JUNE 5, 2011, 8:57 AM IST

Why Doesn’t Microcredit Create Entrepreneurs?

The authors of a new book that looks at ways to reduce poverty around the world (and whether they work) have
suggested one possible reason why the microcredit model may not be creating more entrepreneurs: It rewards
cautiousness.

Microfinance institutions have “rigid rules” that require small loans of

a pretty fixed size, a weekly cycle of repayment often starting within
one week of loan issuance, and lending to groups whose members
keep an eye on each other, say the authors—economists Abhijit V.
Banerjee and Esther Duflo.

“There is a clear tension between the spirit of microcredit and true

entrepreneurship, which is usually associated with taking risks and,
no doubt, occasionally failing,” they write. “It has been argued, for
example, that the American model, where bankruptcy is (or at least
Sam Panthaky/Agence France-Presse/Getty Images
was) relatively easy and does not carry much of a stigma (in contrast
A microfinance loan recipient in Gujarat noted weekly
with the European model, in particular), has a lot to do with the
repayments from fellow borrowers in January.
vitality of its entrepreneurial culture. By contrast, the MFI rules are
set up not to tolerate any failure.”

The book cites a study that allowed some clients to begin repaying
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This might appear to be more fodder for critics of the microfinance
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Mr. Banerjee and Ms. Duflo don’t say microcredit firms are
necessarily wrong to focus on inculcating strict repayment discipline or keeping loan sizes small. In fact, that may be
exactly the right approach, they say, for lending in the circumstances in which they operate. Those small loans just won’t
necessarily create businesses. And maybe that’s okay. The implication of this section seems to be that financing
entrepreneurship and reducing lending costs for the poor are two different goals—and perhaps don’t need to be
combined.

For those who see microcredit as a way to give poor households a little more flexibility in making financial decisions and
to improve their lives, the industry is already accomplishing a fair bit. No one faults credit card holders, after all, for using
their cards to take advantage of a great discount on a necessary purchase and save money, rather than to set up a
business (as long as they pay back their debts on time).

In 2009, Mr. Banerjee and Ms. Duflo found distinct differences in neighborhoods around the city of Hyderabad where the
microfinance firm Spandana expanded. They compared the 52 areas the company entered, chosen at random out of a
total of 104, to the ones it didn’t, after a period of 15 to 18 months.

Although they didn’t see a “radical transformation” and the fraction of families that started businesses went up only from
5% to 7%, there were positive developments in the neighborhoods with access to the cheaper credit.

“People in the Spandana neighborhoods were more likely to have purchased large durable goods, such as bicycles,
refrigerators or televisions,” they wrote. “Households that did not start a new business were consuming more in these
neighborhoods, but those who had started a new business were actually consuming less, tightening their belts to make
the most of the new opportunity.”

They suggested critics might regard the accomplishments of microcredit firms more kindly if these institutions would
acknowledge their limits, particularly in fostering small businesses.

Mr. Banerjee, 40, and Ms. Duflo, 38, who are described by their Indian publisher as “the two hottest young economists
today,” are at the forefront of shift to using randomized controlled trials to test poverty initiatives, most notably at MIT’s
Abdul Latif Jameel Poverty Action Lab, which they founded along with Harvard economist Sendhil Mullainathan. Those
trials, modeled on those used to test medicines, involve comparing groups where one set of people was randomly
assigned to get the treatment or intervention in question, and the other (the control) wasn’t.

“Poor Economics,” which was published in the U.S. in April and is out this month in India from Random House, is one of
several new books that talk up the importance of testing anti-poverty programs to see what they’re actually
accomplishing. New York University economics professor William Easterly, who is known for his skepticism towards
foreign aid, reviewed it for the Wall Street Journal, along with the very similar “More Than Good Intentions,” in April.

The book probably doesn’t contain surprises for readers familiar with development issues in India, but there are some
nice anecdotes from their India research.

One of them describes how Nachiket Mor and Bindu Ananth, who were developing financial products for the poor at the
ICICI Foundation at the time, unwittingly created a market for cow’s ears when they tried to set up a cattle insurance
program a few years ago. Both are now with the IFMR Trust, an Indian group that aims to promote financial inclusion
through market principles.

How? By instituting a requirement that policy holders making a claim for a dead cow must produce the said beast’s ear.
Soon, enterprising sorts were cutting the ears off any cows that died, insured or not, and selling them to policy holders
who wished to file a claim but whose cattle were still alive and kicking.

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