Chapter 6! Development as Proven Poverty Reduction

November 20, 2009

I have just posted a draft of chapter 6 (.doc and .pdf). [Update: comments from Nancy Birdsall and Eben Lazarus incorporated.] More than any other so far, this draft incorporates text from this “open book” blog, forging a richer link between the two media. By the same token, regular readers of this blog will find less new in the chapter.

The subject of the chapter is what we should conclude from the academic literature on the impacts of microfinance.

I posted a draft of chapter 7 back in September. So now I have done 1–7. As always, I welcome your comments.

Here’s the conclusion:

I draw two main lessons from this tour of the evidence. First, poor people are diverse, and so are the impacts of microcredit upon them. Thus, microcredit undoubtedly helps many people. A distinction that appears particularly important in the latest results is between entrepreneurs, who are a minority, and everyone else. More controversially, I conclude that there is no convincing evidence beyond the widespread impression that microcredit raises incomes on average. That Holy Grail, though many have sought it and many have thought if found, still eludes us. It is entirely possible that for a majority of microfinance users do not invest in microenterprises, but instead use the loans to smooth spending on necessities, as we saw in chapter 2. That would show up as lower spending (net of interest payments)—and getting to eat every day. So far, the randomized studies have not checked this possibility.

The ambiguity about average impact arises from an opaque mixture of four factors: 1) different people use microfinance different ways; 2) credit in particular must make some borrowers’ lives worse and leave others little changed, and those effects weigh into averages; 3) families, villages, and neighborhoods are complex webs of causal relationships, which are hard to disentangle from each other, except with RCTs; 4) average effects depend as much on the ability of microfinance institutions to select those most likely to use finance well as it does on the spectrum of potential effects on different kinds of borrowers.

These complexities no doubt obscure the real impact of microfinance; yet their significance should not be exaggerated. The benefit of cash lending in South Africa shines through in Karlan and Zinman’s data for not-so-poor people who hold jobs. Where the average benefits of microcredit for poorer people without much access to steady employment are as clear-cut, they too should shine through in RCTs. Until that happens, prudence calls for skepticism of any claims about the systematic transformative power of microfinance. And until researchers understand better how many are made worse off by microcredit, we cannot be sanguine about the ethics of the intervention. Suppose microcredit lifts 90 percent of borrowers just above the poverty line and consigns the rest to a spiral of indebtedness and destitution. Is that a reasonable trade-off, or a bargain with the devil?

All of which brings me back to my encounter with those women in the Choubra district of Cairo. Should I have told them they were making a mistake, risking their good names on an unproven intervention? Can 50 million microcredit borrowers around the world all be wrong? I think not. Absent strong evidence of harm, it would be the height of arrogance to question their judgment. On the other hand, absent strong evidence of benefit, it is reasonable for me to ask whether my taxes are well-spent subsidizing their credit.

Think of the paradox this way. In the last decade, the mobile phone has spread like wildfire in most poor nations, including the Democratic Republic of Congo (DRC), a vast and war-torn nation with shards of government. Few doubt that this is a good thing. Scarce are the skeptics who demand RCTs to prove that mobile telephony helps the poor. Clearly, interconnection adds new possibilities to life. And the triumphs of Grameen Phone in Bangladesh and Celtel in the heart of Africa are properly sources of national pride. By demonstrating corporate excellence in nations long seen as economic basket cases, they inspire imitators in other lines of business. Indeed, most of the countries that are today rich got that way thanks to just such business successes, repeated a thousand times over. But another Western import has also overspread the developing world: cigarettes. Few doubt that this is a bad thing. The scientific evidence on the dangers of smoking should trump any attempt to cast the global tobacco addiction as a welcome triumph for consumer autonomy of entrepreneurship. So is microfinance more like cell phones or cigarettes?

Cell phones, almost certainly. Though the dangers of debt are indisputable, researchers have produced no solid evidence that microcredit systematically does harm. Savings, insurance, and money transfers seem even more benign. But if microfinance is the monetary equivalent of the mobile phone, does it deserve permanent charitable support through grants, cheap loans, and unusually patient equity investment? To turn that around, should Mo Ibrahim win a Nobel Peace Prize for founding Celtel, as Yunus did for founding Grameen? Should Kiva.org broker airtime minutes as well as credit?

Unless or until randomized microfinance trials show strong benefits, the most convincing case that can be made for charitably supporting microfinance must rest on grounds less compelling than hard and evidence of impact—but also more honest. The next two chapters explore two major themes in this vein, both hinted at in the mobile phone metaphor: the extent to which financial services give poor people more options and agency, and the extent to which microfinance has contributed to the commercial fabric of nations.

