A Few Questions About Microfinance

A Few Questions About Microfinace Greg Fischer MIT & CMFR

Introduction • A quick caveat.

– This is not a “seminar” but a dialog about a number of interesting and unanswered questions in microfinance.

• What I hope to accomplish today.

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Some Stylized Facts The following stylized facts appear applicable to microfinance in India • Uses of proceeds cluster within communities and are drawn from narrow range.

• Very few businesses expand beyond selfor family employment.

• Most borrows start businesses that would not warrant outside investment.

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A quick illustration: Starting a Shop Cost of initial shop inventory: Rs 10,000 Interest rate on loan: 18% full balance End of year repayment: Rs 11,800 Effective Interest Rate: 40+% By way of example, assume the shop generates Rs 930 per day in revenues at a margin of 15%.

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Starting a Shop, Returns • To an outside investor who needs to employ labor at a rate of Rs 100 per day, the NPV of this investment at a discount rate of 40% is approximately zero.

• Excluding labor costs, the NPV at 40% is over Rs 24,000.

• Of course, in classical economic theory, this makes no sense because it neglects opportunity cost.

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Starting a Shop, Market Imperfections • What if market imperfections or social norms results in wages exceed MPL or opportunity cost?

• For example, a borrower may be able to work as a day laborer for Rs 100 per day but only able to find work for 150 days out of the year.

• Yet social norms, behavioral factors, production non-convexities or the like may prevent paying workers less than Rs 100 per day.

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What’s Happening?

• Given the fixed costs of starting a business (inventory, indivisible capital goods, etc.) it is extremely unlikely that the optimal scale for each business is a single owner-operator, yet that’s what we see.

• These observations are consistent with a model of surplus labor where borrowers are effectively “buying a job.”

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Towards a Theory & Test Theory • Still working through the surplus labor literature.

• Need to expand on the I/O questions.

Implications • For a given investment, borrowers with better outside options will be willing to pay lower rates.

• Other ideas?

• How to test.

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Other Issues • What would the policy implications be if we found that in fact people are borrowing to create effective wage security?

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Part II: Investment Decisions

Investment Decisions • Why are there so many small vegetable vendors and identical dosa sellers? • Why do so many borrowers in the same village, in the same JLG, start similar businesses? • And a related question, are borrowers taking an efficient amount of risk?

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A Handful of Explanations • Don’t know about other opportunities.

• Don’t know how to execute other opportunities.

• Perceived risk of other opportunities (either uncertainty about mean or overestimate of variance) is too great.

• Actual risk of other opportunities is too great.

• A form of credit constraints, MFI or JLG discourage risk taking.

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Next Steps

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