

Even if we set aside the philosophical objection, there is the question of its financial viability. In order to be sustainable, a micro-pensions entity has to overcome the following constraints.

1. The country should have deep enough long-term investment opportunities. Pension funds will have very strict and low regulatory limits on equity exposure and that too to highly rated ones too. But in low income countries the supply of such instruments which are not very risky and which can generate a significant return (to cover inflation, costs and returns) is likely to be limited.  

2. These micro-instrument agencies are unlikely to have the expertise to manage these funds internally in a manner as to generate the required returns, thereby necessitating outsourcing of funds management responsibilities to asset managers, with the attendant high management cost. This is a problem for even established microfinance NBFCs in mature markets like India. 

3. Since poor people are unlikely to be able to make certain in-payments for long periods (and in case of micro-pensions are also likely to withdraw money at the earliest opportunity), the entity offering such instruments may have to offer the product with flexible terms. This would seriously limit the flexibility of its investment options.

4. Minimise customer acquisition and retention costs, as well as ensure reasonable average savings inflows for each customer, and that too among the most financially vulnerable groups of people

5. Overcome the business longevity risk and remain a going concern for a long time, in the range of decades, a critical determinant for a business like insurance/pensions. It is also not for no reason that large legacy institutions are, for good or bad, the ones who have been successful with penetrating the insurance and pensions market in developing countries. Successful pension and insurance companies don’t suddenly emerge overnight and grow big. The entry barriers are very high. They have to piggyback on existing credible platforms. 

6. Finally, as discussed earlier, success of these instruments will have to overcome the large body of evidence on poor people being unable to accumulate large amounts in cash (as against physical assets like house, livestock, gold etc), even through small periodic cash savings, required to sustain a pension or insurance scheme. 

There are the following costs associated with these constraints and the final investment returns have to offset them

1. Cost of routine operations (acquiring, retaining pensioners etc)

2. Outsourced asset manager cost (even if done in-house, the costs can be prohibitive, in terms of attracting and retaining talent etc)

3. Costs due to uncertain inflows and outflows associated with the nature of customers 

4. Reasonable profits for the entity

5. Inflation – typically high in all low income countries

In a typical case, the first four alone will aggregate to 10-15% returns, if not more. Add in a 10% inflation rate, and we are looking upwards of 20-25% rate of return over a very long-term for this to be commercially viable as a micro-pension entity. Can we imagine the enormity of this challenge? How many such asset managers (or any kind, much less those dealing with low risk instruments/asset categories) are there in any developing country who can generate such returns? And all this out into the future? 

As an illustration of a micro-pension program, MicroSave has this nice illustration of the Abhaya Hastham program of the Government of Andhra Pradesh for women self-help group members, which pays out Rs 500-Rs 2200 per month (depending on the age of enrolment, and in today's nominal rupee) by saving Rs 1 per day (or Rs 365 per year). As the graphic below shows, when the program reached 4 million clients, it required very significant top-up by government required to make it sustainable. 

Whatever the wonders of technologies like digital money and blockchains, we cannot escape the bitter reality that poor people have hardly anything to save. It is a constraint which cannot be relaxed. I cannot imagine that we are helping the poor by making them cut back on their basic human necessities to save penurious amounts for their old age. And that too by asking them to trust a financial model which does not stand the test of even a cursory scrutiny. 

The micro-pensions fad is yet another example of the unfortunate digression away from serious  debates on important development challenges like, in this case, fiscally sustainable and incentive compatible social safety nets. 

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.”

Observations on the "Amma" canteens

Tamil Nadu has been a leader in pioneering populist policies. The latest example is the "Amma" canteens, which have apparently become a major hit with the residents of Chennai. So much so that the government has now announced expansion of the canteen to nine more cities, besides the offering of a greater variety of dishes. The 200 canteens are run by the Chennai Municipal Corporation by involving self help group (SHG) women in cooking, serving, and managing it, and currently supply breakfast and lunch. A few observations

1. Arguably its biggest contribution would be in freeing up time for women-folk in those households who eat at these canteens. A typical Indian woman spends a major share of her time in the kitchen,   preparing food for the family. Unwittingly, the "Amma" canteen may therefore have become a powerful gender empowerment intervention, especially if it sustains and expands as envisioned. Given the fact that women in most urban households work full-time, such canteens can have a potentially transformational impact in redressing the gender imbalance in a typical household.

2. While the low price are undoubtedly important, the success of these canteens cannot be exclusively attributed to it. The quality of food, the cleanliness of the canteen, and its operational effectiveness have all contributed to its success. This raises the question of why the market did not address the felt need. At a time when the retail chain business model has become pervasive, and affordable fast-food chains are among the largest business in many countries, it is surprising that this has not taken hold in India. By any logical reasoning, given the size of any Indian city market, a restaurant chain, which supplies clean and consistent quality food at affordable prices, and whose profitability is driven by volumes, should be an excellent commercial proposition. Now, the success of these canteens can be the trigger for private entrepreneurs to enter this market.

3. Now that the canteen is up and running successfully, it is important to look at its long-term management challenges. The problem with public systems is that while it may be do well in managing an on-going enterprise, it is less likely to be effective in responding to emergent dynamics. In particular, there are two risks. One, given the public financing of these canteens and the resultant incentive mis-alignment, there is the strong likelihood that the management systems will degenerate over time and the canteens will join the long list of public "white elephants". Two, for the same reasons, there will be less pressure to be responsive to changing market signals and being dynamic with its business model.

4. An effective strategy to address these twin problems would be to develop public private partnerships (PPPs). In fact, this offers an excellent example for a potentially successful PPP collaboration. The most ideal PPP would be to let these canteens become fully owned and operated by SHGs. The local governments should provide technical assistance in standardization, quality management, and expedite licenses and approvals. Since it is neither desirable nor practical for governments to support such canteens over a longer period of time and in large scale, such PPPs offer the best strategy for the Corporation to gradually disengage. If the Tamil Nadu government managed to achieve this, the "Amma" canteen will surely be held up as an excellent example of how public policy can  facilitate the development of a missing market.

Negative interest rate for microloans

This announcement by the Andhra Pradesh state government is certain to be another defining moment in the history of competitive populism in India, one that is certain to be emulated by atleast a few other states.

