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UNDP private sector brief II - Microcredit: A suitable instrument for poverty reduction?

UNDP private sector brief II - Microcredit: A suitable instrument for poverty reduction?

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2012 - Is microcredit a suitable instrument for poverty reduction? Evidences from more recent systematic analyses.This private sector brief addresses start-ups and micro-businesses, focusing on delivering results. This is part 2.
2012 - Is microcredit a suitable instrument for poverty reduction? Evidences from more recent systematic analyses.This private sector brief addresses start-ups and micro-businesses, focusing on delivering results. This is part 2.

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Private Sector Brief 
 
September 2012
Microcredit: A suitable instrument for poverty reduction? 
Introduction
It is over 30 years now since microcredit started off, and over 20 years sincethe movement caught on internationally, principally fuelled by the efforts of Mohammad Yunus, who was later, in 2006, rewarded the Nobel Peace Prizefor his work.
1
The goal of the movement is to reduce poverty through theaccess to and provision of microloans, which usually do not exceed a fewhundred dollars.
2
This brief will look at the existing evidence in how far thisgoal is being achieved. It mainly does so by comparing the results of variousmore recent reviews that systematically analyse the impact of microcreditand draw preliminary conclusions.The impact of microcredit on the different dimensions of poverty can bedivided into three categories. Microcredit can: 1) reduce poverty byincreasing people's disposable income (the income-generating effect of microcredit); 2) alleviate poverty by helping people to smoothenexpenditure requirements so that they can better cope with their plight (thevulnerability-reduction effect); and 3) generate non-financial benefits byreducing social exclusion through, for example, improved education or
ǁŽŵĞŶ͛Ɛ
empowerment (the empowerment effect).
3
 
Measuring the impact of microcredit
The core value proposition is that microcredit enables poor people to makeprofitable investments
Ͷ
usually into micro-businesses, thus increasing theirincome and consumption potential and lifting them out of poverty. In fact,many do regard a
ŵŝĐƌŽĐƌĞĚŝƚĂƐ͚ŐŽůĚĞŶďƵůůĞƚ͛ĂŶĚĞŵƉŚĂƐŝƐĞŝƚƐďĞŶĞĨŝƚƐ
especially for the poorest of the poor.But as Duvendack
et al 
. (2011) show, based on a review of 58 studies, thisclaim is not supported by the evidence:
͞
Almost all impact evaluations of microfinance suffer from weak methodologies and inadequate data [...],thus the reliability of impact estimates are
[sic]
adversely affected. This canlead to misconceptions about the actual effects of a microfinanceprogramme, thereby diverting attention from the search for perhaps morepro-
ƉŽŽƌŝŶƚĞƌǀĞŶƚŝŽŶƐ͟;Ɖ͘ϰͿ͘dŚĞLJĐŽŶĐůƵĚĞ
that no well-known studywould robustly show any strong impacts of microfinance.
4
 This result should not surprise: after all, the impact of credit depends onhow it is spent. Do borrowers use it profitably? What is the time frame formeasuring changes in profitability?
5
Moreover: the precise use of fundscannot easily be tracked because of their inherent fungibility.
6
 
PrivateSectorBriefs
areissuedintermittentlyby
ǯ
SectorCommunityofPracticethrough
ǯ
RegionalCentre. Aimedatpractitio-nersinthecountryoffices,they provideconceptualinsights,analysisofcross-countrycomparisonsandideasdeemedrelevanttoprivatesectordevelopmentandengagement.
IssueII,Sep.2012
StephanSchmitt-Degenhardt,withcontributionsbyBenSlay,NickMaddockandJoernRieken©UNDP,2012
 
