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Microfinance, foreign aid, Commitment to Development Index, debt and debt relief
David Roodman, a former CGD senior fellow, worked at the Center from March 2002 to July 2013. His work at the Center focused on microfinance, debt relief, and aid effectiveness. His widely praised book Due Diligence confronts questions about the impacts of microfinance and how it should be supported. He wrote the book through a pathbreaking Microfinance Open Book Blog, where he shared questions, discoveries, and draft chapters.
Roodman was an architect and manager of the Commitment to Development Index since the project's inception in 2002. The Index ranks the world's richest countries based on their dedication to policies that benefit the 5 billion people living in poorer nations; it is widely recognized as the most comprehensive measure of rich-country policies towards the developing world.
Roodman wrote several papers questioning the capacity of common cross-country statistical techniques to shed light on what causes economic development. He co-authored a 2004 American Economic Review paper that challenged findings of World Bank research that aid works in a good policy environment. His non-technical Guide for the Perplexed builds on analysis of methodological problems and fragility in other studies. Among econometricians Roodman is best known for his computer programs that run in the statistical software package Stata; articles about them won him the inaugural Stata Journal editors' prize in 2012. Also in 2012, Roodman aged off the RePEc list of top young economists in the world, at number 6.
Here are quotes from and a few thoughts on things I'm reading.
Thomas Dichter, "Can microcredit make an already slippery slope more slippery? Some lessons from the social meaning of debt," in Dichter and Malcolm Harper, eds., What's Wrong with Microfinance? (2007). Two contributors to this edited volume pointed me to it in response to my announcing this blog. In the opening chapter, Dichter writes:
Microfinance today makes a mistake in thinking that it is about financial services, plain and simple, with the main concerns being the technical ones surrounding operating costs, transaction costs...and the like. Those MFIs [microfinance institutions] that work especially close to the poorest borrowers...need to be especially aware of the symbols and layers of what is going on behind the mere transaction. Looking at the deeper social meaning of debt can provide insight, for example, into why joint liability works or does not work, give more depth to the issue of drop-outs, help explain misunderstandings about interest rates, uncover unexpressed hopes about further larger loans, or about what happens when women give their loans to their husbands.
For the most part, microfinance has failed to see the slippery slope towards consumerism, and the loss of certain values (embodied in indigenous ways of coping based on reciprocity or mutual aid) that may occur as the results of even partly encouraging widespread formal credit use. Historically valuable mechanisms of reciprocity, exchange, and mutual trust constituted what Durkheim called 'gemeinschaft' (community). This was the original 'social capital'. And Durkheim's student, Marcel Mauss, studying gifts and exchange in primitive society, concluded that gift exchange formed the entire basis of solidarity--exchanges held people together.
How new financial services, and the attendant interdependencies and stresses, disrupt the regulating power of long-honed community norms around borrowing and lending is certainly worth thinking about. But real economic development is always disruptive, for both good and bad, and Dichter provides no specifics about the bad, so he does not convince me.
The developmental NGO [non-governmental organization] is the purveyor of this new economic sovereignty that is represented by corporate capital interests and local institutional interests (NGOs), and is an architect of neoliberalism within a modernist developmental discourse of poor women's empowerment through the market.
Got that? The heavy shibboleths put this reader on guard. But Karim appears to be concurring with Dichter and, to her credit, follows up with fairly jargon-free specifics from her year in Bangladesh:
I saw that credit-related strife amongst members and their families were routine occurrences. Women would march off together to scold the defaulting woman, shame her or her husband in a public place, and when she could not pay the full amount of the installment, go through her possessions and take away whatever they could sell off to recover the defaulted sum. In circumstances when the woman failed to pay the sum, which happened several times a month in the NGOs I studied, the group members would repossess the capital that the woman had built with her loans. This ranged from taking away her gold nose-ring (a symbol of marital status for rural women, and removing it symbolically marks the 'divorcing/widowing' of a woman) to cows and chicks to trees that had been planted to be sold as timber to collecting rice and grains that the family had accumulated as food, very often leaving the family with no food whatsoever. The women who committed these acts did so at the exhortations of NGO officers, but they also considered these acts to be 'protecting their investments', and the defaulting woman as someone who had 'broken faith with the community'. These acts were committed with the full knowledge of NGO officers, but the officers did not participate in these collective acts of aggression. Instead, they threatened to withhold future loans unless the defaulted money was recovered.