"The members of Self Help Groups in the Andhra Pradesh will get interest-free loans up to Rs 5 lakh from January 1... However, women would be eligible for interest waiver only if they ensure prompt repayment. As banks were now charging 14 per cent interest on loans to self help groups, the interest-free loans would cause a financial burden of Rs 1,400 crore on the State Government... To cater to the micro credit requirement, the government has set up a cooperative credit society under the name 'Stree Nidhi' with an initial corpus of Rs 1,054 crore."

Andhra Pradesh has an SHG bank linkage lending target of Rs 10000 Cr this year, nearly half the national target of Rs 22000 Cr. Of this Rs 10000 Cr, Rs 9000 Cr is in rural areas while the rest is for SHGs in urban areas. The state has 1.11 Cr women in SHGs.

Given the nearly 10% rate of inflation, the state government would actually be lending at minus 10% to these SHGs. It would form the most generous bank-lending program in scale anywhere (possibly anytime) in the world.

Incentivizing savings habit among the poor

The government of India have initiated a Total Financial Inclusion (TFI) program to ease formal institutional credit constraints and expand their ability to manage their finances more optimally. However, while the policies under implementation may achieve success with the former, the later remains a much more formidable challenge.

The prevailing set of policies, revolving around the TFI program and door-step banking through business correspondents, will deliver a savings bank account to every citizen. It is also being suggested that the Aadhaar number and Aadhaar-linked savings bank bank accounts could provide the ideal platform to implement the proposed cash transfer schemes to deliver subsidies. All these will still not address the ultimate objective of getting people to optimally utilize their savings bank account to manage their finances efficiently. The challenge will be all the more bigger in promotion of savings among those poor who are more acutely present-biased (or have greater self-control problems).

Promotion of savings habit among the poor has been an area of interesting research in recent years, driven mostly by trends and developments in behavioural economics. Economists like Sendhil Mullainathan have expanded on Richard Thaler's mental accounting framework to explain how people's subliminal predisposition to categorize and evaluate savings and spending decisions can be invoked to nudge people into managing their finances more optimally.

I had blogged earlier about the merits of a system which divides income into separate, end-use based mental accounts.

"It helps people manage their finances more effectively in two ways. One, people are inclined to save if they are aware of what they are saving for. For example, a "car account" is a strong nudge to get people to save for purchasing a car. Two, separation of expenditure heads with pre-defined allocations help in effective management of expenditures."

Based on the mental accounting framework, I have also blogged about the merits of use-directed multi-tier accounts to nudge people into saving for specific purposes.

In this context, the most recent research paper (pdf here) on incentivizing savings among the poor come from an experiment among the rotating savings and credit associations (ROSCAs) of Kenya by Pascaline Dupas and Jonathan Robinson. They provided members of 113 ROSCAs in Kenya with different household and ROSCA savings instruments (like individual lock and key boxes and ROSCA health pot) to save for health and other contingencies and found that it could "substantially increase investment in preventative health, reduce vulnerability to health shocks, and help people meet their savings goals".

They also found that providing people with a designated safe place to keep money was sufficient to overcome the common barriers to savings - transfers to other people and "unplanned expenditures" on temptation goods - through a mental accounting effect ("The money put into the box was seen by respondents as 'for savings' and was therefore less likely to be spent on luxuries or given away to others").

The find strong evidence that use-directed commitment savings products can be effective in promoting savings even among the more present-biased individuals. The ROSCA health pot was a commitment savings approach wherein a sub-group in a ROSCA could agree on a health product and provide additional contribution (over and above their ROSCA contribution), which could be redeemed each month to purchase the particular health product for one member at a time. They write about the present-biased members of the ROSCA,

"The enthusiasm that led them to sign up for the Health Pot tied their hands not only to spend the money a certain way, but also to continue to save on a regular basis (i.e., at each ROSCA meeting). This strong social commitment feature is the only one that enabled present-biased individuals in our sample to overcome their barriers to savings."

They point to an earlier study by the same authors from the same area in Kenya which found that providing simple bank accounts to wmone who run small vending businesses had substantial savings impact only on about 40% of them. They write,

"Since the bank accounts did not provide any form of earmarking or a strong commitment feature, their primary function was likely to provide a designated place to save. The present study suggests that more sophisticated devices that include stronger commitment features might be better suited for some of those individuals who did not use the simple savings account. For others, it appears that a less sophisticated but more easily accessible device such as a Safe Box would be better suited to save small sums on a regular basis."

The populist assualt on incentives - MFI loan defaults

I had blogged earlier about a study by Citigroup economists Willem H. Buiter and Ebrahim Rahbari where they identified factors that could affect future global economic growth. One of the more interesting factors pointed out was the dangers to growth genereated by "the populist assaults on the incentives to work, save and invest". Here is one such example.

Mint quotes Vijay Mahajan of Basix who claims that, thanks to the state-wide default on Microfinance Institution (MFI) loans by self-help groups (SHGs) in Andhra Pradesh, there could be "92 lakh households in Andhra Pradesh who are appearing on the defaulters list of the National Credit Bureau".

Even assuming an element of exaggeration in the figure, it is an extraordinary situation. As far as I can remember, this is the first truly big example of a full-scale debt default by a large section of population. Unlike the loan waivers, where governments decree to write-off loans, here is an example of borrowers deciding to collectively and unilaterally extinguish their debt obligations, without abrogating their loan contract with the MFIs.

First, there is the legal-technical issue of these defaulters, forming a major share of SHGs and women in Andhra Pradesh, losing their credit-worthiness in a single stroke. How would the banks classify or risk-weight future loans to this massive category of borrowers?

More importantly, the larger message that would have been internalized by these women and their communities is that their contractual obligations to their lenders is no longer sacrosanct. The hitherto entrenched belief among borrowers that their private debt will always have to be re-paid is now shaken (the loan waivers have long since shaken this belief on government debts).

Similarly, lenders, of all kinds (who lend to these people), will now be aware that the credit risk of their borrowers have suddenly spurted. Markets will price it accordingly, with higher rates and stronger conditions, which in turn will adversely affect access and hurt borrowers. Unfortunately, this moral hazard is not limited to just borrowers and lenders. It covers all forms of contracts, and this is an even bigger concern.

