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Microentrepreneurs and their money: three anomalies

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

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Microentrepreneurs and their money: three anomalies

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  1. Microentrepreneurs and their money: three anomalies Joint with Dean Karlan and Sendhil Mullainathan March 16, 2007

  2. 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

  3. 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

  4. 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?

  5. 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

  6. 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

  7. 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?

  8. 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

  9. Possible explanations • Joint production more expensive than joint liability • Joint liability is an added tax, but cheaper than alternative • Risk diversification

  10. Current work • Individual vs joint liability borrowing, Philippines (Gine and Karlan, 2006)

  11. Anomaly # 3: role of non-financial market failures • What is going on in other markets that MFI clients are part of? • Labor? • Asset rental?

  12. Why is this an anomaly? • How much are MFI investments sustained by these failures? • ‘Unwitting entrepreneurs’? • Is credit the best intervention?

  13. Possible explanations • Labor market failures • (Emran, Morshed and Stiglitz, 2006) • High business risks and depreciation

  14. Planned work • Evaluate MFI interventions in secondary markets • Daycare • Asset rental • Financing SMEs that employ MFI clients

  15. Thank you

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