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Econ 050: Does foreign aid work?

Date:22 November 2019
Econ 050 is a podcast on the economics and business topics that matter to the Netherlands and the wider world, made by the Faculty of Economics and Business and the Northern Times.
Econ 050 is a podcast on the economics and business topics that matter to the Netherlands and the wider world, made by the Faculty of Economics and Business and the Northern Times.

Microcredit was a major buzzword in the world of development aid in recent years, being breathlessly praised as a breakthrough panacea. But in the latest episode of podcast Econ 050, Professor Robert Lensink of the Faculty of Economics and Business of the University of Groningen, says that providing small amounts of financial support to individuals and projects can still be an effective tool, like most other trends, some bad actors took advantage of it and exploited the men and women on the receiving end.

Microfinance can still be a powerful tool when its recipients are equipped with the right tools to protect themselves, but what is the effectiveness of other forms of intervention? Can aid ever be a true silver bullet, or does the entire system need to change first? You can hear the full episode at (page does not exist any longer).

What is an intervention?

Robert Lensink: So intervention is coming a little bit maybe for medical sciences, to use that word, to describe giving a treatment. So what I do is, there are all types of interventions - so NGOs, if you talk about development aid, NGOs typically do interventions. They give people aid. They give people a cooking stove, for instance, they can give people training.

What is microcredit, and how did it go from being seen as a miracle to a predatory practice?

Lensink :Microcredit means small amount of credit. And it's basically it's a small amount of credit to people who don't have access to normal commercial banks. So it's credit for the unbanked people. So it's meant to let's say includes people who are not included in the financial system, to include them in the financial system with a small amount of credit. The idea was this small amount of credit could induce people to set up a firm, small businesses, small shops and it was meant to be used for small investments. As I said, it was very popular until maybe 2000 a little bit later and then maybe a bit later to around 2008. And then suddenly, the atmosphere completely changed. So there were a couple of scandals. Microcredit was kind of accused for inducing suicides in India.
What you always see if something becomes very popular, then very bad people also step in. So there were some people trying to make money out of microcredit. So what you saw is that some kind of microfinance institutions who were originally meant to help the poor were actually very commercialized, evil people who asked very high interest rates from poor people. And then some people who were borrowing from those microfinance institutions couldn't repay. Then other microfinance institutions stepped in and said, “You can borrow from us”. So people started borrowing from different microfinance institutions to repaying loans to other microfinance institutions.

On whether or not banks should charge interest on microfinancing products:

Lensink:There is a huge discussion about this. Many advocates of microfinance talk about the so-called double bottom line, that microfinance institutions can do two things at the same time: they can reduce poverty and be financially sustainable at the same time. Being financially sustainable means that you should become financially sustainable. You can only become financially sustainable if you also ask some interest rate. So you should cover the costs in one way or another. I have a bit different view here: in my view, the whole idea about double bottom line is a little bit of a myth. So I think it's either one or the other.

How gender training can backfire when it fails to take national context to heart:

Lensink: What the theory tells you is that the best way maybe for reducing intimate partner violence is that increase outside options for women so they can have the possibility of work outside, and then they can divorce. However, that only works in societies where it's allowed to divorce. In those societies like Vietnam, it is kind stigmatized, so you cannot divorce. So whatever the woman does, naturally she will not run away. Now in our case, what we found is that the gender training improved bargaining power for the women. So in a sense, women became more independent within the system: they got more to say about which school the children should go to and this type of thing. That was kind of positive. But they also increased their financial independence, but that then induced kind of a male backlash. So in the end, we had this kind of surprising and negative result that the training seemingly had induced more partner violence.
So maybe the best way of reducing the whole thing is changing the norms in a society that's allowed to divorce, that’s not stigmatized. And so it's a kind of a warning for organizations doing this type of work: look, it's good to give women more freedom, but if it's stigmatized for doing it then, you may get a kind of a backlash and have the opposite result.

On how insurance for farmers can provide more financial security, and the bandwagon effect:

Lensink: In Kenya and Ethiopia, we are still working to develop new type of insurance products, index insurance products, which may lead to a better uptake. So what we did in Ethiopia was that we gave farmers the possibility to pay the premium after the harvest. And we marketed the product in within social groups to give them a bit more trust in the product. So there was an informal group leader and he had a speech for the farmers telling them that they can trust this product.
Traci White: So a local representative that they knew, so that was someone that they trusted more readily than an institution of some sort.
Lensink: And by doing this combination of intervention, to increase the uptake of the insurance product to 70 percent from 44 percent, so it was enormous. It was big success. We worked with 12,000 farmers and we did it for a couple of years. So that was very, very positive, but there was one kind of backlash here as well: the problem of this product is if people are allowed to pay later, then maybe they will default. So they may decide if there's no bad weather, why should we try pay the premium? By selling the product in social groups, we tried, like micro group planning in microfinance, we hoped that was kind of peer pressure going on and everybody was repaying and that worked. But in certain groups, nobody repaid. So it's kind of what we call in microfinance the bandwagon effect. So there is peer monitoring in microfinance, and very much what they call joint liabilities, and the standard idea of group lending is you're only allowed to borrow when you borrow with a group and the group is liable for repayment. And we did this with the insurance products as well. So then, if you don't repay somebody else needs to repay, in kind of peer pressure and therefore defaults will be low. But the opposite effect may happen as well, and what we found out here – it happened in some cases - is that if you don't repay, then I know I have to pay for you. But the best solution for me may be also not to repay. Now you’ve got a bandwagon effect and no one is repaying. We found that in some areas that this happened, so we're now setting up trying to do a new type of intervention. We don't know yet how to control for this problem.