As standard economic theories have taught us, a market economy is underpinned by bonds of loyalty and trust which facilitates contracts that form the basis of most market-driven transactions. There are a number of studies which have shown that developing countries have weaker contract obligation and enforcement capital and they are binding constraints on economic growth in these economies. The MFI default would surely have diminished the already limited contract capital available in such societies.

In this context, governments need to ensure that their policy decisions do not distort incentives. In the instant case of MFI loan defaults in Andhra Pradesh, even if the government wanted to punish the MFIs, it would have been appropriate if it was done without distorting incentives.

One approach would have been to, in some form, recover the loans through the regular government SHG institutions, with or without interest. The recovered amounts could then have been returned back to the banks that financed the MFIs. This would have punished the MFIs, who would have been deprived off their profits and would suffer credibility loss, without distorting borrower incentives nor causing loss to the financial institutions that funded the MFIs.

Are SHGs a public good?

Over the past year or so, the micro-finance movement has been the subject of intense scrutiny, faced with charges of fraud and exploitation. In Bangladesh, the Grameen bank and its iconic founder Mohammed Yunus have been accused by the Government of accounting fraud and diverting money. In Andhra Pradesh, micro finance institutions (MFIs) have been found indulging in practices that exploit the poor.

I have already blogged and written about these allegations and will not dwell on them here. Suffice to say that there are critical procedural/administrative problems and more importantly, serious corporate governance issues with many MFIs. In the absence of meaningful steps to address them, there are strong headwinds against any sustainable progress for the MFI model.

However, there are two interesting macro-perspectives from this debate, especially in Andhra Pradesh, that deserve greater discussion.

1. There is the argument that the spectacular success of MFIs in Andhra Pradesh overlooks the role of the government in creating a million-strong Self Help Groups (SHGs) that the MFIs could readily use (a la "ready cooked food"). There is palpable resentment at the fact that the MFIs, who merely walked in and piggy-backed on the fruits of the state government's efforts of more than a decade to develop SHGs, are claiming and getting a disproportionate share of the credit for the success of micro-finance activities in Andhra Pradesh.

In fact, the officials of the state government have even gone on record to argue that MFIs should confine themselves to non-SHG lending, "They cannot make profit by lending to the poor. Let them lend to the rich and make profit and leave welfare of the poor to the Government."

Without getting into the merits of how the credit for the success of micro-finance should be apportioned, it may be useful to examine what should be respective roles of the government and private sector in such areas.

Clearly, there are two distinct activities - formation and strengthening of SHGs and micro-lending to these SHGs. The strength of the former determines the success with the latter. In other words, SHGs form the fixed social infrastructure on which micro-finance rides.

I am inclined to see striking parallels between SHGs and classic public goods. It is now well-documented that apart from being channel to funnel credit to the poor, SHGs also play a critical role in women's empowerment and is a platform for enhancing the effectiveness of government interventions in many areas. Therefore, the net social benefits of SHGs exceed its net private benefits to the agency forming such groups. Private agencies like MFIs will naturally have less of an incentive to invest time and resources in forming SHGs.

In the circumstances, as is the case with public goods, it may be appropriate if governments focus on the formation of SHGs and invite the private sector to play a greater role with micro-lending. This does not mean an exclusive role for each in their respective areas, but a major role. So the way forward may be for governments to focus on forming SHGs and strengthening them, and for private sector to partnering with governments in increasing the volume of micro-lending. And all this assumes that the governance and other problems related to MFIs are largely resolved.

2. The second issue is related to the respective roles of the government and the private sector in combating poverty. More specifically, the success of the MFIs (most conspicuously, the success of SKS with its IPO) has generated a strong feeling that MFIs are making super-normal profits by exploiting the poor. This in turn raises the issue of what should be ethical standard for private agencies working in the area of development, the so called social enterprises.

Is it alright for a private social enterprise firm, playing by the rules of the game (assuming that the rules are themselves fair), to make profits even as it delivers on certain social objectives (as being delivered through the regular government initiatives)? In this case, is it acceptable if MFIs follow the rules, make micro-loans, and in the process also make handsome profits? Or should their profits be capped at some level? Or should the cost of lending be brought down and thereby reduce the excessive profit margins? Or should a share of their huge profits be ploughed back into helping the poor in some other effective manner?

In other words, is it acceptable for a private social enterprise, functioning with its capitalist efficiency and playing by the letter and spirit of the rules of the game, to work towards the objective of maximizing its profits?

Regulating MFIs

Sriram and me have an article in this month's edition of Pragati that examines the issue of regulating micro finance institutions and its larger implications on the future of "social enterprises".

The last-mile gap with microfinance and the way ahead for MFIs

In a country full of paradoxes, it should have come as no surprise that one of India's most profitable business sectors is also one that claims to provide a platform to lift its millions out of grinding poverty.

After a brief lull, microfinance institutions are back in the news with a big bang. First came the spectacular $354 million IPO of SKS Microfinance followed by an ongoing debate about the ethical concerns with making profits out of poor people. Then came the acrimonious ouster of the CEO of SKS under mysterious circumstances.

Now, following a number of high-profile suicides allegedly driven by harassment from usurious micro-lenders and mounting opposition, the Andhra Pradesh (AP) government has cracked the whip on microlenders. An ordinance has been promulgated capping the interest rates charged by micro finance institutions (MFIs) and introducing stronger regulatory requirements. In AP alone the MFIs are estimated to have given loans worth Rs 3500 Cr so far this year, against Rs 2358 Cr given by government banks (against annual target of rs 7500 Cr).

On the face of it, there should not have been any competition between MFIs and government-financed SHGs, especially in AP. The SHGs financed by the government of AP receive considerable interest subsidy, leaving them to pay an interest of just 1% if the group maintains regularity in repayment for six months continuously. The linkage amounts too are large, Rs 75000 for the first linkage (given to groups after six months of satisfactory thrift activity), Rs 2-4 lakhs for the second linkage, and so on.

In contrast, the MFI groups recieve smaller amounts and at usurious annual interest rates of 24-60%. The repayment terms are much more onerous - weekly repayment (as opposed to monthly for government SHGs) and the threat of force and public humiliation for recoveries. Despite these obvious disadvantages and attractions of the other side, women groups prefer MFIs in large numbers. What are the last-mile gaps that force poor people into making such apparently irrational choices?

