Microcredit Impact Revisited
A few years ago, a storm was raging in the microcredit world. Nobel laureate Muhammad Yunus, a pioneer of the idea behind giving small working capital loans to groups of mainly poor women based on social collateral, had promised that microcredit would end poverty and "put it in the museums." But in an influential 2010 study, a group of researchers who spearheaded the concept of randomized-controlled trials (RCTs) in development economics, found no evidence that microcredit was making poverty history. What followed was a heated debate about the impact of microcredit that occasionally flares up even today. Microcredit proponents and practitioners pointed to their experience and cited earlier research showing the benefits of microcredit. The RCT researchers dismissed that earlier work, mainly on methodological grounds.
While the technical arguments might seem arcane, the underlying question of the impact of a development intervention is an important one. This is particularly true when scarce philanthropic or tax-payer money is used to subsidize the initial stage of a market development. After all, the money could be used elsewhere. So, the development community decided to gather more evidence across a broader range of settings of financial access for the poor and compare it with the best understanding of economic thinking.
Some 20 RCTs later, a more nuanced picture has emerged, which supports broad financial inclusion efforts: mounting evidence shows that on the whole, access to financial intermediation helps poor families in developing countries improve their lives.
To better understand the impact of financial access for poor families in the developing world, it is important to realize that they live and work in the informal economy -- not by choice, but by necessity. Traditional economic thinking distinguishes between the objectives and needs of individual households and firms. Individuals are selling their labor in the market and strive to smooth consumption over the life-cycle. When people are young, they need to invest; at the prime of their earnings power, they save; and in old-age, they spend what they have saved. On aggregate, households are net savers. Firms, on the other hand, compete for investible funds to finance their operations and growth. On aggregate, firms are net users of savings. Financial markets are supposed to make the match between savers and users and to allocate capital towards the highest productive uses.
But for poor households in the informal economy, this distinction is not meaningful. In economic terms, they are consumption-smoothing households and capital-seeking small enterprises at the same time. They need a broad range of financial services -- and as the growing body of "financial diary literature" has shown, they use these services too. Without access to formal financial services, poor households have to rely on the age-old informal mechanisms such as the rotating savings club or the money-lender, which can be unreliable and very expensive.
A growing body of evidence suggests that access to formal credit helps poor families with their often subsistence-enterprise activities, but its impact on broader family welfare measures is less clear. Formal savings, on which there are fewer studies to date, seem to have a more unambiguously positive impact. It helps to manage cash flow spikes and to smooth consumption, but it also helps as a mechanism to accumulate working capital with more lasting household welfare improvements.
Insurance is another financial product that can help poor households mitigate risk and manage shocks. The impact studies on insurance to date have looked at agricultural insurance for smallholder farmers. Agricultural micro-insurance seems to have a strong impact on the underlying farming activity and household welfare. Studies showed that insurance made smallholder farmers switch to higher-yielding cash crops and use more land and inputs such as fertilizer. The resulting higher yields and income led to fewer missed meals and school days for their children. But these traditional insurance designs suffered from low uptake due to key barriers, such as lack of trust and liquidity constraints.
Increased evidence on the impact of financial services for the poor also includes intriguing examples of improvements to local economies. For example, Banco Azteca in Mexico in 2002 rolled out over 800 new low-cost branches overnight in conjunction with a retailer. Comparing the impact of these new branches on their communities with similar ones not covered by the roll-out, researchers found increased local economic activity and higher income in the roll-out locations.
Policymakers at the global and national level have increasingly embraced financial inclusion as an important soft infrastructure ingredient for social and economic progress. The G20 has made financial inclusion one pillar of its development agenda and some 50-plus countries have made explicit financial inclusion commitments. There is macroeconomic evidence to show that economies with deeper financial intermediation tend to grow faster and reduce income inequality. This explains why G20 leaders have made financial inclusion a global development priority. More recently, World Bank President Jim Kim has called for universal access to basic transaction services as a building block for economic development by 2020. The growing evidence clearly supports the underlying rationale for the efforts and aspiration of these policy makers. While the "does microfinance work" debate might continue between proponents and skeptics, the emerging bigger picture around impact is quite clear. We are seeing more and more examples of how appropriate financial services can help improve individual and household welfare and spur small enterprise activity. This broader look seems to answer the question of whether and how financial inclusion can improve the lives of the poor and will also help us to focus and sharpen our future market development efforts.
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