We Need to be More Skeptical about Microcredits
Rising evidence points towards an inefficiency in how we tackle global poverty
Development economics is slowly gaining an amount of notoriety proportional to the importance of the topics it tackles. For evidence, we need not look further than this year’s Nobel Prize Awards. The 2019 Nobel Prize for Economics was won by Abhijit Banerjee, Esther Duflo and Michael Kremer, researchers whose lifetime work focuses on assessing the efficacy of global anti-poverty solutions. Two of them (Banerjee and Duflo) authored the groundbreaking pop science book Poor Economics, which synthesizes years of research on various hot topics in the field of international development.
Abhijit Banerjee and Esther Duflo, authors of Poor Economics
One tool they analyze is the provision of microcredits to low income individuals, a very popular discussion point in academia and a booming investment sector for privates. However, their conclusions contrast the hype surrounding microlending in general. They point to previously under-discussed pitfalls of the technique, as well as to an over-exaggeration of its benefits. Increasingly, evidence is arising that the once cornerstone policy for poverty alleviation is not as effective as we once thought.
To the non-initiated, microcredits are small, short-term loans given out to poor communities. The target demographic of microfinance institutions (or MFIs) are people who do not have enough capital to get a loan from a traditional bank (many of whom live on under $2 a day). The logic behind it is that with the money, borrowers will be able to start small businesses which will help them get out of poverty. This is supposedly beneficial not only for the individual entrepreneurs, but also for their community who benefits from an increase in goods, services, and job openings, as well as greater market efficiency from competition. This is why they have been heavily invested in during the past decade. Thus, the number of borrowers reached 221 million by 2013. While microloans are most popular in South Asian and Latin American communities, it is a misconception that they are only adopted in developing countries. In fact, Italy is currently planning on rolling out the provision of one million euros worth of microloans for women in order to help domestic abuse victims escape their relationships and rebuild their lives.
Rise in worldwide microcredit borrowing from 1997 to 2013
There is a lot to like about the idea of microcredits. Aside from what is outlined above, they present an opportunity to mitigate the impacts of gender inequality in developing countries. Globally, 81% of microcredit recipients are women. In India (one region where microloaning is widespread), women make up 90% of borrowers. This potentially helps with the defeminization of poverty by allowing individual women to have greater control of their finances. Additionally, lending is frequently organized and managed in groups, which helps both with compliance and building closer ties to one’s own community.
However, while all of these life-changing benefits look good on paper, reality tends to be less glamorous. The primary problem we encounter is the lack of available data. MFIs have been failing to keep a record of their operations, and so it is very hard to assess their efficiency. Due to the grassroots and innovative nature of their work, it is inherently harder to collect and standardize information about how microlending functions.
Furthermore, when we analyze the information that we have in the context of data on regional development, we see few measurable effects of microcredits (especially when it comes to the claimed societal benefits outlined above). Women did not seem to become more financially empowered in the household and there was no massive multiplier effect caused by competition. More alarmingly, a report assessing the efficiency of Spandana (one of the most profitable MFIs in the world) found that in one region the fraction of families who started a business in a fifteen month period jumped from 5% to just 7%. Not nothing, but clearly not proportional to the way microcredits were portrayed in the academic discourse at that point.
What is left to wonder is why? Why do poor families not start businesses even when they can borrow at low interest rates? In fact, the reason why microcredits might be less efficient than once thought may also be the reason why they are able to provide any societal benefits at all: very rigid terms and conditions – e.g. borrowers have very little choice about how much they can borrow or when/how much they have to repay per month. These standards are something MFI CEOs do not want to abandon because they ensure impressively low default rates on microloans (defaults are on average 7% in Latina America and only 4% in South Asia). Without them, the industry would likely turn into one of exploitation, which traps low income communities in cycles of lending that keep them impoverished – similar to what the payday loan industry is like in the US, for example. Additionally, the lack of flexibility decreases administrative costs, which ensure that the low interests provided are sustainable.
Indian women showing their microcredit cheques
While indispensable, rigid standards work to keep borrowers away from microcredit. This is why, even though MFIs are widely accessible, large amounts of poor families still borrow from other moneylenders and pay significantly higher interest rates for more control over their borrowing. Some are aware they will not be able to pay the loan back for some time; others need money for emergency expenses which do not generate capital (e.g. medical bills) and know MFIs will not finance them. Looking to the future, the challenge MFIs face is balancing expanding demand for their service with sacrificing the extent to which they increase welfare in the communities they work with.
It is vitally important to spend time critically assessing the efficacy of the solutions to global poverty we chose to invest in. The resources the international community has to work with have always been fewer than ideal, so distributing them to the methods that have the highest returns is crucial. The conclusion we reach by analysing the evidence about microcredits is not that they are not at all helpful for the poor. But rather, that we must reassess the merits of investing in the microlending industry realistically and critically, always confronting the narratives we create in our minds with what we know is happening on the ground. Microlending might not be the life-changing, revolutionary tool we once thought it was, but it surely is something that pragmatically makes people’s lives safer and more stable.
