What's the News: Making loans to small business owners in developing countries has quite the positive reputation. It has given people in poverty, especially women, a chance to bootstrap themselves up the economic ladder despite having marginal or no credit history and little work experience, as people have used the tiny loans to start businesses, purchase herds of animals, or invest in improvements to their shops or inventory. The Nobel Peace Prize was awarded to the economists who developed the practice in the 1970s at Bangladesh's Grameen Bank
. But does microcredit
really pay off? In a study published today in Science, economists have taken a rigorous look at it and concluded that in many or its modern implementations, it's not having the touted benefits. What's the Context:
The problem with studying the effects of microcredit is that there tend to be a lot of factors at play in addition to the money. Lenders might provide counseling to business owners---as part of a broader category of services called microfinance---or decide to give credit to only those they think most likely to succeed. This makes it hard to tell whether the money, all on its own, can have the positive effect that people generally observe: more successful businesses and happier businesspeople.
The distinction isn't just academic. While the earlier generation of microlenders were non-profits that tended to loan to collectives or cooperatives, 50% of microlenders now loan just to individuals, and 25% are for-profit businesses. They are acting more like traditional lenders, and their loans aren't cheap, with 10–100% annualized interest. Because microcredit continues to be praised as a development strategy, discerning whether such loans can have positive effects without the bells and whistles that sometimes accompany it is key.
How the Heck:
To get around this compounding effect, the economists randomly selected 1272 loan applicants who were approved to receive loans of $100–$500. All had received a "marginal" rating in a credit check---the usual category of individuals who receive such loans---with First Macro Bank, a lender near Manila that is typical of Filipino microlending operations, making 3-month loans with 60% annualized interest. But the researchers also randomly rejected some applicants, yielding a control group of 329 applicants.
Then, 11–22 months after the loans were made, the recipients and controls were surveyed. They found that in general, businesses that had received loans were not larger than those in the control group, nor had the owners seen a boost in well-being.
They also discovered that the money was often used to deal with unexpected expenses, almost as a kind of household insurance policy. Perhaps the right marketplace for microcredit is as insurance, rather than as capital for investing in business, they write.
The Future Holds: Microcredit is already established in the eyes of many, especially NGOs and the United Nations, as a route to development. But before pressing forward with this strategy, the researchers say, economists should undertake more rigorously controlled studies to suss out exactly what microcredit can accomplish, what situations yield the best results, and what's an unreasonable expectation. Reference: Dean Karlan, Jonathan Zinman. Microcredit in Theory and Practice: Using Randomized Credit Scoring for Impact Evaluation. Science, 10 June 2011: Vol. 332 no. 6035 pp. 1278-1284 DOI: 10.1126/science.1200138
Image credit: Tjook/flickr
