Microcredit and Poverty Alleviation

Can Microcredit Close the Deal?

M.G. Quibria

In the wake of the worst famine of Bangladesh of the post-World War era Professor Muhammad Yunus launched a microcredit experiment in 1976 to assist a group of poor, highly indebted households, in Chittagong, Bangladesh. This experiment, which was to later emerge as the Grameen Bank, marked the beginning of the modern-day microcredit movement. In the past few decades, microcredit has blossomed into a global phenomenon, culminating in the awarding of the Nobel Peace Prize for Muhammad Yunus and the Grameen Bank in 2006.

In popularizing microcredit, an important contribution of Muhammad Yunus has been his innovations in credit contracts that helped overcome such issues as adverse selection and moral hazard that traditionally bedevil the access of the poor to credit. By making the poor ‘bankable’, microcredit programmes have made a contribution toward fostering a degree of financial inclusiveness that did not exist before. Despite these successes—and a continued increase in micro-lending in developing countries—poverty shows few signs of abating in many poor countries. This persistence of poverty has generated widespread doubt about the effectiveness of microcredit.


There is a large body of empirical literature on the effectiveness of microcredit in alleviating poverty. A landmark study by the World Bank on Bangladesh suggested that microcredit had a significant impact on poverty: for every 100 taka borrowed by a woman, there was an 18 taka increase in consumption. While some studies found a similar positive impact, there were many others deliberating the same question who discerned little or no impact on poverty. The latter conclusion includes some recent studies that were based on randomized controls trials (RCTs).

This inconclusiveness of the literature largely reflects the weaknesses of current studies, as well as the coarseness of available tools for analysis. Past empirical literature, based on observational data, was often marred by various endogeneity issues and characterized by controversies over identification strategies, and instrumental variables. The RCT studies, which had no undergirding model and have yielded an exotic mix of results, have had their own share of inherent methodological issues.

In short, the recent empirical literature sheds little light in clarifying the outstanding policy issues. With its focus on the ‘average’, the empirical literature has suffered twin failures. First, it failed to go beyond the averages to identify the characteristics of successful cases and explore policy options. Second, it failed to recognize the fact that the impact of microcredit, like many other development interventions, is context-specific, contingent on the supporting environment, and not amenable to easy generalization.

In a recent WIDER Working Paper, ‘Microcredit and Poverty Alleviation: Can Microcredit Close the Deal?’ I seek to broaden the scope of the inquiry. Rather than asking the usual binary question—whether or not microcredit is effective in reducing poverty—the paper reframes the query: under what conditions does microcredit work? To investigate this question, the article relies on a bare-bone model that abstracts from such considerations as imperfect information and uncertainty. While these aspects are important, they are somewhat less central to the subject that the paper addresses. Instead, the paper highlights issues—such as the nature of the labour market, technology, product demand, entrepreneurship, and intra-household decision-making—which have a critical bearing on household poverty in an impoverished rural setting.

The paper argues that access to microcredit has increased the monetary income of beneficiary households by creating self-employment possibilities for the female labour force in societies where female work remains largely non-marketed. While microfinance can potentially help poor households by allowing them to utilize their female labour and explore their entrepreneurial abilities, it has not necessarily afforded them an expeditious escape out of poverty.

The crux of the problem lies in the economic environment where poor households find themselves. The immediate factors that affect their incomes adversely are the credit limits and relatively high interest rates imposed by the microcredit institutions. Even in the absence of difficult credit market conditions, there are other constraints to expanding the incomes of microenterprises.

The working paper highlights two fundamental constraints to the process of graduation of out of poverty. The first relates to the supply side that keeps the productivity of these microenterprises low. Usually, microenterprises are engaged in activities where traditional and primitive technologies predominate. This state of technological backwardness, which partly reflects the lack of skills and education of the microentrepreneurs, keeps the productivity of the microenterprises low. The other fundamental constraint relates to the demand side: the products produced by microenterprises fetch low prices. Most products produced by these rural microenterprises are (internationally) non-traded domestic goods, whose prices are often low by world standards due to inadequate domestic demands and weak purchasing power. Paradoxically, the explosive growth of microcredit programmes can further exacerbate this price problem by creating a glut of traditional rural consumption goods. In short, while microcredit can help facilitate the development of new microenterprises, it does not necessarily ensure reasonable financial returns for them.

The escape from the twin challenges of low technology and weak domestic demand lies in improved access to technology and greater economic openness that fosters integration with the global markets and networks. However, addressing these twin problems is not easy as they constitute the crux of the development challenge facing poor countries.

Finally, it is claimed that microcredit helps alter the household power dynamics, strengthens the woman’s agency to make household decisions and tilts household consumption more toward family goods that improve health, nutrition, and educational outcomes. However, as the paper shows and the available empirical evidence appears to support, female empowerment does not automatically spring from the introduction of microcredit—it closely tracks woman’s trajectory of economic success.

M.G. Quibria is a professor of economics at Morgan State University, Baltimore, MD 

WIDERAngle newsletter
October 2012
ISSN 1238-9544