Many of us in the financial inclusion community were drawn to the field because of its potential to improve poor people's lives. Early advocates, including Muhammad Yunus, claimed that microfinance would help people get out of poverty, even seeing it as a silver bullet for eradicating poverty. Yet researchers in subsequent years, especially with the emergence of randomized controlled trials (RCTs), couldn’t verify these sky-high expectations. As a result, critics called microfinance a “delusion” and came to the verdict that “microfinance doesn’t work.” To make matters more complicated, different methodologies came to different conclusions, sparking a heated debate between microfinance proponents and opponents similar to the worm wars in the public health community around the same time.
Over the years, it has become apparent that the financial inclusion community did not have a very nuanced understanding of how access to and use of financial services actually led to poverty reduction, and over time we have become more measured in the way we discuss impact. With poverty reduction becoming an increasingly questionable goal, it seemed that a whole industry had lost its North Star. At the same time, financial services are used more widely than ever before in emerging markets. Without a clearer North Star, it is difficult to build a coherent narrative around what role financial services play in the lives of the poor. Tim Ogden makes a convincing case that we need to reset our expectations.
But what should be the new North Star?
CGAP has been giving this question a great deal of thought, particularly as we undertake an exhaustive impact literature review while trying to update a realistic theory of change for how we expect financial inclusion to impact poor people. We began the exercise by revisiting the fundamental questions of what poverty is, how it is measured and whether it is a realistic outcome for financial services.
Over the past 20 years, various attempts have been made to get to the core of what constitutes poverty and how it can be measured. In the past, poverty was mainly defined by income — either in absolute terms (less than $1.90 per day) or in relative terms (as a percentage of average household income). Today, it is generally accepted that poverty is more than just a lack of income. Multidimensional concepts of poverty, such as the Global Multidimensional Poverty Index, have helped to shift the focus from income to a broader set of indicators, including health, education and standard of living. However, there is still disagreement over which dimensions of poverty should be measured and how they should be weighted.
There are two very different views of poverty measurement worth exploring. Both are heavily influenced by Amartya Sen’s seminal work on poverty, as laid out in his book Development as Freedom (1999) and in the UN Development Reports of the 1990s and early 2000s. Sen emphasized both the multidimensionality of poverty and the importance of choice.
- The normative definition. The first approach is a normative concept of poverty linked to income and consumption. Increasingly, this definition includes other aspects of human development, such as access to basic services (e.g., energy, water or electricity) and proxy measures of human capability (e.g., educational attainment). This view has many benefits, as it allows us to compare poverty across countries. Yet, as the impact debate sparked by RCTs has demonstrated, it has limitations when it comes to measuring the impact of financial services. The value of using financial services seems to be difficult to capture through average effects, such as increased income or consumption, when a normative definition of poverty is used. People make different choices on how to use financial services, so the benefits can be dissipated and quite small on any one of the dimensions in the definition.
- The capability-based definition. The second definition builds on Sen’s focus on the concept of freedom, choice and capability. It defines poverty as the lack of individual freedom and says that development is about creating broader agency in people's lives that enhances their capabilities. It is intuitively appealing, particularly for financial services, which are tools to achieve people's preferences. Silvia Storchi and Susan Johnson in a 2016 paper examines the potential of Sen’s capability approach as an evaluative framework for the impact of financial services. Through this lens, financial services add value to people’s lives if they increase the range of options that allow people to pursue their well-being goals.
CGAP believes we need to advance work on both fronts. The capability-based definition is important for the longer-term objectives of financial inclusion. We need to better understand people's needs and values and how financial services enable them to live well according to those needs and values, instead of according to externally imposed ideas. To do this, we need to advance measurement tools to help us capture these individual impacts. Taken to its ultimate conclusion, Sen’s emphasis on choice might lead us back to where we started — customer demand is not such an outdated proxy for impact if that impact is defined as helping people reach what they value. Accessible, affordable and responsible financial services might be more important than ever in enabling poor people to make their own choices based on their needs, priorities and values instead of those of the international development community. We hope that one day development actors will put more emphasis on increasing poor people’s freedoms and choice and see it as sufficient reason to warrant public attention.
However, we recognize that that is not where development is today. A nuanced way of understanding impact will not meet the needs of an industry that is searching for direction nor donors who are looking to demonstrate contributions to the Sustainable Development Goals (SDGs) and must defend public funding for financial services alongside other development priorities. Using the capability-based definition will make measurement difficult, and the results may not aggregate sufficiently to build a higher narrative. For these stakeholders, more concrete evidence of how financial services support development outcomes like education, income, jobs and other global priorities must be available. Given these realities, the normative definition of poverty is more pragmatic. Standard measurement practices are already in place, and the concepts align with the SDGs. The challenge is with the evidence itself, which is mixed since the tools we have primarily feature average effects. Unbundling the heterogeneity of impacts — who benefits, when and why — emerges as an important priority.
Should we stick with poverty reduction as a North Star or explore other options? In the next post in this blog series, we’ll explore the alternatives before tackling this question.
This post is part of CGAP's "Evidence and Impact in Financial Inclusion: Taking Stock" blog series. The series explores recent efforts to synthesize evidence on the impact of financial inclusion and examines whether concepts like usage, financial health and poverty reduction capture the real impact of financial inclusion.