Does Microcredit Really Help Poor People?
Washington, United States, January, 13 2010 -
With public funding for development under the greatest pressure in nearly two decades, the international community has focused more than ever on asking questions about what aid works best and why. Microfinance, particularly microcredit, has come under scrutiny as recent studies have emerged that may cast doubt on some of the claims around its impact on the lives of poor people.
In a new Focus Note entitled, “Does Microcredit Really Help Poor People,” CGAP’s Richard Rosenberg reflects on the state of the evidence.
Microcredit began to capture public attention a quarter-century ago, rising to prominence with reports that tiny loans were enabling millions of poor borrowers, mostly women, to start or expand microbusinesses, and that the new income from those businesses was lifting many out of poverty. There have been hundreds of inspiring stories of poor people who lifted themselves into the middle class with income from businesses they financed with microloans. Rosenberg asks, “Do these individual anecdotes represent the general experience of the hundreds of millions who have gotten microloans over the years? Is microcredit being oversold?”
In the paper, Rosenberg notes that it is difficult to conduct reliable scientific testing on the impact of microcredit on its clients. People who eventually take out microloans may be fundamentally different from the general population—for instance they may be more entrepreneurial, more motivated, and less risk-averse. “If this is true, those people might be expected to earn better than the general population whether or not they get a loan,” he says. “If we find that their incomes rise faster than other people’s incomes, we can’t tell whether the cause was from the loans they took, or underlying personal characteristics that would exist whether or not they got a loan.”
A new “random controlled trial” (RCT) study technique avoids this problem. The few RCT studies published so far have not supported the proposition that microcredit raises household incomes or improves welfare, at least in the short term. More studies are on the way but Rosenberg argues that so far the evidence doesn’t permit a conclusion about whether microcredit is lifting millions out of poverty.
The dominance of the escape-from-poverty story has distracted attention from another set of benefits from microcredit (and microsavings as well)—namely, giving people reliable tools for managing their household cash. A new study, Portfolios of the Poor (Collins at al. 2009) demonstrates the surprising proposition that poor households need these financial tools even more than wealthier households, because their income tends to be irregular and unreliable. Poor people are borrowing and saving all the time, not only to meet the challenge of keeping food on the table every day, but also to build up larger chunks of money that are needed for emergencies, opportunities, and social commitments such as weddings and funerals.
“Whether or not microcredit and other financial services help people escape from poverty, there is strong evidence poor people value them very highly because these services help them cope with poverty,” Rosenberg argues. “That evidence includes the high and continuing demand for microfinance, and especially the phenomenal willingness of poor borrowers to repay uncollateralized loans when the only real motive to do so is to maintain access to a highly valued service.”
Overall, a year of microcredit may not be as helpful as a year of primary education for women, Rosenberg states, adding that the advantage of microcredit is that, if it is done right, it costs a lot less than education. After a small initial subsidy, well-managed microlenders can and do survive and grow, using deposits and other commercial funds, rather than more subsidies, to extend permanent services to massive numbers of poor clients.
When we hear that the evidence about microfinance raising poor people’s incomes is unclear, and that many (sometimes most) clients use microloans and savings to smooth consumption rather than to grow enterprises, we tend to be disappointed. “Consumption smoothing sounds like a mere palliative,” says Rosenberg. “If that’s all it is, why bother?”
“We react this way only because our own minimum consumption levels are seldom if ever threatened. Financial diary studies like Portfolios of the Poor
, as well as the observed behavior of hundreds of millions of microfinance clients around the world, show us that poor people think this “palliative” solution is enormously important in helping them cope with their circumstances.”