In instances where everything had been repossessed because of a large default, members would sell off the defaulting member's house. This is known as house-breaking (ghar bhanga) and has a long history in rural society.
Then, a conversation with a prosperous moneylender and microcredit client:
Jahanara proudly told us that she had broken many houses when members could not pay. 'We know when they cannot pay, so we take a carpenter with us to break the house.' When I asked Jahanara, 'Why do you break the houses of kin?' Jahanara became indignant at first. Her initial comment was 'Why shouldn't we? They have breached their trust with us. If they cannot pay, then we will have to pay. Why should I pay for them?' Then she became quiet and said after a while:
It is not good to break someone's house, but we are forced to do it. This is how we get loans from Grameen Bank and other NGOs. They put pressure on us to recover the money, then we all get together and force the defaulting member to give us the money. We don't care how we do it.
Helen Todd also wrote about microcredit after living a year in Bangladesh, in the mid-1990s. Women at the Center paints powerful and detailed portraits of a handful of women, some of whom had been using microcredit for ten years, some who never used it. The borrowers are clearly better off on average. On page 72, she takes on a major criticism of her approach, that comparing these two types of women is misleading because it weeds out all those who tried microcredit, failed, and dropped out before she arrived:
It could be argued that women like Zarinah and Norjahan did not become economically active and entrepreneurial because they had access to capital through Grameen Bank. On the contrary, they joined Grameen Bank because they were active and entrepreneurial. Therefore we would expect to find Grameen women to be more active economically and more influential within their family circle than women in the control group.
There is some limited truth to this argument. Obviously, a woman like Habibah and a couple like Norjahan and Nurul, who were already engaged in activities that required capital--and were borrowing it from wholesalers or moneylenders--jumped at the chance to join Grameen Bank when it came into their villages. However, there is something unreal about the assumption behind this argument--that women can somehow be classified as "entrepreneurial" or "passive." Here in Ratnogram and Bonopur, at the bottom of the social heap, there are not many "inactive" women....Poor women must hustle to survive. Whatever they can do to bring a few Taka into the household they do and most women are doing several things at once. Some are more astute than others, but the real differences relate to the resources at their disposal.
When we look at a [non-borrowing] woman like Shireen...tending her calf and share-sheep and scratching each day for enough food to feed her family, we see a woman who is hard working and grabs at whatever chance she gets. But she has neither land nor capital. Her own family is too poor to help and as an unwelcome second wife, she has few allies in her husband's gusti. As a result, she can do little to boost the fortunes of her family and is completely dependent on her husband for survival; a fact which is reflected in her subordination.
Contrasting stories of triumph and trauma, like those from Karim and Todd, are what led me to write in chapter 1 that "The truth turns out to be an elusive thing."
Commenting on chapter 2, Debbie asks "what [interest] rate do you feel is too high?" This relates to my user fee post. But the question matters enough to me to deserve its own post. I do not have practical advice for Debbie, who is looking to lend more through kiva.org. But I must confront the challenge of defining just lending in the coming months, as I write the chapter on "development as freedom."
Philosophers and religious thinkers have struggled with this question since the dawn of history---check out this papal decision in 1515---so don't expect me to nail it. My sense is that several factors enter the moral calculus:
The interest rate.
The transparency of the rates and rules. It is one thing to knowingly pay 100%/year; it is another to agree to do so unwittingly because of hidden fees or complicated and undisclosed penalties.
Other consumer protections, including prevention of inappropriately coercive collection techniques (hat tip to commenter Lindsey).
Whether the local credit market is competitive. A creditor who must compete can't extort monopoly profits so easily.
What it costs to deliver the credit. Costs depend on factors such as population density and the wage level for the skilled workers who staff microfinance institutions.
Whether the lender has demonstrated culture and practices designed to soften the edges of credit and keep it out of the hands of those at risk of getting into trouble with it, what Gary Woller calls "Social Performance."
It seems to me that much of the moral burden rests on Kiva.org and other intermediaries to develop policies on these issues and explain them to their funders and investors.
The report finds that while there are a few institutions charging rates that seem unreasonably high, most interest rates seem to be in line with MFIs costs. The report also finds that microcredit rates have been dropping by 2.3 percentage points each year since 2003, much more steeply than the decline of bank loan rates. Administrative costs are also declining along with lenders' profits- the savings are being passed to borrowers.
