The Macroeconomics of Microfinance

This paper provides a quantitative evaluation of the aggregate and distributional impacts of economy-wide microfinance or credit programs targeted toward small-scale businesses. In our analysis, we find that the redistributive impacts of microfinance are stronger in general equilibrium than in partial equilibrium, but the aggregate impacts are smaller. Making the typical microfinance program more widely available has only a small impact on per-capita income, since an increase in aggregate total factor productivity (TFP) is offset by lower capital accumulation that stems from the redistribution of income from high-saving individuals to low-saving ones. However, the vast majority of the population are positively impacted by microfinance, but only through the equilibrium increase in wages. UCLA and NBER; [email protected] University of Notre Dame and NBER; [email protected] Washington University in St. Louis and Federal Reserve Bank of St. Louis; [email protected] Over the past several decades microfinance— meaning credit targeted toward smallscale entrepreneurial activities of the poor who may otherwise lack access to financing— has become a pillar of economic development policies. In recent years, there has been a concerted effort to expand such programs with the goal of alleviating poverty and promoting development. Between 1997 and 2006, access grew by up to 29 per cent a year, reaching a scale at which macroeconomic considerations become relevant. The Microcredit Summit Campaign as of 2007 reports 3,552 initiatives serving roughly 107 million borrowers, which including borrowers and their households affect 533 million people, roughly the size of Latin America. For various countries, microfinance loans represent a significant fraction of GDP. 2 Despite the growth and magnitude of such interventions and their importance in academic and policy circles, quantitative analyses of these programs are almost exclusively limited to microevaluations. The macroeconomic effects of economy-wide microfinance have been largely unexplored. This paper is an attempt to fill that void by providing a quantitative assessment of the potential impacts of economy-wide microfinance availability. We focus on a single important aspect of scaling up microfinance: general equilibrium (GE) effects. We find that typical microfinance, when made widely available in an economy, can have significant aggregate and distributional impacts, and that the GE effects on interest rates and wages are quantitatively important. Microfinance is a pro-poor redistributive policy, benefitting the poor and especially marginal entrepreneurs and potentially hurting the most able entrepreneurs. A resulting increase in wages greatly amplifies this aspect of microfinance. Microfinance redistributes income away from individuals with high saving rates (high-ability entrepreneurs) to those with low saving rates (marginal entrepreneurs), lowering aggregate savings. Higher interest rates partially mitigate this, but in the general equilibrium lower savings lead to lower capital accumulation. Although microfinance has a positive impact on total factor productivity (TFP), wages, and consumption, given lower capital accumulation, it has substantially smaller long-run impacts on aggregate output. This contrasts with the partial-equilibrium The United Nations, in declaring 2005 as the “International Year of Microcredit,” called on a commitment to scaling up microfinance at regional and national levels in order to help achieve their Millenium Development Goals. The scaling up of microfinance is often understood as the expansion of programs providing small loans to reach all the poor population, as opposed to expanding the size of loans provided. Examples are Bangladesh (3%), Bolivia (9%), Kenya (3%), and Nicaragua (10%), as calculated using loan data from the Microfinance Information Exchange and domestic prices GDP numbers from the Penn World Tables. The microevaluations of the economic impacts of microcredit on households include Pitt and Khandker (1998), Banerjee et al. (2009), Kaboski and Townsend (2010a), and Karlan and Zinman (2010a,b). We note two important exceptions. Ahlin and Jiang (2008), using the stylized model of Banerjee and Newman (1993), derive the theoretical conditions under which microfinance can lead to aggregate development. Kaboski and Townsend (2010b) use reduced-form methods to estimate the general equilibrium effects of village banks on wages and interest rates within the village.