How a Microfinance Program Encouraged School Dropouts

A new working paper (abstractPDF) by Britta Augsburg, Ralph De Haas, Heike Harmgart, and Costas Meghir uses a randomized trial to assess a microcredit program in Bosnia:

[W]e randomly allocated loans to a subset of applicants considered too risky and “unreliable” to be offered loans as regular borrowers of a well established MFI [micro-finance institution] in Bosnia. Our group is poorer and generally more disadvantaged than regular borrowers. What is particularly interesting is that they have applied for the loan and thus believe they have a profitable investment opportunity; however, they were turned down. This is exactly the group we need to analyze if we are to understand whether alleviating liquidity constraints in this way can be an effective anti-poverty tool.

The authors found some positive effects in the 14-month period after the loans were granted, including higher levels of “business activity and self-employment,” but no increase in profits or household income:

It may of course be the case that income will increase later as the new or expanded businesses mature, although the type of activities undertaken are not such that one would expect longer term realization of benefits. Those without savings — mainly the less-educated — reduced consumption while those with a prior business and some savings ran down their savings. These facts are consistent with investments being lumpy and with the loans being too small in themselves to start or expand a business. It seems that households, in anticipation of future returns, used their own resources to top up the loan to reach an amount of funds that was sufficient to make an investment of a certain minimum size.

More troubling was the authors’ finding of an increase in labor supply and a decrease in school participation among 16-to-19-year-olds. “Such an unintended effect may lead to negative impacts in the long run if no corrective policy is put in place,” they write. “For example, a conditional cash transfer program could be used to ensure that children complete high school while at the same time alleviating liquidity constraints for poor households.”


So, no increase in household income (and whether higher levels of self-employment are a postive effect in itself is debatable) and several negative side-effects. It seems to me that the banks and investors have developed quite good criteria to determine who will likely provide a return on their investment. If the money had been invested in more prospective individuals it would seem possible that this would have created more jobs or lower prices/more variety of goods that the low income group could consume. At least it seems unlikely that this would have further decreased their own household income. So the free market wins again, heh.


So, an "established MFI [micro-finance institution]" turned DOWN a bunch of applicants. Our researchers run an experiment, randomly allocating loans to a group even micro finance would not have lent to and we draw inference on the entire MFI experiment in Bosnia? Sounds like "entrapment" to me, but I'm no lawyer. Not fair, headline writers of Freakonomics. Not fair as your headline is the only thing that will be tweeted/shared in today's day and age.


Not all MFIs are created equal - it all depends what are you looking it, in terms of providers, product type, terms, etc.

I've been working in microfinance in Bosnia, on and off, for 15 years. I suppose that my background doesn't really matter.

I am an AVID Freakonomics fan. In fact, I've used the book with my colleagues in Indonesia as a part of a Friday afternoon book club to help us develop critical thinking, by reading a different essay every week, from the book. People really liked it.

Still, I am a little surprised to see this study quoted in such short pieces. I am all for RCTs, microfinance needs them, Bosnia needs them. I am excited to see more of them.

Still, would love to learn a bit more about the methodology, the study length etc. Microfinance is far from being a perfect tool, but recently the pendulum has swung so far from favoring microfinance to throwing the baby out with the bath water.

One last thought - not all MFIs are created equal. There are different institutions operating, with variances in mission, methodology, products offered. To say that all microfinance does X is equally false as saying that all microfinance causes microfinance dropouts. . .


Hugh Sinclair

This is not the only academic paper discussing the unintended consequence of school drop-out as a result of microfinance (abstracts from three papers):

“The results show that household participation in a microcredit program may increase child labour and reduce school enrolment. The adverse effects are more pronounced for girls than boys. Younger children are more adversely affected than their older siblings and the children of poorer and less educated households are affected most adversely.”

Islam, Asadul and Choe, Chongwoo (2009): Child Labour and Schooling Responses to Access to Microcredit in Rural Bangladesh.

"credit obtained for investment purposes may reduce the likelihood of schooling for children who currently work in their family business.”

Nidhiya Menon , Brandeis University, 2004: The Effect of Investment Credit on Children’s Schooling: Evidence from Pakistan

“expanded access to credit raises entry into entrepreneurship for households in specific wealth groups while simultaneously increasing the use of child labor in these households.”

Leah Nelson, University of California, 2011: From Loans to Labor: Access to Credit, Entrepreneurship and Child Labor (Thailand)

The topic is carefully ignored by the microfinance community. Only two microfinance investment funds have explicit policies preventing child labour (Oikocredit and Vision Fund/World Vision). Indeed, the self-regulatory body of the microfinance sector, the so-called SMART Campaign, has explicitly refused to include the rights of children in their Client Protection Principles. It is perhaps no coincidence that Peru and Bolivia have large informal sectors - where most child labour occurs and where most microfinance institutions operate - and the highest levels of child labour on the continent according to the ILO. This does not prove causality, but it does suggest that this might be an area worthy of further investigation, but as long as the majority of the microfinance sector remains unregulated, it is little surprise that the issue is quietly brushed under the carpet.

Walk around a crowded market in any developing country with substantial microfinance during school hours. Notice who is stacking the shelves? We all know this is going on, it is blindingly obvious, but we have to keep the emotive topic of child labour off the agenda, particularly as the microfinance sector faces a wave of criticism currently following the suicides in Andhra Pradesh, the collapse of Nicaragua, endless cases of extortionate interest rates etc. This is simply the next skeleton in the closet of microfinance.

Common sense alone suggests this is a real risk. If you had to pay 150% in interest for a loan to grow your labour-intensive, low-margin, volume-based micro-enterprise selling homogenous goods in a competitive market place, who would you hire?