THE MACROECONOMICS OF MICROFINANCE; Financial Deepening, Macro-Stability, and Growth in Developing Countries; September 24, 2012

We provide a quantitative evaluation of the aggregate and distributional impact of microfinance or credit programs targeted toward small businesses. We find that the redistributive impact of microfinance is stronger in general equilibrium than in partial equilibrium, but the impact on aggregate output and capital is smaller in general equilibrium. Aggregate total factor productivity (TFP) increases with microfinance in general equilibrium but decreases in partial equilibrium. When general equilibrium effects are accounted for, scaling up the microfinance program will have only a small impact on per-capita income, because the increase in TFP is counterbalanced by lower capital accumulation resulting from the redistribution of income from high-savers to low-savers. Nevertheless, the vast majority of the population will be positively affected by microfinance through the increase in equilibrium wages. Francisco J. Buera Department of Economics University of California, Los Angeles 8283 Bunche Hall Office 8357 Mail Stop: 147703 Los Angeles, CA 90095 and NBER [email protected] Joseph P. Kaboski Department of Economics and Econometrics University of Notre Dame 434 Flanner Hall Notre Dame, IN 46556 and NBER [email protected] Yongseok Shin Department of Economics Washington University in St. Louis 1 Brookings Dr Saint Louis, MO 63130 [email protected] Over the past several decades, microfinance—i.e., credit targeted toward small-scale 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 to microfinance grew by up to 29 percent a year, reaching a scale at which macroeconomic considerations become relevant. The Microcredit Summit Campaign as of 2010 reports 3,552 institutions serving 155 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 their GDP. Despite the growth and prevalence of microfinance and its 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 impact of economy-wide microfinance availability, with particular attention to general equilibrium (GE) effects. We find that the typical microfinance program, when made widely available in an economy, can have significant aggregate and distributional impacts, and that the GE effects through wages and interest rates are quantitatively important. In partial equilibrium (PE), microfinance induces a high rate of entry among marginally productive entrepreneurs, increasing the capital/labor demand and output, but lowering the aggregate total factor productivity (TFP). In GE, however, the increase in wage that results from marginal entrepreneurs selecting out of the labor supply—and demanding labor instead—has strikingly different impacts on output, capital, and TFP. In redistributing income away from individuals with high saving rates (high-ability entrepreneurs) to those with low saving rates (marginal entrepreneurs and workers), microfinance leads to lower aggregate saving and capital accumulation. Higher wages and interest rates also lead low-productivity entrepreneurs to exit, and TFP actually increases with microfinance in contrast to the PE result. In net, the lower capital accumulation and higher TFP lead to positive overall impacts on consumption and output, but the magnitudes are substantially smaller than in PE. 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 achieve their Millenium Development Goals. The scaling up of microfinance is usually understood as the expansion of programs providing small loans to reach all the poor population, as opposed to increasing the average size of loans. Examples are Bangladesh (0.03), Bolivia (0.09), Kenya (0.03), and Nicaragua (0.1), as calculated using loan data from the Microfinance Information Exchange and domestic price GDP from the Penn World Tables. We note two important exceptions. Ahlin and Jiang (2008), using the model of Banerjee and Newman (1993), derive the theoretical conditions under which microfinance can lead to aggregate development. Kaboski and Townsend (2012) use reduced-form methods to estimate the general equilibrium effects of village banks on wages and interest rates within the village.