Microentrepreneurs and their money: three anomalies

Joint with Dean Karlan and Sendhil Mullainathan

March 16, 2007

Motivation

Microfinance has grown extremely fast Yet we know little about the production side –

the uses of money What are the investments that are profitable

enough to pay off MFIs? Investment environment?

Implications for MFIs Design of loan products Other financial products High-impact non-financial interventions

Anomaly # 1: borrowing persistence A typical urban working poor profile

Has a small vegetable vending business Daily working capital cycle Borrows Rs. 1000 in the morning and repays Rs.

1100 at the end of the business day Has been in this cycle for 10 years

Why is this an anomaly?

Return from not borrowing is 10% overnight! Working capital outlays small enough to be

‘saved up’ in a few months Power of compounding

Why do we observe this persistence of high-cost borrowing?

Possible explanations

Mismeasuring ‘true cost’ of the loan Desire to keep relationship with money lender

Access to savings devices Intra-household savings conflicts Mis-construal of compounding

Do not understand how much they’re losing

Current work

Give cash to get people out of debt trap Ask whether they fall back

Would rule out pure consumption constraints (i.e. could not cut back on consumption to finance getting out of trap)

Test efficacy of financial planning and savings interventions to prevent fall-back

Anomaly # 2: too few joint production ventures Typical investment opportunity

2 types of cows: Rs. 5000 and Rs. 10000 Rs. 5000 cow yields Rs. 500/flush month Rs. 10,000 cow yields Rs. 1200/flush month So 10,000Rs. cow earns 20% higher rate of

return Why do joint liability group clients

consistently choose lower return cows?

Why is this an anomaly?

Costs of cooperation do not deter from joint borrowing

Group solidarity hypothesis would predict more joint production

What are the implied limits to monitoring? Note: the cow production function is especially

simple Could alternate days in taking care of the cow Input feeding should be easy to monitor in small

groups

Possible explanations

Joint production more expensive than joint liability

Joint liability is an added tax, but cheaper than alternative

Risk diversification

Current work

Individual vs joint liability borrowing, Philippines (Gine and Karlan, 2006)

Anomaly # 3: role of non-financial market failures What is going on in other markets that MFI clients

are part of? Labor? Asset rental?

Why is this an anomaly?

How much are MFI investments sustained by these failures?

‘Unwitting entrepreneurs’? Is credit the best intervention?

Possible explanations

Labor market failures (Emran, Morshed and Stiglitz, 2006)

High business risks and depreciation

Planned work

Evaluate MFI interventions in secondary markets Daycare Asset rental Financing SMEs that employ MFI clients

Thank you

Buffalo cost 6000

Daily revenue 24

Monthly revenue 720

Annual revenue 5760

Annual feed cost 2400

Net profits 3360

Capital costs (25%) 1500

Net profits after capital costs

1860

Labor 2700

Daily pushcart rental rate

30

Annual rental cost 10950

Cost to purchase 2000

Annual rent to cost ratio

5.475