Can small loans reduce poverty?

National Science Foundation: Small loans, somewhere in the neighborhood of $100 to $500 dollars, are an increasingly popular weapon in the fight to reduce poverty. Called microcredit, institutions dole out these monetary advances to help extremely poor people engage in successful entrepreneurship and improve their quality of life.

While proponents extol its virtues, researchers look for evidence; they want to know if it works. Does it really increase financial development and help individuals make solid monetary decisions as its supporters claim? "Microfinance works," said Dean Karlan, economics professor at Yale University. "But it isn't the Hollywood ending that we've been sold."

Karlan, coauthor of a recent book More Than Good Intentions that also discusses research on this topic, and Jonathan Zinman, an economics professor at Dartmouth College in Hanover, N.H., recently published the results of a 22 month study that examined how individuals make economic decisions over time and whether micro-lending policies aid economic development.

…The researchers found "microloans increase ability to cope with risk, strengthen community ties and increase access to informal credit." But they also found the subjective well-being of loan awardees slightly declined. In addition, they found awardees reduced their overall number of business activities and those in the study did not increase investment in their businesses.

"Enterprise growth is the canonical story that the microcredit industry promotes," said Karlan about the amount of financial investment. "This isn't to say that microcredit never produces such an impact. But it should not be seen as the singular story. We need to know more about how people actually use their loans, and we should not be judgmental if the answer is not always for investment in enterprise."…

A market in rural India, shot by த*உழவன், Wikimedia Commons, under the Creative Commons Attribution-Share Alike 3.0 Unported license