Broader and deeper financial inclusion means that households have more financial management options. How does a household benefit from having more options?
There are many, many well-documented cases in which poor households invest their loans or savings or both in microenterprises that grow and yield enough profit to substantially increase the household’s income and consumption, sometimes even enough to rise above the national and international poverty lines. But these cases are a minority of the households that participate in microfinance. There are surprisingly few data on just how sizeable the minority is, but they are still a minority.
Benefits for enterprise development do not describe the full value of microfinance for the majority of poor households who participate. Yet participate they do – at least 150 million, maybe 200 million relatively poor households. What is in it for them? What in fact does microfinance reliably do for poor households? The answer provides the overall rationale for massive investment in the infrastructure and operations of microfinance.
In a recent post on The Evidence Project blog, I reviewed 12 reports of recent randomized trials and found that 10, maybe 11, offer solid evidence that people use microfinance to reduce their vulnerability; i.e., to manage the risk of consumption interruptions and financial shocks for their households. Enterprise investment can be seen as just one of a suite of tools that people use to reduce their vulnerability.
Unlike other risk management tools, investment in microenterprise can have the happy consequence of actually raising total household income, as well as smoothing income through the year as part of a diverse portfolio of revenue streams. However, as we know from at least two recent, excellent books, Portfolios of the Poor and Poor Economics, most households are not counting on this poverty-reduction effect of microenterprise investment; they just do business as one of several ways to keep the wolves of hunger and ill health at bay, to clothe and shelter themselves, and to have a little enjoyment in their lives, too. Call this poverty alleviation—reducing the uncertainties and stress of being poor. Not so many are using microfinance in a way that will raise them from the ranks of the poor—poverty reduction—because there just aren’t that many opportunities for thriving enterprise in the absence of robust local economic development.
What optimistic yet realistic theory of change can be crafted from this evidence? Consider this formulation (mostly drawn from page 93 of the year 2000 paper by Sebstad and Cohen):
People from poor households tap microfinance services to smooth consumption and build assets to protect against risks ahead of time and cope with shocks and economic stress events after they occur—leading to poverty alleviation.
This is also the narrative coming out of the financial diaries reviewed by Portfolios of the Poor and the research summarized in Poor Economics and Due Diligence. A new theory of change is emerging for microfinance. It is shaped not only by the results of research. More or less independently, perhaps in spite of that research, the microfinance industry has been adjusting in this direction toward supporting risk mitigation strategies of the poor as it has become more sensitive to client demand – by moving toward a mix of loan, saving and other services and greater flexibility and choice to accommodate the use of microfinance for supporting household resilience rather than focusing just on the needs of microentrepreneurs.
Many consider consumption smoothing, or even the resilience it reflects, a consolation prize at best in the quest to eliminate world poverty. But what could be more fundamental to poverty reduction than helping the poor make sure they have enough to eat and other basic necessities throughout the week, the month and the year? From that stable ground, the poor are in a much better position to seize whatever opportunities are provided by health and education services and a decent economy. Though financial services by themselves cannot provide these opportunities, they do seem quite capable of helping the poor provide the stable ground to stand and build upon. That is the significance of consumption-smoothing, risk mitigation and resilience in poor households.
Assuming more, confirming evidence will come soon from properly targeted research, we must pose this question to ourselves and the larger world we live in: Is this resilience-building benefit of financial inclusion enough to justify the massive investment of public and private funds in the infrastructure and operations of microfinance and related financial service providers? This question–and the underpinning research–prompt us to put financial services for the poor into proper perspective as part of the larger development narrative. The old narrative of the microentrepreneur who, by removing capital constraints, is enabled to grasp business opportunities and lift a whole family from poverty isn't wrong; it is just one way people use financial services.
--- The author is the former president of Freedom from Hunger and the editor of The Evidence Project.
Photo credit: Mohammad Ponir Hossain
Chris, this post is powerfully didactic and thank you for making a complex issue so easy to understand and contribute on.