2Accepting the inherent methodological flaws of most studies, it is nevertheless useful to look at theexisting research results related to the identified three categories.
Evidence of the impact of microcredit on poverty reduction
Chowdhury (2009), in a UN/DESA study referring to over 20 research papers, concludes that itsimpact on poverty reduction remains in doubt. Stewart
et al.
(2010, p. 6), in a review of 15 studies of 
͚ŐŽŽĚĞŶŽƵŐŚƋƵĂůŝƚLJ͛ŽŶ^Ƶď
-Saharan Africa,
7
similarly conclude that microcredit has mixed impactsin relation to incomes of poor people. Many other studies come to similar conclusions.
8
 Of course
ŝŶĐŽŶĐůƵƐŝǀĞŽƌŵŝdžĞĚĞǀŝĚĞŶĐĞŽĨŵŝĐƌŽĐƌĞĚŝƚ͛ƐŝŵƉĂĐƚŽŶƉŽǀĞƌƚLJƌĞĚƵĐƚŝŽŶ
reflectsstudies that found positive as well as negative impact. So it is worth looking at some details. Aninfluential research by Hulme and Mosley in 1996 found that microcredit had little, none or evennegative impact on the poor and poorest, but positive impact on the slightly better off (in terms of human or financial assets) and those who are already in business. Other studies, among others SIDA(2004), confirm these results.
9
Banjeree
et al.
(2009, pp. 20f.), in a randomized study of 104 slums inIndia for the Centre for Micro Finance, find that when provided with access to microcredit, existingbusinesses, better-off households and also households with a high propensity to start a businessreduce consumption of non-
ĚƵƌĂďůĞƐĂŶĚ͚ƚĞŵƉƚĂƚŝŽŶŐŽŽĚƐ͛ƚŽďĞĂďůĞƚŽĨŝŶĂŶĐĞĂŶĞǀĞŶďŝŐŐĞƌ
initial investment, and improve their well-being.
10
 
Why does microcredit not lift poor people above the poverty line?
First, loans might be much lessfrequently invested in income generating activities than it is assumed. Although donors and manymicrofinance organizations claim that credit is predominantly provided to promising start-ups and
ĞdžŝƐƚŝŶŐďƵƐŝŶĞƐƐĞƐ;ŝŶĐůƵĚŝŶŐzƵŶƵƐ͛'ƌĂŵĞĞŶĂŶŬͿ͕
few studies attempt to verify the claimed useof the microloans. One research showed that borrowers usually and significantly underreport theirloan use for consumption purposes (stating it to be about one third to one half of the actual value).
11
 The same research estimates that borrowers in fact spend 20 percent to 30 percent of their loans onhousehold expenses, health or education. But in a debate between Bateman and Roodman,Bateman claimed that only 20 percent of the microloans are really invested in micro-businesses
 ʹ
 the rest being invested in consumption
 ʹ
a claim that Roodman did not contest.
12
No wonder, then,that the impact of microcredit is lower on income generation than on more consumption-orienteduses.Second, credit alone does not turn a poor person into an entrepreneur: entrepreneurial motivation,skills and opportunity are also required (see also PS Brief #1). In most countries, being a micro- entrepreneur means the equivalent of not having a job. As so-
ĐĂůůĞĚ͚
necessity entrepreneurs
͛ƚŚĞLJ
usually invest in low skill - low capital businesses such as retail, where price competition is intensebecause of overcrowding. Hence, they often do not manage to improve their income situationthrough these business activities.
Why do the poorest benefit less from microcredit than the better off?
First and foremost, thereappears to be a bias in the selection of clients by microfinance institutions: many microfinanceinstitutions do exclude the poorest, as this might endanger their repayment rate, or because there isa methodological bias in client selection. Instead, they focus on those clients that
ĂƌĞ͚ďĂŶŬĂďůĞ͛͘dŚĞ
above mentioned focus of donors confirms this.
13
 Second, the poorest often exclude themselves from micro-borrowing, as they are too risk averse orlack the confidence.
14
 Third, while the better-off may have to struggle to generate additional income from their businessactivities, the poorest will have even more problems.
15
 
