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The Myth of Microfinance? Why MFIs Shouldn’t Be Freaking Out (Yet)
November 13, 2009
By Jenny AkerThis is a joint post with Michael Clemens.
The headline in the Boston Globe on September 20, 2009 was catchy: “Billions of dollars and a Nobel Prize later, it looks like ‘microlending’ doesn’t actually do much to fight poverty.” The article referred to the findings of two recent impact evaluations in microfinance in India and the Philippines conducted by researchers at MIT and Yale, respectively. The studies, which were randomized controlled trials (RCTs) of microfinance interventions, found “weak and in some cases nonexistent effects” of microfinance on profits, expenditures and well-being. Privately and publicly, donors, MFIs and practitioners are expressing concern about the impact of these studies on the future of microfinance. Are they right to be worried?
Not yet. Let’s look at why we can’t (or shouldn’t) reject credit and savings programs for the poor based solely upon these studies.
- India and the Philippines are not Mali and Guatemala. It’s a simple concept, right? We know that India is quite distinct from the Philippines, which in turn is distinct from Africa and Latin America. The economists know this too. While RCTs have a high degree of internal validity – meaning that we can “trust” the findings – they have low degrees of external validity. In other words, the findings are valid for that particular country, area, program and context, but cannot be easily extrapolated. So unless your MFI is operating in the exact same way, using the same methodology and targeting the same client group as Spandana and First Macro Bank, we can’t use these studies (alone) to predict results in other countries. Does this mean we have to do a separate microfinance impact evaluation in every country? Certainly not. But it does mean that we need to look at a body of evidence across countries for similar products before we can start drawing conclusions. Our colleague, David Roodman, has discussed these studies and their strengths (and weaknesses) on his blog.
- Not all microfinance products are created equal. This seems self-evident, but it’s also often forgotten. One of us (Jenny Aker), is working on impact evaluations of cowpea and rice production in West Africa. Both of the projects facilitate farmers’ access to seeds, training and inputs. If we find that the projects don’t improve cowpea and rice yields, would we therefore conclude that all agriculture projects don’t work? Hopefully not. It’s the same with microfinance. Providing credit could technically be a “microfinance” program. But the devil is in the details. How much is the loan size? Does it target men or women? Are they individual or group liability loans? What can loans be used for? What are the interest rates? How long are the repayment periods? You get the idea. The two programs being evaluated in India and the Philippines are pretty different MF products. So while these studies provide some important insights into the impact of these specific products, they aren’t (and shouldn’t) be a general condemnation of all microfinance (yet).
- The potential benefits of credit take time. The effects of any credit program are dynamic in nature and quite diverse. Let’s skip the economic models and imagine a straightforward scenario: A MF client takes the loan and invests it in a microenterprise. The business does well, the client gets higher profits, and he/she spends part of that money repaying the loan and the other part on household expenses. Seems simple, right? But this pathway hides a lot of assumptions, and we can see the myriad of places where things might not go as planned. A client might, for example, use the loan to better manage her cash flow, whereas another might invest in durables. Even if we assume that everything follows our simplistic model, when would we expect to see benefits for the individual and the household? 6 months? 12 months? 2 years? Both of these studies rely upon a period of about 18 months – and in the case of Spandana, a single, 50-week loan. This time frame becomes increasingly complicated when we consider that many microfinance products start out with small loans, which might not allow clients to make huge changes to their businesses during the first cycle. So what happens to these clients 1-2 years from now?
- Size counts – but it’s relative. The Spandana evaluation found that microfinance did not have significant effects on health, education and women’s decision-making, but it did increase durable expenditures and profits for those households who already had a business. This might seem disappointing, but the results are theoretical unless we put it into context. In addition to asking, “Is there a positive impact?”, our evaluations should ask, “How do these benefits compare to the costs? And how does that cost-benefit ratio compare with other potential interventions for the poor?” If, for example, Spandana doesn’t provide a very large loan subsidy, then maybe (small) positive effects are sufficient to justify the costs. And if we compare the cost-benefit ratio for microfinance with other development interventions (agriculture, health and education), then maybe microfinance doesn’t look so bad (Of course, it could look worse). The point is, we need to compare the magnitude of the treatment effect with its costs, and to the costs and benefits of other poverty-reducing interventions.
- We’re on the same side. While we should applaud more recent rigorous impact evaluations of microfinance programs, it’s also important to recognize that some MFI practitioners were asking tough questions about microfinance long before these studies even started. In fact, some NGOs have shifted the emphasis away from pure microcredit towards microsavings, partly in response to these concerns. (Of course, whether microsavings becomes the “transformational panacea that lifts people out of poverty” is a separate issue, although there is a recent evaluation of microsavings in Kenya). Since both MFI practitioners and academics have raised questions about the “miracle” of microfinance, there is a unique opportunity to work together, review our current knowledge of the industry and discuss what this means for future interventions. But this also implies that any future microfinance or microsavings interventions should have built-in, iterative and custom-made evaluation mechanisms to guide the program as it evolves — using RCTs where feasible, and other rigorous evaluation methods when not (as Chris Blattman, Dani Rodrik and many others have argued).
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5 Responses to “The Myth of Microfinance? Why MFIs Shouldn’t Be Freaking Out (Yet)”
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November 14th, 2009 at 1:34 pm
Jenny and Michael,
I think this is a great list and I want to expand a bit on point 3 – “The potential benefits of credit take time.”