Unlike the bureaucracy-layered loans grudgingly given by the scheduled banks as part of their priority sector lending to government managed SHGs, MFI loans come with the red-carpet rolled-out. While the group members are forced into making multiple visits to bank branch, the MFIs offer loans at the door-step. And the paper-work and other procedural formalities are minimal with MFI micro-loans. The repayment procedures too are convenient. The always-available nature of these MFI loans as opposed to the still-distant nature of bank microloans, also ensures that they fulfill the critical timeliness requirements of poor people.

There are also the attractiveness conferred by way of lack of regulation and absence of standard due-diligence requirements. MFIs encourage formation of groups followed by immediate sanction of loans, whereas the government banks insist on six months of continuous thrift activity to become eligible for the first round of loan linkage. The same group can access loans from multiple MFIs, without any questions raised about repayment capabilities.

In simple economic terms, thanks to all the aforementioned last-mile deficiencies, the opportunity cost of accessing micro-loans offered by government banks is much larger than the cost of the MFI loans, even with their usurious interest rates.

My argument that follows is neither in favor nor against MFIs. On the one hand, there is ample evidence that most MFIs indulge in unhealthy business practices that ends up exploiting the very people whom it intends to help. It is by now widely-known that apart from the downright illegal strong-arm tactics to recover defaulting loans, they also employ unethical practices that conceals the true cost of loans from their unsuspecting borrowers.

On the other hand, it is undoubtedly true that MFIs are only the latest in the long-line of businesses that have seized the opportunity to exploit the massive profits that characterize virgin markets. The only difference being that unlike their predecessors, MFIs have been making their super-normal profits even as they maintain pretensions of helping the poor and complementing the efforts of the government in lifting people out of poverty.

In simple terms, it cannot be denied that the MFIs are merely exploiting an extra-ordinary business opportunity. However, it can be argued that they are free-riding on public externalities (tapping into the existing SHGs and the social capital and trained field personnel created by the government microfinance movement) to run an exceptionally lean and low-cost business model. In the purest capitalist language, any business enterprise which, notionally atleast, purports to play by the rules of the game, and generates a return on investment far in excess of 50% is arguably efficient.

It cannot also be overlooked that MFIs, like money lenders, play an important role in meeting credit requirements of the poor. In recent years, MFIs have proliferated in response to the realisation of huge un-met credit demand among the poor, arising partially from the government's own inability to provide universal access to formal credit mechanisms. In other words, MFIs are a form of the cliched "necessary evil".

The challenge now is to ensure that the MFIs contribute towards meeting the credit requirements of poor people, without compromising on the their undoubted capitalist efficiency and entreprenurial drive. In other words, how do we get MFIs to shed their predatory and unethical business practices and start to function like normal businesses? The instinctive answer to such questions is stringent regulation - interest rate caps, severe punishments and so on.

I am inclined towards a more nuanced position. While regulations are essential, it needs to be borne in mind that they can be successful only if the state has the capability and commitment to enforce them. As is the case with similar regulations on a host of other sectors and activities, neither pre-requisites are available. In the circumstances, regulations have to be supplemented with strategies that can re-align the profit-maximizing incentives of micro-lenders with achievement of the desired public-policy objective of expanding access to formal credit mechanisms.

One way to achieve this is to formulate the market for micro-loans in a manner that makes borrowers effectively sub-ordinated equity partners in the enterprise. Profits beyond a pre-defined bound, and after accounting for the regular shareholder dividends, could be ploughed back into the respective accounts of the borrowers as bonuses that effectively lowers the final interest rates. This would enable an efficient form of price-discovery on interest rates which reconciles both the commercial imperatives of the MFI and the reasonableness of the interest rate borne by the poor borrower.

Another approach would be to have a sliding scale for appropriating some of the super-normal profits. In simple terms, a graduated system of taxation can be introduced that internalizes some of the earlier mentioned public externalities that have been captured free by the MFIs. Governments could then reimburse this as an interest subsidy to the borrowing groups.

The administration of both these strategies could become dramatically simpler with the coming of UID and the introduction of UID-linked bank accounts. It also becomes easier to enforce regulatory requirements on capacity-related eligibility norms for groups, on the number of separate loans a group can hold, and other factors.

In conclusion, MFIs may or may not have succeeded in their ostensible mission as social enterprises. It may also be debatable as to whether their activities will be to the benefit and long-term good of their customers. However, it is undoubtedly true that they have enormously enriched their promoters.

Making financial inclusion morew effective

My Mint op-ed on designing financial instruments for the poor that take into account their spending patterns and cognitive biases is available here. The links for the article is available here.

Financial engineering for the poor

The last two decades have seen a proliferation of financial instruments that have had a dramatic impact on the global financial markets. While many of these instruments of financial engineering have played critical contributory roles to the current crisis, it cannot be denied that they have had considerable beneficial effects.

In the circumstances, it may be appropriate to borrow atleast some of the more obviously beneficial initiatives and instruments of financial engineering and use them to help the poor and lower middle class save more and efficiently and control their expenditures. Unlike the profit-driven nature of conventional financial market interventions, financial innovation for poor people should draw in on insights from behavioral psychology that point to numerous cognitive biases that forces them into sub-optimal spending and saving decisions.

Instead of providing inefficient direct assistance through revolving funds, interest subsidies and plain vanilla bank loans, it may be more effective to take a leaf out of behavioural economics and design instruments that incentivize savings, optimize consumption expenditures, and more effectively manage income flows for poor people.

In view of the large number of competing immediate consumption needs and their limited income, poor people experience very high opportunity costs on their savings. They also face self-control problems with managing their incomes and expenditures due to their dynamically inconsistent inter-temporal preferences. Recent research in behavioural economics have shown numerous examples of the aforementioned problems and offered suggestions on overcoming them.

In this context, in a classic paper, Shlomo Benartzi and Richard Thaler have advocated the use of instruments like "Save More Tomorrow", that commit savers in advance to allocate a portion of their future salary increases toward retirement savings.

In the present arrangement, the SHGs leave their thrift savings in the group savings bank account, which yields meager returns. Savings accounts, similar to the Corporate Liquid Term Deposit (CLTD) accounts offered to corporate clients, that automatically sweeps all the balances in the account into short term (say, money market) instruments and gives higher returns can optimize returns on their savings.

