Do Microfinance Projects Reduce Poverty

The Economist this week has an article on the evidence supporting the efficacy of microfinance programs, citing two recent papers:

“The Miracle of Microfinance? Evidence from a Randomised Evaluation” by Abhijit Banerjee, Esther Duflo, Rachel Glennerster and Cynthia Kinnan, May 2009. “Expanding Microenterprise Credit Access: Using Randomized Supply Decisions to Estimate the Impacts in Manila” by Dean Karlan and Jonathan Zinman, July 2009.

The article suggests that there is very little evidence from methodologically sound studies of the effectiveness of these programs. While there are lots of true believers, there are also skeptics as to the utility of the programs.

The two research projects suggest that the microfinance project which they studied did not reduct poverty, although one suggested that in the short term effect was to switch purchases into longer term, more durable materials and The Economist inferred that that might have a long term beneficial impact on poverty.

The Economist article states that

despite growing interest from private investors, 53% of the $11.7 billion that was committed to the microfinance industry in 2008 still came at below-market rates from aid agencies, multilateral banks and other donors.

Of course, if microfinance does not reduce poverty, one should question the allocation of scarce donor funding to microfinance programs. On the other hand, it might be the case that the donor subsidies for loans to poor people are a reasonable approach to humanitarian aid since the loans tend to generate new forms of matching funds. I assume that there is a welfare improvement when people can borrow to make an immediate purchase, paying back the loan later.

The Economist has a touching faith that since microfinance programs trigger investment in microenterprises, they should have an eventual economic benefit. I wonder how much money is lost by incompetent entrepreneurs encouraged by the availability of microfinance to invest in businesses they are incompetent to run well.