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1. anuj Says:
   November 21st, 2009 at 1:22 am

   This is a no brainer. Any serious and honest practitioner in microfinance will tell this without hesitation. Here is another way to explain this. I don’t know who Bill Gates banked with when he started his Microsoft, but can that banker claim that it made Bill gates rich? Hmm… Bill Gates at least won’t agree if the banker were to make that claim. Could Bill gates have gone under and failed. Certainly. Every day, there are 99 failures for each ‘Bill gates’ success story. So… are the banks required? Hmm… Try living without them. In the modern capitalist world, financial transactions are a reality; like it or not. In tribal societies, barter worked very well, and when someone could not sustain, others chipped in. No longer is that the case in most societies / communities. But unfortunately, rules of the Banking industry are written such that it lures you to buy an umbrella in good weather and takes it away when it starts raining. No matter what the pundits of Market economy will tell us, Capital is risk averse in large measures around the world. And, when there are plenty of seekers at the top end of the pyramid, why venture to the bottom? If mainstream Banking industry had the solution, we would not have had the so called microfinance revolution (it is a misnomer, by the way).

   Here are some facts to consider. Most Banks in the developing countries (I would not know if this is also true otherwise) collect more capital from poorer communities (villages/ rural areas/ Slums) in the form of deposits than they lend. In many countries in Africa, this ratio can be as low as 40%. Many banks keep this money with govt. treasury, to make their money. What does that tell us? There is net capital outflow from poorer communities to those sections of the societies where ‘investment’ priorities are decided upon. In worse case scenario, a State in India, Credit to Deposit ratio is also as low as 35%! The reason is simple and does not require a great depth of research. Banks simply don’t consider ‘investment’ in and by those poor community members as ’safe’ and ‘paying’ enough. The microfinance story sounds more credible in Bangladesh because the formal banking industry simply does not have the outreach infrastructure (or mind-set) to reach the poor. It will be a great day when the main stream banking industry will wake and say – here are my 2 billion customers whom I need to serve and help them participate in increasingly ‘capitalist’ world; and in doing so, make money for myself as well. Even when that happens, will Banks be able to claim that they made poor people rich? Certainly not. What allows people, rich or poor, to explore and exploit opportunities in the market place, is access to capital, capabilities to interact with market forces in a fair and equitable way, access to information, and market policies that allow them to become an equal and fair player. They also need, as any entrepreneur will, reasonable safety net in the form of regulation protection if they go bankrupt (as GM and Delta will vouch); or a place where they can save for a rainy day (as Chevron will agree).

   The debate of whether microfinance is good or bad for poor is such a rhetorical one. After 30+ years of modern microfinance; what we need to be asking is – how to keep microfinance from not becoming a cigarette, and more becoming a cell phone. As in any other industry, microfinance has diverse players, with diverse intent; some naive, other noble, and yet another which are not so altruistic. Where we have right macro economic factors, along with right public policy, microfinance is likely to do better. Where we have those absent; and there are many places on this earth where that is the case, microfinance is unlikely to do that well. And then, there are simply good and bad microfinance practices – as banks fail, some microfinance should fail too!

   In the lighter vein, ‘fair and lovely’ does not sell a cream; it sells a dream (a very old adage in marketing parlance). Similarly, some of microfinance practitioners have indeed been more romantic and enthusiastic than others; selling microfinance as that dream. There is ‘marketing’ and ‘advertising’ and then there is ‘reality’. It is for you to decide, weather they are guilty of lying, or is it media and neo-pundits who have been more responsible for paying too much attention to them.

   best,

2. Ahmad Jazayeri Says:
   March 4th, 2010 at 1:29 am

   Dupas and Robinson (2009), quoted in your chapter, have attempted to prove, through a randomized statistical study, that offering savings accounts can reduce poverty by enabling women (not men) to save and use the lumpsum for investment hence increasing their incomes and expenditure and improve their ability to cope with health shocks (e.g. Malaria). The policy advice is to promote savings accounts as a tool to fight poverty. Although I share the general view (based on personal experience) that the availability of savings accounts are an important component of any anti-poverty strategy, I remain unconvinced by the study.

   First, it is unfortunate that the authors do not refer to the original concept article on Financial Services Associations (Jazayeri, Small Enterprise Development Journal, June 1996) or the lessons learnt from FSAs (Jazayeri, microfinancegateway.com, 2005). This would have given them a better understanding of what the FSAs were supposed to do and some elements of their history. Unfortunately, history does not have much meaning for quantitative economists who think together with Descartes that “history about the Roman Empire will teach you as much about the Roman Empire as was known by Cicero’s servant girl”.