Note the "most interest rates seem to be in line with MFIs costs." That's the cost argument the pope made 500 years ago.
I've been asked before what being on the show is like. Imagine someone comes up to you and asks most intently, What are the major causes of the global financial crisis? 30 seconds into your improvised monologue on this complex issue, your questioner's body language begins to suggest it's time to wrap up. You do, maybe accelerating a bit just before you screech to a halt. Then the questioner turns to someone next to you and asks a vaguely related question, like Are mortgage rates likely to stay low? It is not a natural conversation. The funny thing is that it sounds fluid on the air. Humans are flexible listeners.
My colleague David Roodman has decided to write his next book in public, not only by posting draft chapters as he completes them and inviting comments but also by sharing his discoveries and tribulations as he conducts the research that underpins the book. David writes:
I am using this blog to share the process of writing my book about microfinance (the mass production of small-scale financial services for the poor). The book asks and attempts to answer bottom-line questions about what we know about the impacts of microfinance and what that implies for how governments, foundations, and investors should support it.
For the many people who (like me) have assumed that very small loans to very poor people are a relatively recent phenomenon, David's chapter three on the (surprisingly long) history of microfinance will come as a quite a surprise. Already David is eliciting thoughtful and informative suggestions from readers.
If you haven't yet figured out how to subscribe to an RSS feed and set up a news reader, David's new open book blog may be just the excuse that you need. You can find a list of CGD RSS feeds and instructions for RSS beginners here.
The biggest development in development economics lately is the surge in the use of randomized trials. As in careful drug trials, randomly giving some people a "treatment," such as an offer of microcredit, and comparing how they do to people not offered can be a powerful research tool. Harvard professor and CGD non-resident fellow Michael Kremer (right) received a MacArthur Foundation "genius" grant in no small part for helping to start this movement. One criticism of such randomized studies is that they are hard to generalize from. Sure, air-dropping insecticide-treated bed nets into rural upper-middle-northwestern Uganda in the spring worked great for stopping malaria there, but will it work in central Laos in the fall? Against this backdrop, a new CGD working paper by Alaka Holla of Innovations for Poverty Action and Kremer marks a milestone. For the first time that I am aware of, researchers have performed enough randomized tests of one important question in development to support a paper that makes reasonable generalizations across contexts.
Holla and Kremer's question is: if you charge poor people more to come to a clinic or school--charging what specialists call "user fees" for services--will users use less? Holla and Kremer answer with a resounding "yes." (Can you see how I will link this to microfinance?)
In randomized trials, for example, charging even small fees for treated bed nets or deworming medicine greatly reduced uptake of these health-giving products. That raising prices lowers sales is not surprising; yet user fees have provoked great controversy. Non-governmental groups (NGOs) such as RESULTS have long criticized the World Bank and IMF for promoting user fees that price out the poorest. Yet there are serious arguments for fees too, as Holla and Kremer summarize:
Advocates of charging for these services argue that even the poor can (and do) pay at least some fee for important services; see such fees as vital to sustainability and motivating providers; note that charging may screen out low valuation consumers while allowing take-up by higher valuation consumers (Oster, 1995); and argue that there is a psychological effect through which paying a higher price can induce people to use a product more since they have already experienced a sunk cost (Thaler, 1980). For example, Population Services International, a leading social marketing non-profit organization with activities in more than 60 countries, argues that "when products are given away free, the recipient often does not value them or even use them" (PSI, 2006). Accordingly, they have pursued an approach to condom, mosquito net, and water disinfectant promotion that relies primarily on charging, rather than free distribution.
And pricing of course affects supply as well as demand: charging more can help a provider cover costs and scale up to serve more people.
Interest on credit is a user fee. A fair fraction of microfinance clients are served by big microfinance institutions, ones that got big by largely covering their costs out of interest charges, as I discuss in the forthcoming chapter 5, and (with Uzma Qureshi) in Microfinance as Business. So if we accept for the sake of argument the NGOs' challenge to user fees, should we conclude that interest is harmful too? Are big microcreditors immorally depriving clients of access to cheaper credit? (Rajeev Dehejia, Heather Montgomery, Jonathan Morduch find that higher interest rates lead to less borrowing in the slums of Dhaka.) Or to turn it around, should the example of microfinance be emulated in other sectors? Ironically, the Microcredit Summit Campaign, part of RESULTS, just announced with pride that the global tally of microcredit clients has passed 100 million, a feat made possible by user fees, i.e., interest. So wouldn't it be great if booming organizations in developing countries were opening financially self-sufficient clinics and schools, and building toll roads, as fast as they are opening microfinance branches?
