The Reasons Microloans Won't Solve Poverty

Microfinance was everyone's feel-good anti-poverty program: it's a capitalist approach which funds individual initiative rather than relying on massive government giveaways. It captured the zeitgeist in that it encourages a form of peer-to-peer lending enabled by the internet. How cool.

But the data, so far, suggest little change in the recipients' lives. It is possible that there has not been enough time to see the changes wrought, but it may also be that the design and terms of the microfinance movement need to be adjusted to make it more effective, assuming that improving lives, not ideological purity,  is the intended outcome. JL

Ben Casselman reports in 538:

Microlending programs had little to no effect on participants’ income or financial well-being. Studies find no evidence that borrowers are, on average, hurt by the loans. But they don’t appear to be helped much. None of the studies found statistically significant increases in household income or spending. Four of the six found no change in food consumption.
When Benita Chikaluma’s husband died in 1994, her family could easily have fallen into desperate poverty. Chikaluma lives in Malawi, a poor country in southern Africa where women often have little control over their finances. But thanks to the tiniest of loans — just $25 — she was able to build a business, first selling firewood and then empty plastic bottles, and now owns a home with running water and electricity.
Chikaluma’s story was told in a recent fundraising letter from FINCA, a nonprofit organization that makes small loans to people, primarily women, in developing countries. An accompanying brochure quoted Natalie Portman, Bono and Hillary Clinton praising FINCA’s approach, which the organization called “a proven solution, not temporary relief.” And it cited Jonathan Morduch, a respected New York University economist, calling small loans “one of the most promising and cost-effective tools in the fight against global poverty.”

What the mailing didn’t mention was that Morduch’s quote was from 2005, before a decade of research called into question the effectiveness of so-called microcredit as a tool for fighting poverty. More recently, a series of six independently conducted randomized controlled trials found that a variety of microlending programs had little to no effect on participants’ income or financial well-being. Morduch now says that the studies, along with earlier research that reached similar conclusions, suggest that the impacts of microcredit have been, at a minimum, “overhyped.” (A FINCA spokesman said Morduch’s quotation would be removed from future mailings.)
Researchers say the recent studies carry a broader message about the need for rigorous research in charitable programs. Microcredit has grown into a $60-billion-plus industry reaching 200 million borrowers worldwide despite limited evidence that it actually achieves its goals. Anecdotes like Chikaluma’s are powerful, they say, but only data can reveal what programs work and, just as importantly, how to make them more effective.
The idea behind microcredit is compelling in its simplicity: In many parts of the world, the best pathway out of poverty is entrepreneurship — selling firewood or food or clothing. But the poor often can’t cobble together even the few dollars necessary to get such businesses off the ground. By giving people access to small loans — often in the hundreds of dollars or even less — microcredit organizations allow would-be entrepreneurs to buy, for example, chickens to produce eggs or a refrigerator to keep food cold. And because the help comes in the form of a loan, not a grant, a single dollar of aid can be recycled to help many people.
Microcredit rose to prominence in the 1990s thanks to the success of the Grameen Bank, a Bangladeshi community development bank founded by economist and social entrepreneur Muhammad Yunus. In 2006, Yunus and the bank were jointly awarded the Nobel Peace Prize “for their efforts to create economic and social development from below.” By then, the model had spread to dozens of countries on six continents; supporters hailed microcredit as a key step in achieving Yunus’s vision of “a world without poverty.”
But even as microcredit drew attention, there was relatively little evidence that it succeeded in reducing poverty. Some critics even claimed the opposite: that microcredit left the poor worse off by saddling them with debt. News reports went so far as to link suicides in India to the stress of struggling to pay back microloans.
The recent research rejects both extremes. The studies find no evidence that borrowers are, on average, hurt by the loans. But they don’t appear to be helped much either. In a paper introducing the six randomized studies, economists Abhijit Banerjee, Dean Karlan and Jonathan Zinman walked through the findings: None of the six studies found statistically significant increases in household income or spending. Four of the six found no change in food consumption; one found a modest increase and the sixth found a significant decrease.
Some of the studies did find ancillary benefits. Borrowers got more of their income from their businesses, suggesting that they displaced other sources of income such as wages or government benefits. Those businesses also appear to have become more profitable. But the studies didn’t find any significant increases in school attendance or women’s empowerment in local communities, two commonly cited benefits of microcredit. The findings echoed those of earlier studies that also revealed minimal impacts.
“The takeaway is that there is not much of an effect,” said Esther Duflo, a Massachusetts Institute of Technology economist who was a co-author of one of the studies. “It doesn’t lead to the massive transformation in their quality of life. That’s not to mean that it’s useless, certainly not to mean that it’s hurtful … [but] it’s not the life-changing tool that it was presented to be.”
Researchers offer several possible explanations for microcredit’s apparent failure. Perhaps the most optimistic is that the “microfinance revolution,” as it is often called, has already taken place. Tens or even hundreds of millions of poor people worldwide have gained access to credit. Now, both for-profit and nonprofit lenders are pushing into places and reaching out to populations that they initially avoided and that may be less well suited to borrowing. Perhaps if randomized trials had been conducted in the 1980s or 1990s, they would have found larger impacts.
Another possibility, which is supported by more evidence, is that many borrowers don’t use the loans to start or expand businesses but rather to cover basic expenses or make home repairs. Loans might help such borrowers in the short term, but they aren’t likely to change their lives in the longer run. Other types of aid — perhaps “microsavings” programs that help poor people build wealth, or direct grants that don’t have to be repaid — might be better suited to helping these people meet their needs.
A third — and not mutually exclusive — possibility is that traditional microloans aren’t well designed for many borrowers. For example, in most cases, borrowers are expected to begin making payments on their loans almost immediately, as is standard in a normal business loan in developed countries. But that isn’t realistic for borrowers in many impoverished countries, whose income may be erratic.
But some microcredit leaders reject the studies’ findings outright. Rupert Scofield, who runs FINCA, one of the largest and most prominent microlenders, said randomized controlled trials work well in medicine but don’t make sense in evaluating development aid. He said that for years, his response to claims like Duflo’s was to say he didn’t need data when he could see the effect firsthand.
“I would just say dismissively to them, ‘I don’t have time for that,’” Scofield said. “It’s perfectly obvious what our impact is … I don’t need proof. As long as the clients are coming to us, that’s all I need to know.”
FINCA has now developed its own measure of success, a step Scofield now says he wishes he had taken earlier. But he said he already knows that the outside researchers’ findings are flawed. “The fact that they would reach these conclusions that I personally know to be false really discredits them in my eyes,” Scofield said.
Karlan, a Yale economist, said Scofield shouldn’t see researchers as the enemy. One of the benefits of rigorous research, Karlan said, is that it not only can reveal what isn’t working but also can point the way toward what might. Early in his career, before getting his Ph.D., Karlan worked for FINCA in El Salvador, and he said he wanted to know whether his work was having an effect.
“What I was most struck by when I was there was policy questions. What they were doing and why they were doing it one way versus another way of doing it,” Karlan said. “There was very little to read about what the impact of it was. There was no academic literature.”
Karlan went on to found Innovations for Poverty Action, a nonprofit organization that works with researchers to conduct studies that measure the impact of global anti-poverty programs. IPA is now working with organizations, including the microlender Kiva, to help them find ways to make their programs more effective.
“The goal here is to be more effective, and that does mean recognizing that not everything is going to work,” Karlan said. But he said IPA’s message is ultimately a hopeful one: “We try to be really clear that there are things that do work.”