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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.”