MICROCAPITAL STORY: The Economist Magazine Reviews Studies Of The Impact Of Microfinance By The Poverty Action Lab

A recent report in The Economist magazine reviews two papers which focus on the social impact of microfinance. The papers are “The Miracle of Microfinance? Evidence from a Randomised Evaluation” by Abhijit Banerjee, Esther Duflo, Rachel Glennerster and Cynthia Kinnan and published by CGAP (which has been covered in a previous Microcapital Paper Wrap-Up), and “Expanding Microenterprise Credit Access: Using Randomized Supply Decisions to Estimate the Impacts in Manila” by Dean Karlan and Jonathan Zinman and published by the Poverty Action Lab, a centre within the Economics Department of the Massachusetts Institute of Technology whose aim is to reduce poverty by ensuring that policy is based on scientific evidence.

The report in The Economist reiterates the point that whilst impact assessment is not a new priority in the microfinance sector, there remains few credible estimates of the extent to which microcredit actually reduces poverty. The author of the report in The Economist notes that this would not be a material issue if funding for microfinance were raised via the market (as an increasing proportion is). There would be little cause for concern if investors were satisfied with their returns. Despite increasing interest from private investors, the report notes that 53 percent of the USD 11.7 billion that was committed to the microfinance industry in 2008 still came at below-market rates from aid agencies, multilateral banks and other donors. Given that aid money could be applied to other priorities, and that the rationale for subsidising microcredit is its effectiveness as an anti-poverty tool, it is important for donors to know whether it has the stated effects.

The report reiterates the point that measuring the impact of microcredit is complicated by the fact that the “counterfactual” cannot be easily tested. The counterfactual, or the forecasted course of events that would have taken place in the absence of the research output assessed (i.e. the “without” scenario), is a crucial feature of any impact assessment. In other words, the question as to what would have happened to a person who borrowed from a microlender had he or she not taken up the microloan cannot be easily answered. Many early studies compared borrowers with non-borrowers. The author notes that if borrowers are in any case more entrepreneurial than those who do not borrow, such comparisons are likely to overstate the effect of microcredit.

Reference was made to a study which surveyed 1,800 families in rural Bangladesh and found that an impressive 62 percent of school-age sons of those who borrowed from Grameen Bank were in school, compared with 34 percent of the sons of non-borrowers. Proponents of microfinance insisted that this showed that microcredit helped increase school enrolment. But a comparison with people of similar backgrounds in villages without access to microcredit showed that the difference was because people who were already more likely to have children in school were also those who signed up for microcredit. Even comparisons between areas with and without microcredit may be misleading, because microlenders naturally choose to work in areas where their prospects of success are the greatest.

Researchers who authored the paper “The Miracle of Microfinance? Evidence from a Randomised Evaluation” worked with an Indian MFI to ensure that 52 randomly chosen slums in the city of Hyderabad were given access to microfinance, while 52 other slums, which were equally suitable and where the lender was also keen to expand, were denied it. This allowed the researchers to see clearly the effect of microcredit on an entire community. This study, claimed by the authors to be the first randomized evaluation on the effects of microfinance, arrived at the pessimistic conclusion that microfinance has only a small effect on the fortunes and almost no effect on the lifestyles of poor people after the opening of an MFI in their neighbourhood. The authors ultimately found that there is some difference, albeit not a major difference, in business profit and consumption patterns between households in treatment and comparison areas.

Dean Karlan of Yale University and Jonathan Zinman of Dartmouth College who co-authored the paper “Expanding Microenterprise Credit Access: Using Randomized Supply Decisions to Estimate the Impacts in Manila” carried out a similar exercise in the Philippines, this time at the level of the individual borrower. They tweaked the credit-scoring software of an MFI so that only a random subset of people with marginal credit histories were accepted as clients. These clients could then be compared with those who sought credit but were denied it.

Broadly, neither study found that microcredit reduced poverty. The study in the Philippines also measured the probability of being under the poverty line and the quality of food that people ate, and again found no effects.

The report in The Economist concluded that microcredit did have discernible positive effects. In India, people in the slums that had access to microcredit were more likely to cut down on things like tobacco and alcohol in favour of durable goods (particularly items such as pushcarts or cooking pans that are used heavily by traders and food-stall owners). One reason average consumption failed to increase may therefore be that more people were diverting some of their own income into starting or expanding their businesses. Microcredit may have enabled more people to overcome the barrier posed by start-up costs. The researchers also found that as many as one-third more businesses had opened in slums which had a microcredit branch. This may mean that even though there was no measurable impact on poverty during the study period, there may well be some over a longer time-frame as these businesses prosper.

The report on The Economist further adds that “the role of microcredit in allowing people to signal their creditworthiness is valuable, especially if their success makes banks more willing to lend them larger sums and leads to even more economic activity. By being willing to take a risk on entrepreneurial sorts who lack any other way to start a business, microcredit may help reduce poverty in the long run, even if its short-run effects are negligible”.

Impact assessment in the microfinance sector has been discussed on numerous occasions. Some prior information on impact assessment can be found in the ‘Additional Resouces’ section below.

Additional Resources:

MICROCAPITAL PAPER WRAP-UP: The Miracle of Microfinance? Evidence From a Randomized Evaluation, by Abhijit Banerjeey, Esther Duoz, Rachel Glennersterx, and Cynthia Kinnan

MICROCAPITAL STORY – Highlights From A Hanson Wade Conference On Microfinance Investments And Observations By Key Panelists From MFX Solutions, ACCION, OPIC, Deutsche Bank, Microfinance Transparency And Others

MICROCAPITAL STORY: ‘Microfinance most Cost-effective, Efficient way of Reducing Poverty’, interview of Sam Daley-Harris, Microcredit Summit Campaign Founder

PAPER WRAP-UP: Guidelines to Evaluate Social Performance by ACCION International by Rehka Reddy

NEWS WIRE: United States: Poverty Action Lab Study Indicates Microfinance “Comes Up Short”