Apart from the issue of large numbers of competing needs, it is also commonly observed that a large share of the savings get dissipated in expenditures during festival seasons on "temptation goods". In order to overcome the self-control problem and disincentivize wasteful consumption expenditures, restrictions can be imposed on the periodicity and amounts (minimum balance requirements etc) that can be withdrawn at any time from an account.

Any exception to this should require an elaborate application process, including possibly multiple visits to the bank. Higher premiums (interest rate discounts or flat penalties) can be placed on withdrawls during a specific period, timed to coincide with, say festival season, or higher interest rate return for savings during that particular period ("festival offer" of higher rates for specified periods, complements nicely with the demand-supply dynamics, given that people tend to withdraw their savings in larger quantities during such times).

Savings instruments that combine features of a lottery (which are manifestly attractive for low income people) can be used to incentivize people to both save and keep their savings locked in for longer periods. Peter Tufano of HBS has designed premium savings bonds, that come with a lottery option, in which the buyer can particiapte only if he remains invested for a certain period of time. The Irish government has a unique form of tax and risk-free, state guaranteed savings instrument, Prize Bonds, offering people the chance to win big cash prizes in a weekly lottery.

There is also evidence to suggest that use-directed accounts, that are designed based on people's mental accounting choices, are effective at promoting savings. Accounts designed with pre-defined and use-directed escrows, can therefore be a very effective instrument in nudging people to both making savings for specific needs and limiting withdrawls from specific escrows. Further, sub-accounts like "education accounts" or "bike accounts" can be used to channel specific subsidies like student scholarships or even be linked up with commercial EMI based schemes for consumer durables.

Simple savings instruments that make annuity payments for children's educational purposes are effective means of chanelling savings for specific purposes. Besides, public policy can promote them by making matching or some pre-defined contributions to such accounts. The periodic (monthly/quarterly) contribution can be transferred by default from the savings bank account. Like Save More Tomorrow, the contributions can even be increased every year, in small increments, as a default option.

Appropriately customized (varying subsidies, depending on the size of house to be constructed), easy to access home loan products for the poor, can be designed and offered through private banks at varying commercial terms (tenor, rates and so on). The subsidies - direct cash, interest rate subsidy, etc - can be directly transferred into the account of the individuals.

Similarly, specific business investment products can funnel savings and government subsidies (like those under various self-employment schemes) to make capital investments in starting new or expanding existing businesses. Government support can be made conditional on achieving certain levels of savings, and can also be used to leverage further private bank loans.

In view of the volatile nature of inflation in developing countries, inflation-indexed savings products, especially those with longer tenor, can help mitigate inflation-induced erosion of the value of savings.

Agricultural income comes as harvest-time windfall inflows, which, given the self-control problems that afflict human beings, are liable to be inefficiently frittered away. It is therefore only appropriate that this one time inflow be converted into a stable revenue stream so that the farmers have access to an assured income every month. So how about a "harvest plan" annuity product offering by banks to attract these amounts as term deposits with gradual draw down? Such annuity plans can be offered to farmers groups, so that the banks can attract large deposits from the incomes of a group of farmers.

A share of these deposits can then be channeled into some of the various other savings products, including as default options. Payments on procurements by the FCI can be funneled into these accounts by default, including into a "fertilizer account", which can in turn be drawn down to make payments for fertilizer purchases for the next season. Such instruments can be used to make more efficient use of the proposed nutrient-based direct cash transfer fertilizer subsidy regime.

Or the subsidy can be given as dated vouchers which expire within specific period, timed to coincide with the mid-season, when application of fertilizers is most optimal.

Apart from promoting savings and containing excessive and even wasteful expenditures on "temptation goods" and immediate gratification, such financial instruments also help to more optimally and efficiently target beneficiaries with various direct and indirect subsidies. It also creates signalling platforms that simultaneously enables private companies to tap into the "fortunes at the bottom of the pyramid" and those consumers to access the products of this market.

Are MFIs and moneylenders complements?

Marginal Revolution draws attention to a WSJ article that appears to indicate an increase in traditional money lenders even in areas with heavy concentration of microfinance activity.

The RBI has reported that the number of registered traditional moneylenders increased 56% to 19,627 from 12,601 between 1995 and 2006. Another survey has estimated that the traditional moneylenders' share of total rural Indian household debt grew to 29.6% from 17.5% since the nineties when microfinance movement took-off.

Interestingly, WSJ sees moneylenders and microloans as complementing each other, in so far as SHG members may be drawing on moneylenders to help them keep their repayment deadlines and avoid the very powerful peer embarassment. The argue that since moneylenders may actually be helping SHG members repay their microloans in time, atleast some of the MFIs may have been bankrolled by moneylenders themselves. In this paradigm, moneylenders and MFI are some form of complementary services! Econ 101 defines two goods or services as complementary when they are bought and used together, the demand for one mirrors that for the other and vice-versa.

Speculating about the growth of moneylenders, as evidenced in the aforementioned figures, there are a few silver-linings -

1. It is possible that the proliferation of MFIs has forced moneylenders out into the open and made them register their activities. In other words, the growth of MFIs has generated a positive externality - competitive pressure on moneylenders to become more efficient (and thereby access formal sources of funding mechanisms) and transparent. Further, to the extent that older moneylenders are now getting themselves registered, the true numbers of newly enterant moneylenders may be exaggerated.

2. Even assuming that the numbers of moneylenders have been increasing, it may only underline the severe credit stress faced in rural India. One indication of this is the fact that official figures show the rate of banking credit and deposit growth as being much higher in villages than cities. A recent article in Businessline estimated the appetite for microfinance at about Rs 1.30-lakh crore a year, whereas microfinance disbursements were about Rs 28,000 crore in 2008-09.

In other words, thanks to the increasing penetration of economic growth into villages, the rural credit demand may be rising at a rate faster than what both the banks and MFIs are able to meet. And moneylenders may be only stepping in to fill in the vacuum. So we should be having more aggressive outreach of microfinance. It is also one of the most important arguements in favor of banking access and strategies like Total FInancial Inclusion (TFI).

Four problems with prevailing SHG model

That the existing Self Help Groups (SHGs) based micro-finance model has achieved remarkable successes is delivering both social and basic economic empowerment of women in many developing nations cannot be disputed. However, the prevailing model, especially in the government led micro-finance schemes, suffers from important limitations that come in the way of achieving goals that go beyond the modest initial objectives.

Here are four fundamental problems with the micro-finance based poverty eradication model of delivering development.