   The Kenyan practice of making the buying of shares in an FSA optional and only for those who want to borrow is quite out of line with the FSA concept since in the original concept people must first buy shares to be able to save and not the other way around. In fact, it should be illegal for an FSA to accept savings from non-shareholders. Also, savings accounts were supposed to be free for shareholders up to a certain number of transactions. The Kenyan FSAs seems to have adopted some un-salutary practices.

   Being familiar with FSAs operations – as I spent 7 years (from 1998 to 2005) promoting them in East Africa (including taking the concept to Kenya)- I find the study is trying to prove a theoretical point, i.e. savings leads to investment, based on very thin data and I would say an inappropriate methodology (however much I’d like to believe in the findings). The methodology also shows the weaknesses of high powered econometric studies for situations that require above all a qualitative approach to the study of impact. Below are some of my questions and comments on the study:

   1. What is the impact on expenditure during the savings period and before the withdrawal in the control group? Surely, if withdrawal raises expenditure (a fairly obvious result since the reason people withdraw is because they need to spend), then deposits must lower them. Is the rise of expenditure after withdrawal not a compensation of their fall before the withdrawal? What is the net impact?

   2. The numbers are hard to believe. If the median number of deposits was only 3 and the average size was $ 9 (p. 22), then the average savings balance was only $ 27 over a 6 month period. If the mean daily investment was $5/day (p. 10), this amounts to $ 800 of investments over a 6 month period. How can a $ 27 mean withdrawal (only .03% of mean investment over the period) lead to a 40% increase in personal expenditure driven by a major increase in investments? It is also stated that the $9 average deposit was 3.5 times daily expenditure. This means that the total expenditure over the period was about $540. Again how can $27 have such a huge impact on expenditure? The participants were paid a total of $18 (75 cents per week for 6 months) in compensation for filling up the logbook. Was this impact taken account of? Also remember that the FSA in Kenya charges $ 7 for opening a savings account. This amounts to 30% of the average savings balance (if my calculation is right) of the control group so the actual benefit of the withdrawal is reduced by this amount and the impact of savings withdrawal becomes even more insignificant.

   3. The positive correlation between ROSCA participation and the take-up of the savings account shows that generally the women taking up the accounts were the enterprising types who would experience a positive increase in their income and expenses overtime in any case (regardless of the account).

   4. It is stated that 70% of the funds withdrawn from the savings accounts was used for a business purpose. What is a business expense? How do they separate a business expense and a personal expense? Did the respondent agree with their classification? Also, we are not informed about the types of businesses but we are informed that bulk of the expenditure is on food, entertainment, cosmetics jewelry, etc.). Is an increase in consumption in such expenses good for wealth creation?

   5. Why the results does not hold for men? Is it because men don’t want to reveal their expenses? Or is it because men’s savings levels does not impact their expenditure levels (very unlikely). Or is it because the data is unreliable?

   6. The time preference analysis is not convincing. In fact trying to identify people in terms of their personal time preference and discount rates assumes inherent characters in people as opposed to understanding such behaviour as a response to uncertainty within a context- specific environment and very difficult to generalize. If I ask a Kenyan taxi driver that does he prefer $1 now to $1000 later, he thinks you are going to give him the money and of course he would say $1 now since he is not sure if you will be around after 30 days (To encourage “truth-telling”, one of the preference questions was randomly selected for payment).

   7. Some of the questions that they asked the people for revealing time preference were complicated even for an educated person. Example: ” how much of Ksh. 100 they would like to invest in an asset that pays off 4 times the amount invested with probability 0.5, and that pays off 0 with probability 0.5). Now try to put this in Swahili to somebody who is illiterate!

   I think the study shows the limitations of quantitative studies with very thin sample size (only 54% of 122 or 66 people actually opened an account) and very short period of time (6 months) and too much expectations by highly trained econometricians who want to use what they have learned in graduate school to justify their academic appointments (sorry to be a bit harsh). In my view, researchers should have allocated a good poart of their time (at least as a more convincing supporting evidence) with the respondent doing a one to one open-ended anthropological interview to better understand their livelihood strategies and the impact (if any). Also the context, the economy and history of the village (being border town and very dependent on fluctuating border traffic) and the market environment should have been studied.

   My own experience is that FSA savings are usually a part of a broader financial portfolio and even broader livelihood strategy. Isolated financial variables by themselves (the so-called minimalist view) may not (and usually do not) explain financial behavior.

   Stay tuned for a study (in progress) that uses vide-based qualitative interview methods to assess microfinance impact.

   Warm wishes to you and to the authors,

   Ahmad Jazayeri
   3 March 2010

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