Why microfinance works, economics notwithstanding
In the wake of the Nobel Prize for Muhammad Yunus, a very great deal has been written on the subject of microfinance. But a lot of it makes relatively little sense, especially to economists like Joe Stiglitz. For one thing, interest rates on microcredit are enormous: 30% to 60% is common, and rates over 100% are not unheard-of. And yet default rates remain very low: how is this possible? And how is it possible that demand for loans seems to be unrelated to the interest rate charged? And why is it that borrowers seem to have little if any interest in medium-sized loans, even when they’re offered?
A forthcoming paper by Shahe Emran, Mahbub Morshed and Joseph Stiglitz not only asks those questions, but goes a long way to answering them, too. It turns out that the main factor behind all these puzzles is the place of women in society, and especially extreme illiquidity in the market for women’s labor:
While there exists a labor market for male labor, for women, the outside labor market is largely missing in most of the developing countries, especially in the rural areas. Even where the market for female labor exists, the ‘selling price’ is, in general, much lower than the ‘buying price’, due to the transaction costs that might reflect social norms regarding women’s participation in the formal labor market (like Purdah) along with the usual search, information and monitoring costs. The existence of a transaction cost band implies that many households fall within the band, and the female labor endowment becomes non-tradable for such a household (i.e., household specific missing market for female labor). This implies that the shadow wage rate for the non-traded part of the household labor is determined by the complementary resources available to a household, like land. For a poor household with little land, the shadow wage, in the absence of microcredit interventions, is very low, possibly close to zero. The availability of microcredit enables this nontraded part of the labor to be productive.
Translated into English, a little bit of credit acts as a catalyst for women outside the labor market, turning them into economically productive individuals. Once they become economically productive, they can pay back small loans. But they’re not productive enough to pay back medium-sized loans.
To put it another way, the interest on a microloan isn’t really return on capital, it’s return on labor. It’s just that without a tiny bit of capital, the labor is nascent and can’t be tapped. That’s why microcredit works, and why larger loans are much less popular.
(Via Pienso)
Microfinance: Sustainable Poverty Alleviation or a Short Term Solution to an Unequal System?
No Responses to “Why microfinance works, economics notwithstanding”
Roger • November 7th, 2006 at 12:20 pm
Thank you for the translations.
I assume that the quoted 30-60% interest is supposed to seem extortionate, and to raise a query why it has not been competed down. And the obvious answer is high transaction costs relative to the sums being lent.
Hermenauta • November 7th, 2006 at 12:51 pm
Maybe.
Yet in Brazil there is a surge in small credit since the government instituted the possibility of bank loans that are payable directly from the firms payroll. And the credit takers use to spend their credit in consumer goods, not in capital goods. It seems that poor people are more aware of payments that fit in their income than in interest rates…
Anonymous • December 14th, 2006 at 9:07 pm
Roger,
Read the paper before you make a comment!! I found the paper very interesting…A must read for anyone interested in microfinance.
Guest • December 16th, 2006 at 7:28 pm
Thanks for the pointer to the interesting paper. One thing though. You wrote that “a lot of it” makes little sense to economists like Joe Stiglitz. But reading the paper and talking to microfinance people it seems that it makes the most sense to Joe Stiglitz and his coauthors, and now to me and others as well.
Guest • December 24th, 2006 at 2:58 pm
Wow! The paper by Stiglitz and Co. is definitely a path breaking analysis. It is just amazing how looking at the imperfect labor market can tie in so many different puzzles in the microfinance. I really benefitted from reading the paper…
