Wednesday, November 02, 2016

Microfinance - no silver bullet

You've probably heard the stories. A desperately poor woman in a poor country gets a tiny loan — a couple hundred dollars. It's the break she's always needed. With that money, she can finally buy the materials to start a small business. She turns a profit. Her income rises. Now she has money to expand her business even further, buy her kids more nutritious food, pay their school fees. Over time, she lifts her whole family out of poverty. That's the vision often associated with microloans in the popular imagination.

A sweeping assumption was quickly attached to microfinance in the public consciousness: If poor people — and again poor women in particular — could launch these small enterprises they could earn enough income to lift themselves out of poverty. It's certainly possible that plenty of women have successfully used microloans for a small business purpose. There were tales of women who had been held back by crushing circumstances but finally broke free from poverty traps. So great was the excitement over microfinancing's promise that in 2006 Mohammad Yunus was awarded the Nobel Peace Prize.

But based on the economic studies that have been done to date, it doesn't appear that increasing access to microloans is an effective strategy for helping more women start businesses that will allow them to vault themselves out of poverty, at least not on a large enough scale to be detected. The truth began to emerge with news reports starting to report on poor people who were selling off their last, meagre assets to repay loans.

Today it's hard to overstate how vast the microloan industry is: In 2015, an estimated 125 million people worldwide — about 80 percent of them women — were receiving a total of about $100 billion in microloans from the major microfinance institutions. The size of these loans varies widely, with an average low of about $200 in South Asia to nearly $3,000 in Eastern Europe and Central Asia.

Dean Karlan, a professor of economics at Yale University who co-authored several of the studies, explains that all those rosy before-and-after stories were essentially meaningless. That's because they failed to prove whether a successful borrower had succeeded as a result of the microloan or for some unrelated reason. So Karlan and various others decided to design rigorous field experiments that would properly test the effectiveness of microloans. Karlan notes that at the time the entire notion of applying scientific methods to studying efforts to alleviate poverty was new. "When we started this work there had been practically zero studies using RCTs [randomized controlled trials] to answer a question on any development topic." Since then, about a dozen randomized controlled trials of microloan programs in multiple countries have been conducted — including six that were summarized in this paper in the American Economic Journal: Applied Economics and a seventh also included in this less technical roundup of studies. In each case they compared a randomly selected group of people who had been offered the loans to an otherwise identical group that had not. The studies looked at programs serving mostly women in countries that included India, Mexico, Mongolia and the Philippines.

Across the board, the findings were damning: To be sure, in all but one of the studies, borrowers who owned businesses did use the loan at least in part to expand their business. And in two studies, ownership of businesses increased. But these expansions were modest and rarely translated into increased profits. Most disappointing of all, in none of the studies did the average microloan borrower end up significantly increasing income relative to the control group.

Abhijit Banerjee, an economist at MIT and another author of prominent studies of microfinance, says in theory these findings suggest that extremely poor people served by microloans are somehow inherently bad at business. But he notes that other studies have found that poor people can substantially boost their income if they're given a cash grant or a free asset — for example, some livestock — to use in a business. So Banerjee argues a better explanation could be that microloans have features that make them less suited to launching people into small business. Studies suggest one of these features is the stringent repayment structure of most microloans. You have to start paying back immediately, and there's often no option to delay even one payment. So it's hard to engage in trial-and-error tweaking of your business plan — the kind of experimentation that could help you come up with the most profitable way to run the business. With a classic microloan, says Banerjee, "You have to keep generating cash flow every week and that makes it really difficult."

Simone Schaner, an economist at Dartmouth University who has studied programs aimed at increasing women's participation in the workforce, says another explanation of microlending's limitations is that the whole idea of relying on microenterprise to lift people out of poverty is misguided.
"Entrepreneurship is a great avenue for some people in some contexts," she says. "But not everyone is best served by having their own small business…Microfinance is a victim of an unfortunate tendency in development, which is that everybody wants to find a silver bullet to solve poverty," she says. "And the fact is that poverty is this massive, incredibly difficult problem. There is no silver bullet."

Capitalism cannot solve poverty but socialism can.