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New Research Indicates Microloans Don’t Solve Poverty

In this Feb. 28, 2011, photo, police detain women activists protesting against alleged harassments by microfinance companies in Hyderabad, India

Photograph by Mahesh Kumar A./AP Photo

In this Feb. 28, 2011, photo, police detain women activists protesting against alleged harassments by microfinance companies in Hyderabad, India

Here’s the main argument for microfinance: Making small loans to poor women in developing countries will help them start businesses and escape poverty.

A new, rigorous analysis of microfinance in India suggests its real effects are much murkier. NPR’s Caitlin Kenney points to a working paper by development economists at the Massachusetts Institute of Technology. Led by Esther Duflo, they attempt to study the effects of microfinance with randomized control trials, the same way medical researchers test whether a new drug works better than a placebo. The paper claims to be the longest evaluation of microlending.

Starting in 2005, the researchers randomly chose 52 poor neighborhoods in Hyderabad, India, that had gotten a new branch of microlender Spandana. As a control group, they studied another 52 where Spandana hadn’t opened. Other microlenders entered both areas over the course of the study, and eventually Spandana began lending in the control areas as well. Because Spandana started offering loans earlier in the “treatment” areas, the researchers could study how communities with longer-term access to microcredit compared with those where loans had been offered for only a shorter period. After three years, they found that

“businesses in the treatment groups have significantly more assets, and business profits are now larger for businesses above the 85th percentile. However, the average business is still small and not very profitable. In other words, contrary to most people’s belief, to the extent microcredit helps businesses, it may help the larger businesses more.”

Average levels of consumption, taken as a proxy for overall welfare, didn’t change, nor did development measures such as health, education, or women’s empowerment. The paper concludes:

“For those who choose to borrow, while microcredit ‘succeeds’ in leading some of them to expanding their businesses (or choose to start a female-owned business), it does not fuel an escape from poverty based on those small businesses.”

“Business profit does not increase for the vast majority of businesses, although there are significant increases in the upper tail. This study took place in a dynamic urban environment, in a context of very high growth. Microcredit seems to have played very little part in it.”

The authors note that researchers haven’t reached a consensus about the effects of microfinance. In 2010, borrower suicides in Andhra Pradesh (the state where Hyderabad is located) followed overreach by microlenders, marring the industry in the public consciousness. The MIT researchers’ work isn’t the last word on the idea. But it suggests that small loans to help poor people become micro-entrepreneurs don’t alleviate poverty. In a sign the development community is reconsidering that logic, some microfinance organizations are investing in other financial products for the developing world.

Tozzi is a reporter for Bloomberg Businessweek in New York.

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