YES, this resilience building benefit of financial inclusion deserves every penny available in investment. My confidence is based on the understanding of Abraham Maslow's Hierarchy of Needs model. Any change we want in poverty eradication will come after the bottom of Maslows pyramid is fully satisfied. That is if we want real grounded change. The bottom is the Biological and Physiological Needs which are food, drinks, shelter, warmth, sex among others. Until these needs are satisfied, the BOP will not get to the next level of Safety Needs some of which are protection, security, order and stability. The low income earners are seen as careless and carefree oblivious of health risks they pose to themselves, exposure to violence, poor sanitation etc. But, those only become important after and when they satisfy the basics in the first level. We worry why the poor don't appreciate insurance, forgeting that insurance is part of safety needs which come second after physiological needs. If you think about entreprise, and I really respect the genius insights of Monique Cohen and Sebstad, you realize it is about future security in income. That is on the Safety needs level. No wonder borrowers of microloans use it for consumption. Expecting them to spend it in expanding business is failing to understand Abraham Maslows needs model. Soon, under financial inclusion, you will see many providers of financial services coming up with exotic products meant for the poor, some of which will have self actualizing features. If they fail in them, they will wonder " what's wrong with the poor?" But I will ask, "what is wrong with you provider to introduce products higher than the expected level?"
It doesn't seem like long ago that we were fantasizing about poverty museums. Now we're acknowledging it's only a minority of clients that even net a positive yield on their microfinance loans. Naturally alternative strategies are required to justify our existence. Widening the goalposts from microcredit to financial inclusion, and singing the praises of income smoothening are obvious choices.
Income smoothening is a valuable service to the poor. But as with any service, the benefit has to be compared to the cost. For as long as interest rates exceed 100%, 200% in some cases, these erode the benefit. Car-washes offer a useful service, but it is amazing how one's opinion shifts when offered the service for $20 or $200.
Whether income smoothening is a consolation prize or not is debatable, but comparing the upside to the overall opportunity cost of establishing the massive microfinance sector is an excellent point. 80000Hours made this point succinctly:
"It costs Givewell’s top recommended microfinance charity, the Small Enterprise Foundation, $128 per client served. At $5 per [mosquito] net, this is enough to protect about 40 people from malaria."
I am no expert in malaria, but had we directed the entire microfinance budget to malaria, that's a LOT of mosquito nets - we could have had a profound impact on malaria. Or bought a lot of vaccines. Or built hundreds of additional schools. Instead we offered the consolation prize of income smoothening and achieved an overall impact on the average poverty level of the poor of “zero”, as David Roodman so eloquently and concisely summarised.
The argument is not whether or not microfinance works, but rather whether this is the best use of scarce funds. This depends on the goal. If we set out to improve the lives of the poor then perhaps avoiding malaria would be more effective than an over-priced credit card. But if we want to directly profit from the poor and perpetuate the sector that pays our salaries then mosquito nets are a poor strategy, and over-priced credit in the name of development is ingenious.
To reach the BOP people and really create a lasting improvement is extreamly difficult. Unfortunatly, at the same time, it is also very "sexy" to flirt with their problems and suggest that your organization has the power to actually do something positive. However, exposing the problems of the BOP brings in massive funding for many NGOs in the "Charity Market".
Many people have great "plans" and "smart ideas" how to help them, but most of these plans are beneficiary in the first place for the implementing NGOs.
Its difficult indeed, good intentions are not enough. What the BOP need more than "ideas" are simple marketable products that don't make their lives less misserable, but that can help them to make some money.
A good example is the introduction of indeed the "Money Maker", a simple foot operated waterpump that makes irrigation of crops nearby a water source more efficient. Within a year or so, the farmer has earned back his investment of some 50 US$ and starts to make a profit.
Indeed, health improvements don't have a high return on investment. At least, the business case is not that easy to explain. In Africa, the BOP people solve by tradition problems as they come. For them, it's the most economical way to survive.
How can we help the BOP most effectivly? Well, in the first place, they always need water of course, so water is an entry point. Obviously, their water supply must be maximal cheap AND reliable at the same time.
Therefore it's rather unrealistic, that still today, most NGOs provide water pumps to the BOP that cost a relative fortune to maintain AND are notorious unreliable as well.
These are urgent issues to solve. FairWater is one of the leading pressure groups in this discussion. The message is not always welcome, so it's often an uphill battle to defend the basic rights for low-cost & reliable water supply for the BOP.
No doubt, on the next World Water Day, many NGOs will flirt again with the BOP problems and raise funds for their programs. So far so good.
However, it remains to be seen if the BOP wil ever profit one single "sustainable drop" of water from these charities.
In our opinion, only a solid up-gradable public water supply concept like the "BlueZone", with reliable BluePumps, installed, supported & maintained by a professional private service provider, can profit from economics of scale to keep the cost of water low. We have already proved that it can be done. Now it's up to the NGO world to follow these first steps and make the BOP in Africa happy & Blue.