A Looming Puzzle About Microfinance

This is my first post, so I want to start by saying a bit about who I am, and why I’m writing this. Second, I want to describe a looming puzzle about microfinance.

First, about me: I’m a professor at NYU, where I teach in the Wagner Graduate School of Public Service. NYU is fueled by the energy of downtown New York. The ethos is very entrepreneurial, and my colleagues share commitments both to ideas and to action.

In the past few years, Wagner has created new programs on social entrepreneurship and global development—and that’s been my focus too. I teach a course on International Economic Development which aims to help students better understand why so much poverty persists amidst so much wealth on the planet—and what can be done about it.

My sharpest focus has been on microfinance, driven by a particular interest in the financial lives of poor households. Two years ago, I helped launch FAI, the Financial Access Initiative , a consortium of researchers at NYU, Yale, Harvard, and Innovations for Poverty Action (IPA is a research-focused NGO), and I’m now Managing Director. The Gates Foundation gave us a running start toward reaching twin goals. First, to do cutting-edge research on the big unknowns of microfinance. (IPA now has research teams in the Philippines, India, Peru, Ghana, Mexico, and elsewhere, piloting new financial products and putting ideas to the test.) Second, to communicate lessons beyond the ivy-covered walls of academia. (Or, at NYU, beyond our graffiti-covered walls.) I advise non-profit networks like Pro Mujer and the Grameen Foundation, and international institutions like the World Bank and United Nations.

The first job has been to show that most poor people do in fact have financial lives, even if they’re living on under $2/day or $1/day in countries like India or Bangladesh or South Africa—three countries in which an amazing set of “financial diaries” show this with rich texture. The diaries follow households over the course of a year, and show how the households save and borrow and insure in varying (and often clever) ways. The second job is to find ways to improve those strategies. I’m excited about new technologies like mobile telephone banking and smart cards, but also about doing better at basics: like designing savings accounts with features that help people save more (no surprise: discipline helps!).

Which takes me to the puzzle. I just wrote a short piece for FAI on what we know about how much financial access improves the profits of small businesses. This is the heart of the idea of microfinance, the idea that won Muhammad Yunus and Grameen Bank their Nobel Peace Prize in 2006. Yunus argues that the benefits of financial access can be huge, raising incomes and transforming lives.

The anecdotes are inspiring. Consider, for example, the story of Vidalia Mamami, a 43 year-old vegetable seller in Tacna, Peru. She sells vegetables from a stand in a local market, and her earnings help support her husband and five children. She had been in business for 21 years, but only recently turned to Pro Mujer’s Peruvian branch for a business loan:

With my first loan I was able to buy more merchandise for my business and I was able to add vegetables and condiments, which have increased my earnings. Before, I earned 18 to 20 soles per day by selling only fruit, but now that I have added vegetables and condiments, I earn an average of 30 to 35 soles per day. This money has allowed my family to eat better and allows me to do things for my children that I could never do before. I remember how my older children were not able to go to school because we didn’t have enough money.

The story puts together a dramatic increase in earnings and ties it to broader social impacts. But it’s not just anecdotes. New work from Mexico shows huge returns to expanding capital in small-scale businesses, both in national surveys and in regional experiments: entrepreneurs are increasing profits by an extra 15 percent per month (or more) thanks to expanded capital access. These results don’t hold everywhere or all the time, but they do show that microfinance rests on more than cherry-picked stories.

The big puzzle is: where the returns to having more capital are so high, why aren’t the entrepreneurs saving more (and then investing their savings in their businesses)? If, as a poor entrepreneur, you could catapult your livelihood just through access to a bit of extra capital, why wait for a microfinance institution? Why not save your way to a better life?

The biggest part of the answer has to be that saving is hard. Saving is hard for all of us, and especially hard if you’re on living on tight economic margins. Improving ways to save isn’t necessarily more important than expanding access to loans, but it’s fundamental. Improving ways to save will mean more than spreading bank branches, though that’s a start. It will also mean developing products that are reliable, can work in poor communities, be amenable to regulation, and build on understandings of both the economics and psychology of saving. The Gates Foundation is interested in the savings agenda, and field work is showing promising leads. Odds are that this is the next Big Thing in microfinance.