Does microcredit work?

This post appeared in Dutch on the Oikocredit Netherlands website.

In 2010 I travelled across Uganda to visit microcredit projects. I met inspiring people with remarkable stories. Violet, for example, opened a primary school with the help of a loan. Microcredit seemed to be a big succession of triumphs. Nevertheless, something was gnawing away inside of me. What about borrowers that failed to use their loan successfully? And wouldn’t entrepreneurial types like Violet manage to succeed regardless, even without a microcredit? In other words: Does microcredit work?

Three students from Violet's primary school

One way to answer this question is doing a ‘randomized controlled trial’ (RCT). The concept is simple and well known from medical experiments: one group receives the treatment – a microcredit – and another group gets nothing. By comparing the two groups, you learn about the effect of the treatment. A crucial aspect of this method is the random selection of individuals. By doing this you avoid so-called ‘selection bias’. For example, imagine that microcredit clients have more entrepreneurial qualities than ‘normal’ people. It is likely that those with a microcredit will have more success, but to what extent can we assign this to the loan?

Esther Duflo and Abhijit Banerjee are the uncrowned monarchs of the ‘randomistas’, the researchers that focus on RCTs. In The miracle of microfinance?, Duflo, Banerjee and co-authors study the effect of a new microcredit program in Hyderabad, India. The results? Borrowers invest more in their business, but these investments do not lead to a decrease in poverty. Although income does not rise, money is being spent differently: microcredit clients buy less ‘temptation goods’, such as lottery tickets and cigarettes, and more durable goods, such as fridges and television sets. Other studies arrive at similar conclusions: there are positive effects, but microcredit does not seem to be the silver bullet in the heart of poverty.

But: there is not only one type of microcredit. Loans vary in size, duration and interest rate. Some loans are given to groups, others to individuals. So, instead of asking “Does microcredit work?”, we should ask “Which microcredit works?” The research on this question is ongoing, but there are already some interesting results. For instance, Lars Berge and coauthors found that microcredit works better if it’s combined with business training (link). Training does not only teach entrepreneurs how to run their business, it can also help them to find out whether their idea has potential in the first place.

After all, not everyone is a successful entrepreneur like Violet. And not everyone needs to be. As businesses grow, they create jobs for those who are less entrepreneurial. That is exactly why the Violets of this world should have access to credit, and why their loan should be designed in a way that maximises impact. With a microcredit loan in their pockets, entrepreneurs can fight against poverty in their country. 

Want to know more about RCTs?

• Poor Economics – The book by Esther Duflo and Abhijit Banerjee about RCTs in developing countries. (Amazon.com, website of the book)
• Ted talk by Esther Duflo – Esther Duflo talks about why she believes that RCTs can be used to fight poverty. (link)