There is a new approach to micro-credit:
…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 [TC: I would not have worded it that way]. 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, how can the marginal product of capital be so high? Perhaps the interest on a microloan isn’t a pure return on capital, it is also a return on labor. Without a tiny bit of capital, the labor can’t be tapped. (So the marginal product of capital isn’t really all that high in Indian slums, for instance.) Supposedly that is why microcredit works, and why larger loans are much less popular.
This is ingenious, but the theory won’t hold up if it focuses on liberating the labor power of women. There are plenty of micro-credit markets where most of the loans finance the productive efforts of already-employed men. A more realistic explanation has to consider micro-credit as micro-insurance (what if the kid needs to go to the doctor?, liquid funds are needed now), and the high rate of implicit taxation which needy relatives impose on spare household liquidity. Both of these factors will get the private return from borrowing to be high, without requiring a comparably high rate of economic growth.
Here is the link. Here is my earlier column on micro-credit.
I may be overthinking the point here, but don’t micro-credit loans turn the women in a village into de facto loan officers?
One of the tricks of micro-credit is to only loan to women and to hold the whole village responsible for the payments of individuals, tapping into existing social structures to enforce payment of the loans.
I like happyjuggler0′s take. I think it’s a little bit of both.
Has anyone done any research on Internet micro finance companies like Kiva? They are supposed to make the transaction process easier and more transparent. Does that bring down the interest rates on the repayment amount? Are there any other benefits to the borrower, other than the fact that people can loan money from 10,000 miles away ?
Too much theory and not enough experience. I’ve been evaluating microcredit projects on three continents for almost 25 years, and while I’m not suggesting theory is bunk, you all need to get out to the field and see what’s going on. The women discussed here are not by any stretch “economically productive.” The things they do are low skill, low-barriers-to-entry petty trade activities in the informal economy – in some 3rd wld countries, that is the only economy – they sell rice, old clothing, home made food, tiny packets of spice. One woman I met in a rural market in Guinea last year would buy a large (1 kg) can of red pepper paste and repackage it in hundreds of plastic packets holding a teaspoon each. She’d lay out about $3.50 in the mrning, work all day, and if lucky have sold most of the can by the end of the day, for a profit (after deducting for the cost of the packets, but not for her labor) of about $1.00. When copy-cat behavior (and too much microcredit available) causes a glut in the red pepper paste market, she is clever enough to switch to something else, which may last a couple of weeks. But not everyone is sharp enough to do this.
At any rate we are talking about an atomized economy where everyone is a buyer and seller, with cash moving around the system rapidly. One answer to how microcredit borrowers repay is that they are mostly engaged in activities that generate cash flow, and since microcredit practice depends on frequent repayments (sometimes weekly), they are able to repay little by little (and are often unaware of the actual interest rate). But a phenomenon little covered by those who write about microcredit, is the role of others in the family in loan repayment. Many woman are repaying using money from family members who work in the cities or abroad (worldwide remittance transfers are now in the range of $200 billion per annum). In short money being fungible, we can only guess how loans are being repaid – but do not assume that repayment equals economic productivity.
As for the question of why they don’t take larger loans, the answer is that what they do with the credit simply isn’t going anywhere. Petty trade in the informal marketplace is about pennies and nickels, and of course about survival. It is not about business. The irony is that microcredit in the poorest countries is at best a bandaid; whereas in the countries that are already on the road to growth, microcredit isn’t really needed.
make sure you do your homework, before you get or work with credit.
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