1. The rigidly structured (10-15 members and lack of flexibility with changing its composition and size) group account oriented micro-finance model does not have the required flexibility to accommodate the differential savings habits of members within the group. Since there is only one servicing account for the group, all the members generally save the same amount and equally share any benefits. Therefore, instead of need-based loan uptake, more often than not the loans are equally divided among the members and resultant sub-optimal utilization. This becomes critical, especially when the group has achieved a level of empowerment, and the differential credit needs of group memebers assumes importance.

2. In the absence of access to innovative and beneficial financial products, the SHG members may not be able to make the most efficient use of the inculcated savings habits and financial inclusion. In fact, currently the high opportunity cost (given the scarce income and multi-farious competing needs) thrift is being locked up in the low yielding savings bank account of the group. Unfortunately, even as the focus has been to get people to save and open bank accounts, important issues like the returns on their savings have been lost in the maze of priorities. Further, not enough attention has been paid towards leveraging the savings to minimize the risks associated with the universal and commonplace needs like health care and children's education.

3. The present arrangements also do not place the required premium on the vital forward and backward linkages like access to intermediates and capital goods, markets, and training required for making the most optimal use of the financing available for self-employment generation opportunities. It may be more appropriate if the financing, especially for starting new businesses or expanding existing ones, be bundled with all the required forward linkages.

4. It does not more explicitly acknowledge the reality that SHGs and microfinance are at best an entry-point activity that should be used to propel the group members into a higher growth trajectory. This would require that the groups leverage on the platform provided by the SHGs to access the formal institutions that support them and then its members get gradually equipped to chart out their fortunes independently. It needs to be acknowledged that while the strength of the group is an excellent platform to address the problems facing a group of poor people struggling to survive, it may not be the most efficient vehicle for addressing the challenges faced by those positioned to move up the economic ladder.

Single stop and SHGs

This post is in continuation to the issued raised here about the need to revise our paradigm on Self Help Groups (SHGs) and widen their scope of activities by interventions like this.

I had blogged earlier about the activities of pioneering NGO, SingleStop USA, a poverty fighting startup, which seeks to "connect the working poor in New York with government funds and services intended for them". SHGs and their federations, with the required training and other support from government, could emulate the role of SingleStop USA and provide such one stop services on various issues to both its own members and others requiring such services. Here are a few possible areas of such intervention

1. Assist in accessing various available government welfare benefits. It is well acknowledged that one of the main obstacles to the effective delivery of welfare services to the poorest is the lack of awareness about the myriad welfare programs and schemes among the target groups. These exchanges can become one-stop facilitation centers for poor people to access all the benefits they are eligible for. These centers can help map an individual with the various benefits he or she is eligible to avail, help them fill up the applications and then get the benefits sanctioned and released.

2. Help poor people in getting sanctions, clearances, payment releases, mistake rectifications, and even information from government departments. Such agencies can volunteer to liaison with government departments and help the poor applicants access services and resolve their grievances.

3. Provide assistance with backward and forward linkages for those SHG members who have availed loans for opening new business or expanding an existing one. These agencies can help procure raw materials and intermediate goods at cheaper rates by bundling together the requirements of large numbers of buyers. They can also play an important role in linking up with potential buyers elsewhere and thereby maximize the returns to the SHG member. They can also be assisted with trainings on accounting practices and other specific business needs.

4. Match poor citizens, especially those with medical problems and requiring resources for educational purposes of children, with prospective donors and agencies, government and non-government, willing to support them financially.

5. Provide information and even tie-up educational scholarships and cheap loans for students seeking admission to professional courses.

6. Can provide legal and financial counselling to low-income families, especially those affected by some recent turmoil. Legal advice is valuable to such people in view of the problems faced by them with evictions, land disputes, criminal charges on family members, and so on.

7. Counselling and assistance in helping people addicted to drugs and alcohol. Social workers can also give help on issues including domestic violence and problems at school.

8. Co-ordinate with job placement agencies (and local maistries) to match the unemployed with prospective employers. The agency can establish contact with all the local hiring agents and supply workers to them. They can also provide career counselling.

9. These single stop agencies can maintain a comprehensive database of all its customers and use the same for providing more effectively targeted services to its members.

An agency similar to SingleStop, and located within each federation of SHGs in a block or tehsil, would go a long way towards improving the effectiveness of welfare programs by both facilitating access and improving the delivery mechanisms. It will also help leverage the opportunities available elsewhere to help those in need.

SHG membership as a signalling mechanism

In the last two decades, Self Help Groups (SHGs) and the micro-finance movement have emerged as one of the most important, if not the dominant, platform for addressing the challenge of eradicating poverty in many developing countries. The penetration of SHGs have been especially strong in many parts of India. However, there is a growing danger that these SHGs are becoming an end in themselves, rather than be instruments in fighting the scourge of poverty. I have blogged about this in an earlier post here.

These groups which started out as a means of empowering and inculcating thrift among women continue to remain stuck with the same paradigm and objectives. At best, the existing sets of policies have helped these groups start and expand on small, livelihood-based business activity. However, even in the specific activity of accessing formal sources of financing (for various purposes), the SHGs have not gone beyond traditional bank-loan driven group borrowings.

This post will seek to make a case in favor of a signalling role for SHGs in helping their individual members (and not as a group) access the broad spectrum financing options in the market. I will flag off one dimension - accessing all available formal financial/financing markets - in which SHGs, especially those with adequate capacity, can be invaluable in spurring more macro-level economic activity.

Now, a large number of these groups have gathered substantial capacity to deliver on outcomes beyond those intially envisaged. With some assistance and a different set of policy tools, many of them are capable of leveraging their capacity and built-up strengths in moving up into a higher trajectory of growth. More specifically, those SHGs can enable the transition of the SHG and micro-finance movement from addressing poverty alleviation to promoting vibrant entrepreneurship and economic development.

One of the most important dimensions of the utility of SHGs is in their role as an effective signalling mechanism. The poorer borrowers suffer from an especially acute risk aversion among lenders arising from the greater probability of adverse selection. The peer-pressure driven compulsion among SHG members to repay bank loans has become an effective credit guarantee for banks in making group loans to the SHGs. A logical extension of this argument would be to use the same credit-worthiness signal arising from SHG membership (atleast in the case of the stronger groups) to leverage loans for individual group members.

