Does Microcredit Really Help Poor People?
Since microcredit first came to public attention in the 1980′s, the usual story line has been that it funds creation and expansion of microenterprises, producing additional income that lifts the borrowers’ households out of poverty. But is it true?
It has been clear for some years now that many–sometimes most–microborrowers in fact use their loan proceeds for non-business purposes. Recent analysis has cast doubt on some of the older research studies that found that microcredit increases household income. A new generation of more rigorous randomized studies is now in the works. The first two of them to be published have not found evidence that microcredit raised household income and consumption, at least over the 1-1.5 year term of the studies. Does this mean that microcredit might have been a bad idea all these years? I’ve just drafted a brief paper on this question. The paper should be available in a month or two, but in the meantime let me trot out its core arguments.
I think an honest appraisal of the current state of the evidence is that we simply do not know whether microcredit raises incomes and consumption. If the case for microfinance depended on whether it was lifting people out of poverty, then the appropriate response right now would probably be to declare a moratorium on support for microfinance until further research clarifies this question more.
I’ve worked in microfinance for over a quarter of a century, and I’ve always been agnostic about whether microcredit raises incomes. But I’m pretty sure that it does some other things that are very important to poor people, helping them to cope with poverty whether or not it helps them escape poverty. These other benefits are described compellingly in the brilliant new book Portfolios of the Poor by Daryl Collins et al., which gives a high-resolution picture of how low-income households actually use financial services, based on hundreds of 18-month-long financial diaries in three countries. Portfolios points out that the problem with being poor is not just that income is low, but also that it tends to be uneven and vulnerable to disruption. Given the variability and vulnerability of their income, poor households have to save and borrow constantly (more so than richer households) in order to put food on the table and meet other consumption needs. The informal credit and savings mechanisms they have tend to be unreliable. They value formal microfinance highly because it is more reliable, even if it is often less flexible than their other tools to manage their cash flow.
When we hear that microcredit may not lift people out of poverty, we tend to be disappointed, and regard consumption-smoothing as a “mere palliative.” But we react this way only because our own basic consumption needs are seldom if ever threatened. As Portfolios demonstrates, poor people see it very differently.
I think there is strong evidence that poor people find microcredit very valuable in helping to deal with their circumstances. When you offer microcredit in a new setting, you almost never have to advertise: customers come out of the woodwork in droves. Most of them come back for additional loans. Most important, they usually repay those loans at extremely high rates year after year, when the main motive to repay is not collateral or group pressure, but rather their desire to keep future access to a service they find very helpful. They are voting with their feet.
But does microcredit hurt a lot of poor people by over-indebting them? We need more work on this question, but I think the general answer is very probably no. When a lender is over-indebting a lot of borrowers in a bad situation, sooner or later it will show up high default rates, just as it did in the current financial crisis. But the predominant pattern is that the vast majority of microborrowers repay at very high levels year after year (cf. my posting a couple of weeks ago on repayment rates).
When all is said and done, a year of microcredit probably doesn’t help poor people as much as a year of girls’ primary education (for instance). The value proposition of microcredit, and microfinance more generally, is that each “dose” costs far less. Education, health, and many other social services require large subsidies year after year. When microfinance is done right–and only when it’s done right–small one-time initial subsidies can generate service delivery to very large numbers of people year after year. Not only is no further subsidy needed, but microfinance providers can leverage their initial subsidies with very large multiples of commercial funds. This is not a pipe dream–it’s happening already in dozens, even hundreds, of cases all over the world. For instance, BancoSol in Bolivia represents a few million dollars of donor subsidies in the mid-1990s that have turned into $200 million of loan portfolio and services for 300,000 active savers and borrowers as of the end of 2008. Whether donors and other public funders now lose interest in microfinance is pretty much irrelevant to such MFIs.
For me, this is the strong value proposition of microfinance. The benefits of each dose may turn out to be more modest than some have claimed, but poor people really value those doses, and you can buy an awful lot of them with relatively little subsidy. We certainly need further research on the nature and extent of benefits of microfinance, but I think it’s a very good bet that the observed behavior of millions of microborrowers is telling us that those benefits more than justify the investment.