Credit and Human Welfare: Lessons from Microcredit in Developing Nations

Table of ContentsI. Introduction 1095II. The Welfare Economics of Small-Loan Credit 1098A. The Inadequacy of Revealed Preferences 1099B. Rethinking the Consumer Welfare Benefits and Harms of Credit 1106C. The Human Development Approach to Welfare Economics 1110III. Lending to the Poor in the Developing World - The Grameen Bank Entrepreneurial Model 1113IV. Failures of Microcredit: The Bolivian and South African Experiences 1121A. Bolivia 1121B. South Africa 1125V. The United States Experience - Payday Lending and Incoherent Usury Laws 1128VI. The Role of Law and Regulation in Fostering Beneficial Credit for the Poor 1133VII. Conclusion 1138I. IntroductionHow do we know when access to credit improves or harms consumer welfare? Can legal rules improve the aggregate welfare effects of small loans? The poor need credit and have always borrowed. At the same time, credit, especially in the form of small loans and credit cards, has led to national crises for developing countries and increased poverty and exclusion for overindebted individuals in developed nations. Lending to the poor has always posed a moral dilemma.1 Legal rules, particularly usury and bankruptcy laws, have struggled to find a balance between preventing exploitation while permitting and encouraging responsible credit access. Despite decades, even centuries, of legal experimentation, the story of credit for the poor remains a tale of feast or famine - overindebtedness and exploitation coexist with vast unmet needs for credit.2 While bankruptcy and debt-relief systems play a role in mediating this duahty of credit and debt,3 regulators struggle with how to and even whether to regulate credit markets ex ante, to encourage the benefits the unregulated market fails to achieve, and to mitigate the harms the unregulated market causes. In the United States, the new Consumer Financial Protection Bureau has been tasked with rationalizing our system of credit regulation, relying on research and cost-benefit analysis.4Extensive empirical research literature has developed around the welfare impacts of microlending in the developing world.5 Similar literature has also emerged debating the benefits and harms of payday and "fringe" lending in the United States.6 While payday lending and microenterprise credit are conceptually distinct, they can serve as product substitutes, and, more importantly, similar issues arise in attempts to weigh their costs and benefits. The experiences of different nations with microloans to the poor and the extensive research on both consumer and microenterprise lending can offer insights for regulators seeking to craft a fair and effective regulatory structure for small-loan credit. The welfare impacts of microlending are clearly mixed, but existing research offers some empirical insights about loan characteristics that are more or less likely to result in net borrower benefits.In the United States, the Community Reinvestment Act,7 and the community economic development movement more broadly,8 promote lending to low-income individuals and in low-income communities as a positive, and even essential, tool for improving the welfare of the poor. On the other hand, consumer and civil rights advocates decry the debt treadmill created by payday lenders9 who make small loans to low- and moderate-income borrowers and predatory mortgage lending that strips wealth from low-income and minority families. …