I am looking for the right analytical attack(s) on this paradox. Do financial services differ from other services in such a way that the practical and moral calculi differ fundamentally? Or are their interesting lessons to be transferred across the divide between microfinance and everything else?
Perhaps the key point is that when someone buys a bed net, she pays the cost today and (perhaps) experiences the benefit of less malaria in the future, which is all too easy to discount. (Holla and Kremer suggest that "time-inconsistent preferences" may be at work, meaning that when the future arrives, the customer views her past decision, say, to not buy a bed net, as unwise. But if a woman takes out a loan, she gets the benefit of cash today and only has to pay the cost in the future. This is more enticing. Does this mean that schooling, bed nets, and everything else good for people should be sold on credit? I'm just trying to map out the logical implications of this paradox.
That's one line of analytical attack. I'm sure there are others. Thoughts?
Zambian-born economist Dambisa Moyo has a new book coming out called Dead Aid. In the lead-up to the launch, she is doing interviews with outlets such as the New York Times and Financial Times. She appears to make an old and serious argument, going back at least to P.T. Bauer's 1971 Dissent on Development, that foreign aid does harm by reducing the accountability of government to the governed. The potential harm is especially great in Africa, where many states get large percentages of their budgets from aid. (For a couple of CGD works on this theme see Moss, Pettersson, and van de Walle's Aid-Institutions Paradox and Birdsall's Do No Harm.)
In case you hadn't noticed, one thing that distinguishes Moyo from Bono, Geldof, Sachs, and Easterly is that she is not a white guy. She is African. So she is powerfully positioned to shoulder her way into that constellation of figures, each of whom has to some extent gained fame by becoming a caricature of an extreme position in the grand debate over whether aid "works." (OK, some of those guys also wrote some good songs.)
Unclear to me is whether it is her goal to join them or forge a more nuanced image. Her NYT interview did raise my eyebrows. I would hate to have my comments to reporters taken too literally, so I will try not to do that to her, and await the book before judging statements like these:
What do you think has held back Africans?
I believe it's largely aid. You get the corruption—historically, leaders have stolen the money without penalty—and you get the dependency, which kills entrepreneurship. You also disenfranchise African citizens, because the government is beholden to foreign donors and not accountable to its people.
If people want to help out, what do you think they should do with their money if not make donations?
Microfinance. Give people jobs.
But what if you just want to donate, say, $25?
Go to the Internet and type in Kiva.org, where you can make a loan to an African entrepreneur.
If you'll forgive a little math geekiness, this yields a system of two equations :
(1) Aid ≠ Microfinance
(2) Microfinance = Jobs
As for equation (1): In fact, a lot of foreign aid, as grants and loans, has supported microfinance in Africa and elsewhere. That includes (in my mind) a lot of official-agency investment, which occurs on below-commercial terms, accepting low returns for the perceived risk, and so contains a subsidy element. So is this good aid? If so, what distinguishes it from bad aid? Is aid for microfinance, just by virtue of being for microfinance, better than aid for education or health or roads? Or is the key that the microfinance support she likes goes around the government? Or that microfinance charges for what it provides? ...in which case would education and health and road-building aid be equally meritorious if they did the same?
As for equation (2), I am aware of no credible evidence that microfinance creates jobs, on average. Of course it has in some cases, but we don't know how representative they are, nor how many jobs are destroyed at enterprises out-competed by micro-financed ones. To the extent that borrowers use microfinance for microenterprise, as opposed to, say, paying school fees, they tend to invest it in small, self-employing ventures---corner stores, vegetable trade---that do not hire. That's not to knock Kiva or suggest that financial services are useless to the poor.
I look forward to reading her book, where perhaps she recognizes these complexities.
Also perhaps of interest is a reply to her book from Jamie Drummond, a close associate of Bono and co-founder with him of the One campaign.
