have we misunderstood microcredit?

Have we misunderstood microcredit?

Esther Duflo

Santiago, March 19th 2015

The promise

• Instead of finding a job, the poor can start theirown businesses and make a good living

• Economies draw on a larger talent pool ofentrepreneurs

• Many new products and ideas get created—from the “bottom of the pyramid, for the bottomof the pyramid”

• All we need is an enabling environment—morefinancial inclusion in particular microcredit;and perhaps less regulation.

The temptation

• As countries struggle to create enoughjobs, this is a very tempting narrative

• Easy and “win”-”win”

Hilary Clinton

“Microcredit is a macro idea. This is a big idea, an ideawith vast potential. Whether we are talking about arural area in South Asia or an inner-city in the US,micro credit is an invaluable tool in alleviatingpoverty. Microcredit projects can create a ripple effect -not only in lifting individuals out of poverty andmoving mothers from welfare to work, but in creatingjobs, promoting businesses and building capital indepressed areas. Microcredit (...) has positiveconsequences on the entire community and creates afertile soil for democracy to grow because women andmen can hope in the future of the planet again.”

Today…

• What do we know about the businesses ofthe poor?

• What have we learnt from nearly twentyyears of experience of microcredit in thedeveloping world?

Lots of entrepreneurship among the poor

• Who is an entrepreneur?

• 12% of people in the OECD describethemselves as self-employed

• The corresponding fraction in the rest ofthe world is much higher.

Billions of Entrepreneurs…

How many households had at least one person self employed in agriculture?

How many households have at least one person self-employed in non-agricultural work?

How many poor households have at least one non-agricultural business?

Why is this surprising?

Credit constraints

The pain of bearing risk

Lack of Skills

Limited Connections

“Natural Entrepreneurs”

• Does this mean that these people arenatural entrepreneurs?

• That much more creative and dynamic

• What do we know about the businesses ofthe poor? Size

Type

Multiplicity

Durability/dynamism

Aspirations

How many paid employees do these businesses have?

How many total employees do these businesses have?

What percent of businesses own a vehicle?

What percent of businesses own some machines?

What businesses are these?

• In urban locations Petty retail of standard commodities

Food preparation

Tailoring, stitching

• In rural locations Livestock

• Very little diversity

Limited specialization

And they go in and out

• In Rural Andhra Pradesh, in a panel weconducted, of 100 households who have abusiness at baseline, only 32 still have oneat endline!

Why are these businesses so small?

• We once calculated that some of thesebusiness owners could double theircapital stock by not drinking tea for ayear Why don’t they?

• If credit is the problem thenmicrocredit should help

• Does it?

The evidence

• Is from six different countries

• The countries: Ethiopia, India, Mexico,Mongolia, Morocco, Bosnia

• The settings: Urban and Rural

• All from randomized control trials

• Similar programs, similar evaluationmethods

• Similar outcome variables reported inthe same way.

What do they find?

• Key results are surprisingly consistent across sites.

1. The majority don’t want a loan

2. Microfinance is associated with business expansion, but mainly for existing businesses (limited new business creation).

3. NO significant changes in household total income or consumption

4. Usually NO significant changes in self employment income for the average household, although some find increase in profits for pre-existing businesses.

5. Some increases in household durables.

6. Shift away from temptation goods, celebrations

Detailed Evidence from Hyderabad, India• 31% of the households run at least one small

business (vs. OECD average of 12%)

Of these, 9% of households run more than one business

• But these businesses had few…

Specialized skills (mostly general stores, tailors,

fruit/vegetable vendors)

Employees:

Only 10% have any employees; none has more than 3

Assets

20% use no productive assets whatsoever.

• Scale of businesses:

Sales: Rs 13,000 (~$325) per month

Profits: Rs 3,040 (~$75) per month

Why do you want a loan?

0% 5% 10% 15% 20% 25% 30%

health shock

crisis

education

ceremony

household durable

household consumption

capital for existing business

start business

repay old loan

Impact on investment

12.1

5.3

0

5

10

Business durables

138116

0

50

100

Durable PCE

**

Impact on poverty

1,457 1,419

0

500

1,000

PCE

What is going on?

• People use microcredit primarily to finance “lumpy” consumption

Refrigerators, televisions, marriages

• They pay for that by taking on extra work

Some new businesses

• Or by cutting back on other forms of consumption

• Expanding their business is not their objective

Households do not value their businesses

• Study in rural Karnataka (India).

• Infamous SKS: the organization that had the IPO that brought them so much money that it brought microfinance down

• The organization tried to impose an unpopular health insurance program with a fee of R500, rolled onto the loan: 22 pp (nearly one third) decline in participation in the

program, not offset by joining other MFI

Losing access to microfinance leads to a R20,000 loss in profits for entrepreneurs: 62% of control means.

How can people not want to pay Rs500 to avoid losing Rs20k?

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Why are they in business

• Lack of good jobs: Almost nobody grows therefore no one creates good jobs

• Flexibility

• “Idle” women

Reluctant v/s Natural entrepreneurs

• The results I showed for Hyderabad are the averagefor the population

• Very different results for those who started theirbusiness after getting the loan versus before

• The former substitute one set loans for another; thelatter want them all

• The former don’t buy much business durables; thelatter spend at the least value of the loan

• The former see no increases in profits; the latter see atleast 50% probably bigger increases

• More employees, greater wage bill etc. for the former;nothing for the latter

Long Run impact

• We surveyed these households again after they hadlost access to microcredit due to the crisis inAndhra Pradesh, 6 years after the initial loanswere given.

• Those with no pre-existing businesses: Are more likely to have a loan in original treatment slums

Have lost social network connections

Are no more likely to have a business or have a largerbusiness

• Those with pre-existing businesses

Large impact on profits, especially at the top

• This is explain by type, rather than by maturity

Implications for financial inclusion• Does not mean that financial inclusion is not

important for the average person:

Credit helps people all over the world acquiredurables and deal with lumpy expenditures

No different for the poor

But savings and insurance may be at least asimportant

Indeed credit might sometimes play the role ofsavings, at a very high costs.

We have no adequate savings products for the poorthat mimic what microcredit can do (forced deposit).Those exists for the rich

Implications for the entrepreneurial route

• Not for everyone

• 10% of the population? 5% per cent? Less? have real gift/taste for entrepreneurial activities

Potentially even less in OECD

• They need to grow more and create jobs for the rest

• For making this happen, conventional microcredit o not be the best instrument

Not selective

Too little

Not flexible

• We need financial innovations to go this route

The challenges

• How to identify the “good” entrepreneurs? Thedifference we see in the research between pre-existing and new entrepreneurs will not typically beavailable…

• The social shaming/group structure will not work aswell for larger loans, when defaulting will be moretempting. Repaying will also be harder if people donot invest the money. How will investment andrepayment discipline be enforced?