Profit is Not Welfare : Evidence from an Experiment on Bundling Credit and Insurance

This paper investigates a puzzle posed by the recent literature on the impact of microcredit loans: even in settings where there appear to be large marginal returns for business profits from microcredit loans, loan take-up is low, microfinance businesses do not expand, and these businesses often shut down. We analyze a randomized trial in which microfinance loans were bundled with an unpopular (but cheap) health insurance policy. In randomly-assigned treatment villages, purchase of the insurance policy was made mandatory at the time of loan renewal. This requirement led to a 22 percentage point (or 31%) decline in loan renewal in treatment villages, compared to control villages where the insurance policy was not introduced. The insurance policy itself turned out to be useless, partly due to administrative failures in implementation. Therefore, non-renewing clients’ valuation of microfinance is approximated by the modest fee to purchase insurance; in the presence of any expected gains, the fee represents an upper bound. Comparing client businesses in treatment and control villages, however, the decline in loan renewal had economically substantial and statistically significant negative impacts on client businesses. Clients’ decision to incur these losses, rather than pay the modest insurance premium, implies the substantial financial gains from microfinance are mostly dissipated by unmeasured costs of microfinance business operation. This result potentially reconciles the seemingly large returns to capital for micro enterprises with the lack of growth and frequent business closure, even in contexts where microfinance is available. ∗This project received funding from the National Institutes of Health (grant PO1 HD061315-04), and received IRB approval from MIT (#0609001924) and Harvard (#F18180-104). We thank Aparna Krishnan and Prathap Kasina for outstanding management of this difficult project, and Mahvish Shaukat for tireless research assistance. For comments and suggestions, we thank David Cutler, Jishnu Das, Pascaline Dupas, Andrew Foster, Rachel Glennerster, Jon Gruber, Dilip Mookerjee, and Ben Olken. Microfinance has spread around the world and, for many years, the rhetoric of microfinance organizations has been that customers’ enthusiasm for these loans constituted clear evidence of their positive impact. This presumed improvement in welfare has been so large that microfinance institutions have come to be seen as a potential channel through which other financial products, such as health insurance, might be delivered to the world’s poor (see, e.g., ILO, 2013). The hope is that clients sufficiently value maintaining access to microfinance that bundling microfinance with health insurance would create a large pool of non-selected clients, even where there is very little initial demand for health insurance. Until recently, however, there was little direct evidence on the effect of microfinance loans on small businesses and households’ lives. This has recently changed, with the completion of several randomized evaluations of the impact of microfinance loans in various settings and countries (Crepon et al., forthcoming; Augsburg et al., forthcoming; Tarozzi, Desai and Johnson, forthcoming; Angelucci, Karlan and Zinman, forthcoming; Attanasia et al., forthcoming; Banerjee et al., forthcoming). All of these papers find that the availability of microfinance leads to larger investments in small businesses. Several of these papers, though not all, find statistically significant and very large impacts on the profits of businesses that existed before the introduction of microfinance (Banerjee et al., forthcoming; Crepon et al., forthcoming; Augsburg et al., forthcoming). At the same time, however, all of these evaluations find very little evidence of significant changes in the lives of households who gain access to microfinance. In particular, households’ overall consumption and income (when measured) seem to be unaffected. In addition, even when businesses expand following the introduction of microfinance, these businesses shut down frequently. Further, a striking finding from all of these studies is that the take-up of microfinance tends to be low. Loan take-up is low even when the population is restricted to eligible households in demographics targeted by microfinance organizations, and even in settings where there appears to be essentially no alternative source of credit. The early rhetoric from microfinance organizations has been seemingly turned on its head: the demand for microfinance is low even in settings where there appear to be large returns from their small business loans. To shed some light on this puzzle, this paper uses an experiment in which microfinance clients in some areas of rural India became obliged to purchase a health insurance policy For example, in Morocco, Crepon et al. (forthcoming) estimate a 99% return to capital from microfinance loans (in terms of business profits), and yet the average take up in the village was only 13.2%. In Hyderabad, the capital of Andhra Pradesh (India’s hot spot for microfinance in the mid-2000s), 33% of eligible households had taken up a MFI loan in the sample tracked by Banerjee et al. (forthcoming) five years after several MFIs had started their operation in the city. Karlan and Zinman (2013) also find a large (above 1) price elasticity of the demand for microcredit.