While writing chapter 3--which is on the pre-modern history of financial services for the masses, and will be ready soon--I found many stories with modern resonance. Among my favorite is that of Priscilla Wakefield, the only heroine in the history. The Literary Encyclopedia lists her as an English "children's writer, feminist, travel writer" who lived from 1751 to 1832. A Quaker, she also devoted considerable energy to charitable activities, including founding (arguably) the first savings bank. In starting the small bank, whose deposits were guaranteed by rich patrons, Wakefield was probably influenced by the philosopher Jeremy Bentham. In 1797, he had called for the creation of "frugality banks" to cultivate thrift among the poor, while criticizing the predominant institution to provide such services, the friendly society. For one, the societies usually met at public houses, where members were expected to buy drinks. "Choosing a tippling-house for a school of frugality, would be like choosing a brothel for a school of continence."
Here is Wakefield's thinking, in her own words, as typeset in 1805 and scanned by Google 200 years later:
Savings banks spread quickly up to Scotland, then back down through the British Isles and overseas. By 1820, savings banks were operating in the Netherlands, France, Germany, Switzerland, the United States, and Australia. In 1861, the British government brought its postal service into the savings business. Today, there may be a billion savings accounts worldwide.
Compare and contrast that success with the modern microfinance movement. Two centuries ago, an idea for aiding the poor through financial services caught on and spread across the seas in years. Looking back, we feel pretty cocky about our modern technologies for mass communications; but it turns out that books on boats are powerful too.
The savings bank movement differed from today's microfinance in the motive the promoters usually avowed---cultivating frugality instead of microenterprise---and in the favored means---savings instead of credit. In fact, poor people have probably used savings and credit in similar ways, as I describe in chapter 2. Financial services are (imperfectly) interchangeable. You can save up to start a business, or borrow. You can get an emergency loan to cover doctor fees or, if you're lucky, use insurance. If the dominant story about how poor people can and should use savings, credit, and other financial services has changed so much over time, that's a sign that we should doubt currently fashionable thinking.
Aside from the "bookend" chapters (now there's an odd metaphor), this book is really a series of perspectives on microfinance: the historian's perspective, the microfinance manager's perspective, the economist's perspective, and so on. The first perspective, in chapter 2 (.doc.pdf), is that of poor clients. To borrow the title of Stuart Rutherford's great book, it is about the poor and their money.
Aware of the potential presumptuousness of a white American seeing the world through the eyes of billions of poor people, I begin by inventorying how I use financial services, and inviting you to do the same. I then use this as a point of departure to talk about how the financial challenges and strategies of the poor compare and contrast with those of the rich, whom I define to include the materially comfortable global middle class. I argue that poor people want financial services for the same broad reasons as rich people: not only investing (in microenterprises), but also transferring money, managing consumption, attaining ownership of houses and other assets. But the financial challenges for poor households are qualitatively tougher because most poor people do not have jobs. They tend to diversify across several economic activities, often deliberately refraining from investing too much in any one. In general, because of the unpredictability of their financial circumstances, poor people actually need financial services such as savings, credit, and insurance more than the rich--but can access them less.
The chapter closes with a survey of the role of financial systems in economic development, suggesting that the greatest contribution of finance to poverty reduction may lie in supporting the growth of formal, job-creating enterprises.
Do these ideas make sense to you? What seems wrong? Post comments on chapter 2 as comments on this blog entry.
Thanks to Mai Pham and Anna Rain for edits on earlier drafts.
In chapter 6, I liken the old argument between Mark Pitt and Jonathan Morduch over the meaning of Pitt and Khandker's paper on the impact of microcredit to "a debate between two nuclear physicists over obscure properties of uranium isotopes." Then, I'm just realizing now, I mix my metaphors: "And not even the litigants could fully explain what was going on because each used his own methods and did not, or could not, reconcile his results with the other’s." I'll fix the mixed metaphor. At any rate, this bewilderment about something important is why I waded into the debate and became one of those physicist-lawyers. Now I realize how a lot of you must have felt reading the continuation of that old debate.
It must have felt like reading this note from David Bergman:
And it goes on ...... In the appellate division, Tuesday was mostly taken up with the Attorney General and Bangladesh Bank's lawyers arguing that the court should not recall its earlier order which dismissed Yunus's application to get leave for appeal (against the High Court order) and also to argue why an appeal was (in any case) not necessary
Science says: Liberals more open-minded, conservatives more "conscientious". http://t.co/AzAmmN4x But that's just one view. #
Did Humans Invent Music? - The Atlantic Great debate on whether musicality is an evolved trait http://t.co/M453vAOB#