I’m in the midst of doing my final project for Freedom from Hunger, a throwback to my former life as an academic researcher. It has me crawling through our theory of change to deconstruct it and examine the evidence for each of the cause-and-effect linkages within—evidence from Freedom from Hunger’s research but also research by others on similar group-based microfinance programs. The most compelling evidence comes from high-quality descriptive studies confirmed or corrected by one or more field experiments, or RCTs.
I’m doing this online, as a blog called The Evidence Project. I’m posting my findings as I go, aiming for about one post a week. And what I’m finding has significance not only for Freedom from Hunger, but for all those offering microfinance to support the self-help of very poor people—and even not so poor people.
One cause-and-effect pathway within the Freedom from Hunger theory of change is the same as the classic microfinance theory of change, which involves three steps that people from poor households are assumed to take. First, they tap microfinance services (primarily as loans and/or savings); second, they invest this money in microenterprises; and third, they manage these microenterprises to yield enough return on the investment to increase their household income and consumption—leading to poverty reduction.
Evidence to date makes this theory look problematic.
Let me describe the problems step by step. First, many (perhaps half?) poor households don’t tap microfinance services even when they are locally available. I said “perhaps half” to acknowledge that data on this step are surprisingly scarce. Second, of those who do use microfinance services, many (perhaps half again?) do not invest part or any of their loans and/or savings in microenterprises. The data are remarkably sparse, so these are really best guesses based on what I’ve found so far. We do know for sure there is tremendous variation from place to place. But in very general terms, it seems that only about one quarter of the eligible households who have access to microfinance are using them to invest seriously in microenterprise. So already, you can see that the potential population effects of poverty reduction by microfinance, that is, the average effect for whole communities, are likely to be small. Even smaller, however, because in the Third step of the classic theory of change, most of the microenterprises in which loans or savings are invested remain quite small with only modest returns on investment—generally not enough to lift the household out of poverty.
Let’s be clear. There are many, many well-documented cases in which poor households do in fact invest their loans or savings or both in microenterprises that do in fact grow and yield enough profit to substantially increase the household’s income and consumption, sometimes even enough to rise above the national and international poverty lines. But these cases are a minority of the households that participate in microfinance. Again, there are surprisingly few data on just how sizeable the minority is, but they are still a minority, which challenges the classic microfinance theory of change as the overall rationale for investment in the infrastructure and operations of microfinance.
Now – Does this mean that microfinance is a failure? Of course not! It means the classic theory of change is inadequate. It doesn’t describe the full value of microfinance for the majority of poor households who participate. Yet participate they do – at least 150 million relatively poor households do! So what’s going on? What’s in it for them?
Consider this quote on p. 101 of the March 2000 paper by Jennefer Sebstad and Monique Cohen—this was the capstone to the 1990s AIMS Project of the USAID office now led by Shari Behrenbach; AIMS stands for Assessing the Impacts of Microfinance Services. Here’s the quote:
The use of loans to smooth incomes and the resulting impact on reducing the variability of consumption suggest the positive impact of microcredit on reducing the vulnerability of client households, but not necessarily their income poverty.
Let me emphasize: Reducing vulnerability but not necessarily their income poverty. The quote goes on:
One explanation for greater impacts on vulnerability, … , is that there are many channels through which microcredit can reduce vulnerability, but fewer channels through which it can single-handedly reduce poverty.
In short, a lot of people use microfinance to reduce their vulnerability (i.e., manage the risk of) consumption interruptions and financial shocks for their households. Enterprise investment can be seen as just one of a suite of tools that people use to reduce their vulnerability. However, unlike other risk management tools, investment in microenterprise can have the happy consequence of actually raising total household income, as well as smoothing income through the year. As we’ve seen in at least two recent, excellent books, Portfolios of the Poor and Poor Economics, most households are not counting on this poverty-reduction effect of microenterprise investment; they just do business as one of several ways to keep the wolves of hunger and ill health at bay, to clothe and shelter themselves, and to have a little enjoyment in their lives, too. Call this poverty alleviation—reducing the uncertainties and stress of being poor. Not so many are using microfinance in a way that will raise them from the ranks of the poor—poverty reduction—because there just aren’t that many opportunities for thriving enterprise in the absence of robust local economic development.
It’s notable that the quote I just read to you is from a paper released in March 2000, 12 years ago, well before the recent round of RCTs, financial diaries, and research syntheses came to much the same conclusions (based on a firmer evidence base, of course). We’ve known this truth about microfinance for some time now, but the dominant microfinance theory of change has been slow to yield to a more comprehensive theory that is in sync with the full range of motivations of the poor to use microfinance.
So what would be this more comprehensive theory of change? Try this on for size (with some wording from page 93 of the Sebstad and Cohen paper):
People from poor households tap microfinance services to smooth consumption and build assets to protect against risks ahead of time and cope with shocks and economic stress events after they occur—leading to poverty alleviation.
A decade later, this is also the narrative emerging from the financial diaries reviewed by Portfolios of the Poor and the research summarized in the three recent books More Than Good Intentions, Poor Economics and Due Diligence. A new theory of change is emerging for microfinance. Not only is it shaped by the results of research. More or less independently, perhaps in spite of that research, the microfinance industry has been adjusting in this direction toward supporting resilience strategies of the poor as it has become more sensitive to client demand – by moving toward a mix of loan, saving and other services and greater flexibility and choice to accommodate the use of microfinance for supporting resilience rather than focusing just on the needs of microentrepreneurs.
It’s axiomatic that satisfaction is a function of expectation. In the microfinance world, our expectations were set initially by the origin of microfinance in the microenterprise development movement. The dominant perspective has long been that microfinance is an input for microenterprise development. While microfinance became the tail that wags the microenterprise dog, it is still a dog’s tail. So the impact evidence to date is disappointing in this perspective.
But it doesn’t have to be disappointing. If our perspective were that of the relatively new “resilience” movement, we would be celebrating. Most of us in microfinance don’t know about the resilience movement, because its origin is in the foreign territory of the humanitarian relief world.
The “resilience” folks would be delighted by the reduction of vulnerability experienced by poor households when taking advantage of reliable access to self-financing (i.e., market-based) microfinance institutions and similar entities. This “resilience” perspective helps to show how the actual impacts of microfinance (compared to the hoped-for impacts) have great value.
Now, here’s the same old question: What is the evidence? The research to date has been testing mainly the classic theory of change, not the new narrative. What is the evidence so far to support the emerging theory of change? What is the evidence that participation in microfinance actually generates these “resilience” benefits?