When loans beat grants

By Felix Salmon
December 2, 2013

What’s best: giving a man a fish, teaching a man to fish, or lending a man a fish? Nathan Fiala, of the German Institute for Economic Research, went to Uganda to find out, and the results of his study make for fascinating reading.

Fiala’s study is the first to directly pit the newly-trendy area of cash transfers (which come in both conditional and unconditional flavors), against the slightly tarnished area of microfinance. He found a group of small Ugandan businesses, and divided them randomly into five groups. The first received loans; the second loans with business skills training; the third cash grants; the fourth cash grants with business skills training; and finally, there was a fifth control group. The loans and the grants were both around $200; Fiala went back to all of the businesses after six months and nine months to see how the various groups were doing.

The results were not what you might expect. On the simple question of loans versus grants, it stands to reason that you’re going to be better off if you don’t have to repay the money than if you do. Except that’s not what happened:

By the nine-month point in the study, businesses which received grants saw a negligible increase in profits, while businesses which received grants and training actually saw their profits go down, on average. Women-run businesses also saw a decrease in profits after getting loans, whether they were accompanied by training or not. In fact, the only area where the intervention seemed to do any good at all was in male-owned businesses receiving loans: they did well overall, and even better when they got training as well.

Obviously, this is only one study — although Chris Blattman says that it’s a “very important” one. Certainly people should start trying to replicate it. But I suspect that the effects it finds are real. For while the study itself might be new, there are three well-known effects at work here.

The first is that most microlending very rarely makes people richer. That doesn’t mean that it’s a bad thing: access to loans can be very useful in terms of things like consumption smoothing. But if what you’re trying to do is create increased wealth and economic growth, microlending is a very inefficient way of getting there.

The second is the exception to that rule. The one time when microlending does predictably make people richer is when it takes unemployed women and turns them into small businesses. In many parts of the world, women have not historically been given the opportunity to go into money-making work — and in those parts of the world, microlending can make a substantial difference. It increases the number of employed people, and thereby increases both wealth and economic growth.

Finally, as we know from Portfolios of the Poor and from David Roodman’s book, there are many mechanisms, within poor societies, for wealth to get redistributed — and those mechanisms have existed for much longer than microfinance. When one person needs money, they will get it somehow; when another person comes into an unexpected windfall, that money will find its way to people in need.

Put these three things together, and it’s easy to see how Fiala’s study found what it did. As he says, when the small business owners were given cash grants, “the cash does not appear to have been spent into the business, for men or women, but is instead either spent on family obligations or other consumption.” But loans need to be paid back, which makes it more important for the money to be invested into the business: “knowing that the loan had to be repaid appears to have led men to use the money more effectively in their businesses,” he writes.

Because everybody in the study was already running a small business when the interventions began, all of the recipients of funds — men and women both — had jobs all along. There was no opportunity, in this study, for women to use funds to enter the workforce. On the other hand, there was opportunity for men to use loans to start employing their relatives. It’s unclear why men find it easier to hire their relatives than women do — but once again, the only way to increase wealth and growth seems to be to find a way to employ people who would otherwise be unemployed.

It’s worth emphasizing, here, that Fiala isn’t measuring welfare improvements: I’m quite sure that the people who received cash grants, for instance, are noticeably better off for having received them. Instead, he’s just measuring the profitability of small businesses. Using that narrow criterion, it turns out that throwing money at the business doesn’t make it more profitable — which, if you put it that way, is maybe not so surprising. If you want to help small businesses grow, then there is a case to be made for using loans rather than grants. But even then, I suspect, the really valuable resource is underutilized labor, rather than cash.

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