Micro-credit puzzles

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.