NextBillion - An Initiative of the William Davidson Institute at the University of Michigan

Wednesday, December 9, 2015

When Benita Chikaluma’s husband died in 1994, her family could easily have fallen into desperate poverty. Chikaluma lives in Malawi, a poor country in southern Africa where women often have little control over their finances. But thanks to the tiniest of loans — just $25 — she was able to build a business, first selling firewood and then empty plastic bottles, and now owns a home with running water and electricity.

Chikaluma’s story was told in a recent fundraising letter from FINCA, a nonprofit organization that makes small loans to people, primarily women, in developing countries. An accompanying brochure quoted Natalie Portman, Bono and Hillary Clinton praising FINCA’s approach, which the organization called “a proven solution, not temporary relief.” And it cited Jonathan Morduch, a respected New York University economist, calling small loans “one of the most promising and cost-effective tools in the fight against global poverty.”

What the mailing didn’t mention was that Morduch’s quote was from 2005, before a decade of research called into question the effectiveness of so-called microcredit as a tool for fighting poverty. More recently, a series of six independently conducted randomized controlled trials found that a variety of microlending programs had little to no effect on participants’ income or financial well-being. Morduch now says that the studies, along with earlier research that reached similar conclusions, suggest that the impacts of microcredit have been, at a minimum, “overhyped.” (A FINCA spokesman said Morduch’s quotation would be removed from future mailings.)

Researchers say the recent studies carry a broader message about the need for rigorous research in charitable programs. Microcredit has grown into a $60-billion-plus industry reaching 200 million borrowers worldwide despite limited evidence that it actually achieves its goals. Anecdotes like Chikaluma’s are powerful, they say, but only data can reveal what programs work and, just as importantly, how to make them more effective.

The idea behind microcredit is compelling in its simplicity: In many parts of the world, the best pathway out of poverty is entrepreneurship — selling firewood or food or clothing. But the poor often can’t cobble together even the few dollars necessary to get such businesses off the ground. By giving people access to small loans — often in the hundreds of dollars or even less — microcredit organizations allow would-be entrepreneurs to buy, for example, chickens to produce eggs or a refrigerator to keep food cold. And because the help comes in the form of a loan, not a grant, a single dollar of aid can be recycled to help many people.

Microcredit rose to prominence in the 1990s thanks to the success of the Grameen Bank, a Bangladeshi community development bank founded by economist and social entrepreneur Muhammad Yunus. In 2006, Yunus and the bank were jointly awarded the Nobel Peace Prize “for their efforts to create economic and social development from below.” By then, the model had spread to dozens of countries on six continents; supporters hailed microcredit as a key step in achieving Yunus’s vision of “a world without poverty.”