 
3
Does microcredit create jobs?
One could therefore conclude that microcredit has the potential tohelp the better off to establish or expand businesses, thus creating jobs which again might help theeven less fortunate. For most microfinance institutions, employment creation is their declaredmission statement, and it is widely acknowledged that employment creation is a key link to povertyreduction. Unfortunately, also here there is little conclusive evidence.In a survey of 46 MFIs the ILO found that
ŵŝĐƌŽĨŝŶĂŶĐĞŝŶƐƚŝƚƵƚŝŽŶƐƚŚĞŵƐĞůǀĞƐĂƌĞ͚ƌĞůĂƚŝǀĞůLJŝŐŶŽƌĂŶƚ͛ĂďŽƵƚƚŚĞĞŵƉůŽLJŵĞŶƚƐƚĂƚƵƐŽĨƚŚĞŝƌĐůŝĞŶƚƐ͕
which is inconsistent with their declaredmission statements (Balkenhol, 2006, p. 5). Studies devoted to the topic use very different
ĚĞĨŝŶŝƚŝŽŶƐŽĨ͚ĞŵƉůŽLJŵĞŶƚ͛ĂŶĚŽĨŵĞĂƐƵƌŝŶŐ͚ĞŵƉůŽLJŵĞŶƚĐƌĞĂƚŝŽŶ͛ǁŚŝĐŚŚĂƐŝƚƐŽƌŝŐŝŶŝŶƚŚĞ
nature of most microcredit clients being household enterprises. Some studies focus only on salariedemployment while others include any family employment; some look only at the impact on the
ďŽƌƌŽǁĞƌ͛ƐďƵƐŝŶĞƐƐǁŚŝůĞŽƚŚĞƌƐŝŶĐůƵĚĞƐƵďƐƚŝƚƵƚŝŽŶŝŵƉĂĐƚƐǁŝƚŚŝŶƚŚĞďŽƌƌŽǁĞƌ͛ƐŚŽƵƐĞŚŽůĚĂŶĚ
the community. Mostly, a positive impact on employment is only found in those studies that use thebroader concept of employment. But once the substitution effect is accounted for it turns out thathouseholds mostly re-compose their activities and concentrate more of their time on the incomegenerating activity for which the loan has been taken up.
16
The European Commission (2003, p. 37) finds that microcredit created between zero and oneadditional job (besides the founder) in 10 European countries. But for the reviewed 15 Sub-Saharancountries, Stewart et al (2010, p. 38) found little evidence that microcredit has any impact on jobcreation. Given the higher formality of European businesses and business start-ups, both findingsappear to
ďĞŝŶůŝŶĞǁŝƚŚĂůŬĞŶŚŽů͛ƐĨŝŶĚŝŶŐ;
2006, p. 8) that borrowers with larger businessoperations at the point of first contact are more likely to increase employment. This again is in linewith other findings that businesses beyond a certain size are more likely to create jobs (see PS Brief #1).
Evidence of the impact of microcredit on poverty alleviation
The idea of poverty alleviation through microcredit is that poor people experience high variations inexpenditure requirements. Microcredits
Ͷ
which are still cheaper than funds obtained via localmoney lenders
Ͷ
can help to smooth these variations and therefore spread expenditure patternsmore evenly.
17
All studies that focused on this type of impact found supportive evidence for it.
18
 SIDA, however, warns
ƚŚĂƚ͞ƚŚĞůĂƌŐĞƉƌŽƉŽƌƚŝŽŶŽĨŵŝĐƌŽĨŝŶĂŶĐĞůŽĂŶƐƚŚĂƚĂƌĞďĞŝŶŐƵƐĞĚĨŽƌ
consumption-smoothing purposes raise
[sic]
additional concern about long-term improvement for
ƚŚĞƉĂƌƚŝĐŝƉĂƚŝŶŐŚŽƵƐĞŚŽůĚƐ͘͟
 
^/͛ƐƌĞƐĞƌǀĂƚŝŽŶŝƐƚŽďĞƚĂŬĞŶǀĞƌLJƐĞƌŝŽƵƐůLJ
, given the interest rates of microloans. The validquestion arises if microcredit (that is, micro-debt) is better suited for consumption smoothing thanmicro-saving? As Harper (2011) and others point out, this is rather counter-intuitive: reductions inconsumption to service and amortize debt incurred at high interest rates always places a higherburden on households than do reductions in consumption necessary to yield savings. Roodman andQureshi (2006, p.
ŝǀͿŐŽĨƵƌƚŚĞƌďLJƐƵŐŐĞƐƚŝŶŐƚŚĂƚ͞ƚŚĞŚŝƐƚŽƌŝĐĂůĞŵƉŚĂƐŝƐĂŵŽŶŐD&/ƐŽŶĐƌĞĚŝƚ
rather than savings appears to have arisen for practical business reasons rather than because it hasbeen shown that credit helps
ĐůŝĞŶƚƐŵŽƌĞ͘͟
 
Evidence of the impact of microcredit on non-financial benefits
Researched non-financial benefits of microcredit usually include housing, food, health, educationand especially women
͛Ɛ
empowerment. Improvements in these areas can reduce the impact of poverty, increase social inclusion, and as a consequence help to lift people out of poverty in thelonger term. Studies usually find no or some positive effect.
19
 

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