This would enable individuals to use their group membership to access/draw individual loans from banks for specific productive investments like business expansion or starting new businesses, constructing homes, purchasing consumer durables and automobiles, loans for education and health care, and so on. Presently, individual group members who want to make these purchases or investments access credit through the group loans, and then use it to incur their expenditures, thereby causing considerable transaction costs and duplication of activities.

Further, group loans generally involve equal distribution of the loan amounts among all group members. However, within a group, different members have varying levels of credit thresholds. Members use these loans for different purposes, move along varying growth trajectories, and have non-uniform credit needs and repayment abilities. In the circumstances, it becomes likely that those members who are more enterprising and have higher credit appetite gets constrained (in access to more credit) by their laggard compatriots. All these only highlight the importance of enabling individuals to access loans at their terms.

Here are a few examples of how this would work. Retailers (or their partner financing institutions) selling consumer durables on EMI can lend directly to poor customers, without the standard collateral requirements, by banking on the implicit guarantee provided by the individual's group membership. Typically, in the rural areas and smaller towns, there are likely to be only a handful (even only two or three) of retailers in the local market selling consumer durables or automobiles. It is easier and more efficient for them to administer these EMI sales of consumer durables and automobiles to the small numbers of local customers.

Poor people, looking to construct their homes, face numerous problems in accessing home loans in the regular financial markets. Given the large demand for home loans and the massive government spending on providing housing to the poor, it is natural that it offers ample mutually beneficial opportunities for both banks and the poor customers. The regular government housing programs for the economically weaker sections can be dove-tailed with direct bank lending to individual members of good SHGs, either by government providing the interest subvention subsidy (soft loans to beneficiaries) directly to the bank or the individual leveraging bank loan to top up the government assistance and construct a larger house with an additional loan.

Similarly, individual members should be able to access education loans by leveraging their membership of the SHGs, especially for higher education in professional courses. Here too, the regular government interest subsidies can be transferred directly to banks, thereby minimizing transaction costs and effectively addressing the targeting problem.

By encouraging the banks to lend directly to individuals using the signalling platform of SHG membership, and then transferring the interest subsidy directly to these banks, the government can reduce the considerable transaction costs and other numerous distortions associated with government subsidies.

It is true that there is nothing that prevents bankers today from providing loans to credit worthy individuals who are members of SHGs. But a formal recognition of provision of individual loans to the members of SHGs with good track record on the back of an implicit (not explicit) guarantee as a component of priority sector lending of banks, would go a long way in boosting the demand for such loans. It would encourage bankers to lend and borrowers to access formal financial institutions to meet their financial requirements. Bankers do not bear much additional substantive risks. Afterall, loans provided to SHGs were done so without any collateral backing and have borne impressive returns till date.

In the absence of credible signalling mechanism about the credit-worthiness of these individuals, such transactions would not have materialized. The banks benefit by increasing their loan portfolio without a disproportionate increase in the risk assumed, while the poor consumer gains access to the formal sources of credit provisioning, and government becomes able to more effectively target and deliver its assistance. We have a clear Pareto improvement, brought about by the signal emanating from membership of a credit-worthy SHG.

In order to avoid any moral hazard arising from this, it may be prudent to limit such lending to only those groups which have availed of and repaid atleast one or two tranches of loans in the recent period. The lending should be done strictly only after a resolution has been passed by all the members of the group permitting the specific individual to access the loan. Further, such lending can start off with small loans and the credit limits can be progressively loosened, both among group members and specific individuals availing of the loans. Also, the initial rounds of such loans can be limited to specific categories of expenditures like purchases of consumer durables, automobiles, student education loans etc.

Questioning the SHG led micro-credit movement

Despite breaking into the arena of development public policy making atleast two decades back and assuming the role of being the premier anti-poverty instrument in countries like India, there have been very few detailed studies on the impact of Self Help Groups (SHGs) and micro-finance as a poverty eradication tool. All the while policy makers have been increasing their exposure to SHGs as the "magic pill" to deliver on the objective of poverty eradication. This does raise very valid questions about whether we are putting all our "development eggs" in the single "basket of SHGs"?

It is in this context that two recent studies raises interesting questions about the micro-finance driven model of poverty eradication that has become the touchstone for all such efforts in India. From a randomized trial in 104 slums of Hyderabad, Esther Duflo, Abhijit Banerjee and Co find mixed results on economic activity and no impact on social dimensions like measures of health, education, or women's decision-making. From a field experiment on credit expansion for microentrepreneurs in Manila, Dean Karlan and Jonathan Zinman find no evidence of improvements in the well-being of those accessing micro-loans, and also results that are diffuse, heterogeneous, and not directly on the targeted group.

Karlan and Zinman find several indirect effects or positive externalities from micro-loans. They find that targeted micro-entrepreneur households shrink by shedding un-productive workers form their businesses; use loan proceeds to invest in human capital of their children, rather than in capital specific to their businesses; and male entrepreneurs appeared to benefit more than female ones from mico-loans.

The study by Duflo, Banerjee and Co about the micro-finance to SHGs in Hyderabad flags off several interesting issues. They find that those households with high entrepreneurship propensity exhibit the most positive response to microloans, as they use the micro-loans to finance the fixed cost and revolving capital requirements of running a business. Micro-loans are found to increase their consumption/purchases of durables (or investments), either for their businesses or for their personal use. It is observed that micro-loans crowd-in investments in starting the business or expanding existing businesses and crowds-out spending on consumer non-durables and temptation goods (alcohol, betel leaves, tobacco, gambling, and food and tea outside home). Further, existing businesses report a large and significant increase in profits after the micro-laons were provided.

The study indicates limited or no effect of the opening of MFI branches on education, health or women's empowerment. This appears to overturn the conventional wisdom that self-help groups and microfinance activity has much greater utility as a tool of social than economic empowerment.

The purpose of this post is not so much to question the utility of SHGs and micro-finance as to examine the possible changes in approaches and methodologies required to make more effective use of these anti-poverty policy instruments. I will first list out some of the general issues relating to the role of SHGs and the present approach and policies surrounding their functioning and development.

1. What should be the most optimal size of groups? Why should it be 10, as is the case with the majority (if not all) SHGs in the country? Does not the otpimal size vary with the backgrounds of the groups - urban-rural, very poor-poor, literate-illiterate etc? What should be the size of federations? Vary the numbers of members in treatment groups to study this.