There seems to be a basic disagreement in the development community about what we want from microfinance. Do we want return on investment or contribution to growth?
These randomized trials are looking for social return on investment, i.e. how much poverty reduction do we get from a dollar spent on microfinance? Return on investment calculations are often used in business to help decide which project or company will be most productive in using next dollar of investment. As most investors or project managers will tell you, ROI calculations really have very little meaning beyond a ten year horizon because so much will have changed in the marketplace and many of the basic assumption that went into your initial calculations will have shifted.
The other (more difficult) way to evaluate microfinance is through its contributions to growth, or how it makes small changes to the basic equation that determines how fast an economy grows over the course of decades. The difference is subtle but I think its important for folks looking to judge MFI’s impact on poverty.
Here’s a very simplified example of the distinction between contribution to growth and ROI: If tomorrow you fell sick with some sort of infection, antibiotics could immediately save your life. That means that each dollar you sent on antibiotics would have a tremendously high return on investment. However, once you’d been cured, you’d go back to the same job you had before (if you’re lucky) and face the same income earning potential that you did before you fell sick. No one would be more inclined to give you a raise or a bonus because you invested in antibiotics. That means that the contribution to growth (from your perspective) is low.
By contrast, if you decided to go to get an MBA, you’d face years with high debt and relatively low earnings. Even when you get that MBA, it’s likely that you start a job very similar to the one you might have had without your MBA, making only sightly more then the recent college graduate next to you. In this way the return on investment to education is often very low. However, with that MBA in hand, the equation that underlies your career has changed. Each time you and the college graduate doing the same job are up for a promotion, you are more likely to get it thanks to your education. In any given year or facing any given promotion that advantage may seem small. But, it compounds over your 30-40 year career and really can change your lifetime earnings. That’s why we say that education has a tremendous contribution to growth.
As a rule of thumb, some of the most important contributors to growth look like a waste of money in the short term (because they are measured in ROI terms). But contributors to growth do something that many projects with high ROI can’t, they compound over time. A healthy economy will balance its investment in high ROI activities and activities that contribute strongly to growth.
So getting back to micro finance, in the wake of these randomized trials maybe the industry should stop looking at itself as a provider of great social ROI (even if it provides high rates of return on actual capital). If that is what the evidence suggests, then so be it. Instead, folks should ask the question: can we measure the subtle changes that the industry makes to the equation underlying the economic growth of poor communities? (That would make a very catchy slogan for a fundraiser, no?) Does the micro finance industry gently push poor communities toward higher growth over the course of decades?
Unfortunately for MFIs, these macroeconomic questions are very difficult questions to answer definitively. It may be that, in the short term, the best we can do to settle these questions is to make sure that we’re measuring the data we need to make solid conclusions years from now.
-Grant
November 15th, 2009 at 2:20 pm
Dear Jenny -
Thank you for this post. It would be interesting to learn which studies have had an impact on the decisions of practitioners, and not only the strategies of old-fashioned MFIs but also big banks, telecoms, and consumer businesses like SELCO or Walmart that use MF as part of a larger strategy.
My hunch is that RCTs to date have had very little influence on the world of practice. The studies are esoteric and very 1979 in terms of subject matter, and not founded on the discussions or even the literature of more influential works. Even the 2009 savings paper you post does not cite literature that was powerful in shaping Equity Bank’s own approach to MF right in Kenya. (The CEO was a student at Microsave’s training.)
In 2001, Microsave published the work of Graham AN Wright and Leonard Mutesesira, “The Relative Risks of The Savings of Poor People.” This was a profound piece, useful and influential. So too were works by Stuart Rutherford, particularly his financial diaries in Bangladesh and more recently, papers by Olga Morawczynski. Practitioners know these works are not necessarily perfect or generalizable but realize there are kernels of insight packed into them. The RCTs, the Spandana one in particular, are missing these insights.
To date, practitioners have built their work on the shoulders of writing by Marguerite Robinson, JD Von Pischke, Marty Chen, Parker Shipton, and Hans Dieter Seibel (and many others) writing in the 60, 70s, 80s, 90s, and 00s. These writers had a great deal of influence on the practice of microfinance.
Will RCTers have similar influence in the next generation of inclusive finance? What extra might you bring to the table that would enhance what anthropologists and observant practitioners already have documented and debated for forty years? At the moment, the focus of RCTs seems stuck in the microfinance of one, two, three, even four decades ago. RCTs need to get more hip to have an impact on today’s new, young, cutting edge practitioner.
November 15th, 2009 at 11:37 pm
A great post – thanks for laying the issues out so clearly.
November 16th, 2009 at 11:00 am
Social comments and analytics for this post…
This post was mentioned on Twitter by chrissiy: Jenny Aker weighs in on the MFI RCT debate: http://bit.ly/2PZ3F7…
November 18th, 2009 at 7:11 am
Drake Bennett’s article does a decent job at demolishing Dean Karlan’s supposed findings, but as a good journalist Bennett still headlines the bad news, however discredited.
The LOL clue is where Karlan says “Microcredit is not a … panacea.”
While we know that the essential source of long-term economic growth is adoption and advance of technology, diversifying financial services into micro levels is still a good thing. Fried chicken isn’t a panacea either, you know.