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A microloan can help poor people in Bangladesh. What about New Jersey?

A new study of low-income American women finds that small loans can help them a little.

Building across a river in New Jersey.
The New Jersey skyline.
Wikimedia Commons

For a while, microfinance was the hottest trend in global development. The promise? That you could transform a poor person’s life with a very small loan that would let them start their own business — and then the lender gets their money back, which could then go on to transform someone else’s life.

That early promise proved to be inflated. Microfinance did not, in fact, solve global poverty. But it wasn’t a complete failure either. Under the right circumstances, it does seem to improve conditions for some poor people.

This month, a new study affirmed that finding in an unlikely place: New Jersey.

The Grameen Bank, one of the pioneers of microfinance, which has been operating its program in Bangladesh since the 1970s, released a study on one of its programs in New Jersey. The program works like this: Low-income women apply for a microloan as part of a small group, and all members of the group are accountable for ensuring each member makes payments (that’s the approach Grameen has found does the most to increase repayment rates).

Initial results six months into the study have been positive. “The Grameen America program produced improvements in several measures of material hardship — for example, how often the respondent ran out of money in the three months preceding the survey, the respondent’s ability to afford necessities, and the respondent’s current financial situation compared with the previous year,” the report states.

It’s the first randomized test of Grameen’s smaller and newer US-based programs, and, their paper argues, “perhaps the most rigorous test of group microlending in the United States to date.” We’ll need more evidence to be confident in the results, but they largely track what the literature on microfinance says.

But something bothered me when I read about the New Jersey microfinance trial. It wasn’t anything about the trial itself, which looks systematic and well designed. It had more to do with the conversation around microfinance that the development world has been having for the past couple of decades.

The initial narrative about microfinance was incredibly hopeful — unsustainably so. To think back to the height of optimism about microfinance is to think of a lot of claims that were embraced pretty unskeptically by many philanthropists — that every poor person could become a business person, that every small group of five desperately impoverished women had a promising business idea just waiting to happen, that the poor were just one boost away from prosperity.

It’s hard to imagine any of those claims being made with a straight face about poverty in New Jersey, and very few were. When Americans think about poverty in their own communities, we tend to think of it as a complicated and multicausal problem — that there are some poor people who may just need a loan but many more who likely need a lot more than that. Even in the heyday of microfinance, you couldn’t market an antipoverty program in New Jersey by promising donors that you’ll unleash the inner entrepreneur in every human being — at least not without attracting lots of skepticism.

So why did we believe that about Bangladesh?

What we know about microfinance now — and what we thought we knew then

A 1999 Harvard Business Review article is emblematic of the thinking behind microfinance two decades ago.

The piece puzzled over the fact that microfinance, which had supposedly been transforming the developed world — a claim it took at face value — had such modest results when it’s put to work in the United States.

“Microcredit programs have been used throughout the Third World to promote grassroots entrepreneurship. The programs, which provide small-business loans of as little as $50, have helped literally millions of low-income people improve their material well-being,” the article argues. (We now know that microcredit likely does not affect material well-being — income and consumption barely change among people offered credit.)

But in the US, the article notes, no such magic has been happening. “Our survey of more than 33 loan programs in California, for instance, revealed that each program made only seven loans per year on average and that too much available capital — about half of it — sat idle. Some program managers attributed the low volume of loans to a lack of viable proposals from people who would be likely to repay the money; others reported a lack of demand.”

Now, some of the problems the article cites with US microfinance — higher overhead because salaries in the US are much higher, slowness at dispersing money, red tape that US entrepreneurs have to navigate — seem like genuine partial explanations for the more disappointing results.

Others, though, should obviously have applied in developing countries as much, or more than, they applied in the US. For instance, the article points out that many applicants in the US “lack small-business management skills and a large enough base of customers” but assumes that wouldn’t be a problem in developing countries because of less competition. Lack of business skills is a challenge for entrepreneurship charities in the developing world, too.

Another explanation proffered by that Harvard Business Review article elegantly anticipates concerns that microcredit involves predatory lending practices, while at the same time missing the concern entirely: “U.S. programs,” it laments, “also face legal limits on the interest rates they can charge, which further complicates their efforts to cover costs. Third World programs, by contrast, have much lower overhead and can charge interest rates that exceed 30%. Those advantages give them a higher chance of attaining financial self-sufficiency.”

That’s one way of framing it. Another, of course, is that microfinance is only sustainable when it charges interest rates in excess of 30 percent, and in that case, it’s very, very rarely going to make the entrepreneurs coaxed into accepting such loans much better off.

Revisiting this piece now, one comes away with the impression that we could have accurately anticipated the limited effects of microfinance in the developing world if we’d taken seriously what was implied by the limited effects in our own backyard. Instead, philanthropists kept working with untrammeled optimism on microfinance in the developing world.

Microfinance today — and in New Jersey

The microfinance enthusiasm of the early 2000s has given way in recent years to a lot more skepticism — including India determining most microfinance programs to be predatory lending and banning them, stories of suicides among recipients, and new research suggesting the positive effects, while not imaginary, are fairly small.

As Stephanie Wykstra summarized for Vox:

The most recent six microcredit studies, published in 2015, were conducted by economists working independently across six countries. The studies found fairly consistent results: None found evidence that income went up on average among those offered credit. A few saw modest positive effects, such as people choosing to spend more time on their small businesses and some changes in spending habits. Abhijit Banerjee, Jonathan Zinman, and Dean Karlan sum up the studies, concluding, “We note a consistent pattern of modestly positive, but not transformative, effects” — not the result that many people had hoped for.

That seems like bad news in comparison with the grandiose promises, and flimsy, eye-popping research that was used to prop up the initial wave of interest in microfinance.

But in another respect, such modest findings actually are good news. Poverty is a hard problem. Almost any solution will be a moderate, partial one.

Sure enough, those are the results we’re seeing six months into the Grameen America study in New Jersey. The best way to study program results for an intervention like this is a randomized controlled trial, in which some groups of women are assigned to receive a loan and others are assigned to receive no loan, but be tracked over time anyway. Follow-ups are scheduled for six, 18, and 36 months into the program.

We’re getting the six-month results now. The program found that recipients were less likely to run out of money, more able to afford necessities, and assessed their financial situation as better — though no improvements in income were measured yet.

It remains to be seen whether the recipients in New Jersey will buck the trend that microfinance programs don’t increase income, even as they do improve some variables associated with well-being. The improvements in measures of material hardship are promising, but I’d still bet against effects on income, which just seem very hard to achieve from microfinance even when other indicators are all promising.

And one particular figure in the report gave me grounds for hesitation. “Thirty-three percent of sample members were operating or intended to operate a direct-selling business at study entry. Examples of the listed businesses include cosmetics companies like Avon, Jafra, and Mary Kay; herbal/natural medicine companies like Herbalife; cookware companies like Royal Prestige; and companies like Amway that sell a variety of personal and home products,” the report noted.

Such multi-level marketing schemes are money losers for nearly everyone involved, and many of them use dishonest practices. To the extent that microlending enables poor people to buy into the expensive initial training and startup kits for multi-level marketing schemes, they may end up doing those people long-term financial damage. That problem, more than most that microfinance faces, would be uniquely American.


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