2. Are smaller groups more effective for economic empowerment through capital investments, while larger ones are better for social empowerment and consumption smoothing? Does this mean that groups should split as they gather capacity to ensure that the varying requirements of the different members of the group are more effectively addressed? In other words, after the second or third linkage, should the SHGs be split into smaller groups so as to enable the members to move forward at raising credit and expanding their businesses at their choice?

3. What should be the most optimal size of initial and subsequent loans? What should be the repayment tenor and schedule? How should loans be packaged? Should loans be use-directed or left to the discretion of the group? Should loans, especially for business investments, be supported with backward linkage support - business literacy, training, helping to source their capital equipments, marketing etc?

4. Women of which age group are more responsive for each category of loans? Does it not make greater sense to target business loans to women of a specific age group? What should be the most optimal age range of group members? Which age group is the most effective target group for SHG activity and bank linkages? Treatment groups to be divided along different ages and studied.

5. What is the impact of financial literacy, group capacity built, general adult literacy, business training etc on how the loans are utilized? How should different categories of loans be packaged, so as to optimize their cost and effectiveness for the group members? Is it more effective to package different categories of loans as loan plus one of these aforementioned linkages or support? In other words, should some categories of loans be disbursed only as a bundled product?

6. Would any other intervention involving increasing financial access, like opening of bank branches and starting of no-frills accounts have also produced the same impact as SHGs and microloans? What would be their respective impacts? Treatment-control studies on these would be instructive.

7. What is the impact of presence of MFIs on moneylenders? Do they lower their rates in view of the reduced demand for their funds? Do MFIs inculcate market discipline into moneylenders? What other positive externalities do the presence of MFIs exert? This assumes important given the fact that moneylenders perform (and will continue to do so for the foreseeable future) an important credit provisioning role in such societies and the challenge is not to eliminate or drive them out, but to discipline them into moderating their lending practices and terms.

8. What is the comparison of the loan-use break up on loans given by money lenders and MFIs? Did MFIs change the loan distribution profile by encouraging new business or business expansion loans?

9. Which economic, social, and religious groups are most and least responsive to loans? It is important to supplement with other anti-poverty measures for those groups of people who take to SHGs with the least effectiveness. In such cases, it would also be important to identify the deficiencies and the reasons for the relatively poor uptake by these people. What is the treatment impacts of loans for consumption, paying off debts, starting business, expanding old business, and purchasing consumer durables, on different categories (economic and social) of SHG members?

10. Should we not explore getting consumer durables retailers/financial institutions that sell their products in Equated Monthly Instalments (EMI) into lending directly to individual SHG members (who would other-wise take loan and purchase consumer goods)? If need be, the government can then directly transfer the interest subvention differential to the respective bank or financial institution. Is it not possible to nudge established financial institutions to provide individual loans for expanding established business by leveraging the credit worthiness provided by the individual's membership of a good SHG?

11. Should we not have a detailed database which tracks the uses to which different groups and its members have used their share of loans for and their impacts, so as to more efficiently tailor and direct the next round of loans? For example, if one member in a group was repeatedly using a large share of the loans for children's education, it may be useful to help the student linked up with a scholarship provider. The information on consumption loans can be used to provide assistance to access alternate smoothing strategies like insurance etc.

And here are a few questions on the aforementioned Hyderabad study involving the MFI Spandana

1. I cannot but help feel that Spandana, being a commercial MFI, showed selection-bias in identifying the areas it proposed to set up its branches. This is evident in the criteria it used to select the slums - "poor, but not the poorest of the poor", smaller habitations/bastis within the slums, home ownership by 80% of the groups members etc. Did these not provide an implicit guarantee and distort the selected group? SHGs in rural areas may not fit into this profile.

2. Did the comfort provided by home ownership, among 80% of group members, provide an implicit guarantee for Spandana? If this were the case, would the individual members have accessed institutional loans by mortgaging their title deeds (assuming they had title deeds, which they should have had in Hyderabad)?

3. Was the decision of new MFI entrants on where (which places) to enter influenced by the presence of Spandana groups? Did Spandana's presence have spill-over effects which may have created an upward bias on the outcomes of the other groups? What effect did these new entrants have on Spandana groups themselves? Since MFI activity was virtually absent, the impact of Sapndana's entry may have been different from if there was already strong MFI activity.

4. Was there no government SHG activity in these sample areas at the baseline of 2005? I am inclined to believe that there was, more so given the fairly strong network of SHG activity in Andhra Pradesh. Has this effect been controlled for?

5. The quality of such household surveys are suspect, especially given the type of information solicited - asset ownership, decision making issues, expenditures, borrowings, savings etc. The households, especially in urban areas, have been socialized by government surveys to under-report their assets and savings, over-report their expenditures etc.

6. Is the increase in business openings in the aftermath of entry of Spandana due to the MFI loans or due to the fact that a few members who initially accessed these loans set off an emulation effect on their neighbours to start businesses? In other words, did Spandana's work exhibit spill-over effects on those who otherwise may not have taken micro-loans and if they did take it, would have used it to for other purposes? Did the new addition, due to this bring in an attrition bias into the sample, by adding newer memebers into the possible group of beneficiaries?

7. However,the selection-bias inherent in the choosing of Hyderabad, with its urban and relatively empowered socio-economic context, may have masked the cause-effect relationship between microfinance activity and social empowerment. One explanation for the limited assessed impact on the social empowerment dimension may be attributed to the fact that social changes take much more time than the two years of the study to have any noticeable impact. I am also inclined to believe that the effects would have been much more marked in the rural areas.

All these aforementioned issues can (and should) be examined extensively using randomized control studies, so as to re-design policies on SHGs and micro-finance to make them more effective and deliver greater bang for the buck.

Update 1 (20/6/2010)

Abhijit Banerjee argues that "there is now recognition that poor people and small firms have very limited access to capital and risk diversification"; they "do start a lot of firms, but these firms seem intended to remain tiny"; "the poor are not particularly well-suited to be entrepreneurs: They neither have the risk bearing capacity nor the human capital"; "nor will anyone give them enough capital to really grow the businesses". He therefore suggests that the main source of dynamism has to be growth of medium to large firms, though "there is evidence showing that these firms are too rare and too small in developing countries".