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Microentrepreneurs and Their Money: Three Anomalies

This is an interesting paper relating to some ongoing research being undertaken primarily in India. The authors are interested in how microfinance clients manage their cash and what drives and constrains their investment behaviour. In this paper they discuss three observations from the field which they believe should affect product design in financial institutions and also lead to a number of non-credit interventions.

The first observation concerns the persistence of borrowing cycles. Given the high cost of borrowing, it is striking that many individuals find themselves in perpetual debt. Surveys conducted among microentrepreneurs such as vegetable vendors in both India and the Philippines showed that the majority used high interest short term loans to finance daily working capital. Very few reported attempting to substitute borrowing with savings. This is what puzzled the researchers – why do vendors not put aside some profits and borrow less? Their calculations showed the following: “Saving 10 Rupees a day, a vendor would have 1000 Rupees saved for working capital in only 28 days. Saving 5 Rupees a day, it would take a vendor 33 days. Saving just 1 Rupee a day, it would take 50 days. She then saves one hundred rupee a day in interest expense, which is roughly $2 a day, enough to raise the person above the poverty level.” The researchers examine a number of possible explanations for this and conclude that improving mental accounting and financial planning, plus access to a savings lock box may help people to switch from a debt cycle to a savings cycle.

The second observation is the lack of joint production ventures. Many MFI models are built on a foundation of group solidarity. This being the case, the researchers wonder why there are not more instances of profitable joint production. If social collateral is powerful enough to overcome information asymmetries in the credit markets for formal sector lenders, why haven’t poor individuals come together for years to engage in more profitable production ventures when there are economies of scale to small operations? Even activities that rely on minimal cooperation such as joint purchase of items which benefit from bulk discounts are not commonly observed. Extrapolating this back to groups used by MFIs, they conclude that joint liability groups may significantly discourage people from using these services.

The final observation concerns the consequences of labour and rental market failures on the decisions of microentrepreneurs. The researchers suggest that perhaps more investment should be made in businesses that provide employment or rent out capital equipment. Currently MFIs over-emphasize entrepreneurship.