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Microfinance, foreign aid, Commitment to Development Index, debt and debt relief
David Roodman, a former CGD senior fellow, worked at the Center from March 2002 to July 2013. His work at the Center focused on microfinance, debt relief, and aid effectiveness. His widely praised book Due Diligence confronts questions about the impacts of microfinance and how it should be supported. He wrote the book through a pathbreaking Microfinance Open Book Blog, where he shared questions, discoveries, and draft chapters.
Roodman was an architect and manager of the Commitment to Development Index since the project's inception in 2002. The Index ranks the world's richest countries based on their dedication to policies that benefit the 5 billion people living in poorer nations; it is widely recognized as the most comprehensive measure of rich-country policies towards the developing world.
Roodman wrote several papers questioning the capacity of common cross-country statistical techniques to shed light on what causes economic development. He co-authored a 2004 American Economic Review paper that challenged findings of World Bank research that aid works in a good policy environment. His non-technical Guide for the Perplexed builds on analysis of methodological problems and fragility in other studies. Among econometricians Roodman is best known for his computer programs that run in the statistical software package Stata; articles about them won him the inaugural Stata Journal editors' prize in 2012. Also in 2012, Roodman aged off the RePEc list of top young economists in the world, at number 6.
The WHO has recently debated whether to reaffirm its long-standing recommendation to deliver deworming drugs en masse to children in places with high worm prevalence. While deworming drugs are safe and cheap, a recent Cochrane review concluded there is “substantial evidence” that mass deworming has no impact on weight or other child outcomes, leading some to question the WHO policy.
My earlier posts on the definition of Official Development Assistance (here, here) dwell on the questions of when and how to count loans as aid. That focus makes sense because it was a controversy over loans that drove the donors of the Development Assistance Committee to ask the staff to review whether there is a “need to modernize the ODA concept.” In this post, I’ll set loans aside and make recommendations on what kinds of activities to drop from or add to ODA. For details, see sections 1 and 2 of my CGD policy paper.
What to Omit
In 2005, the UK advocacy group ActionAid made a splash with its Real Aid report. It alleged that “two thirds of donor money is ‘phantom’ aid that it is not genuinely available for poverty reduction in developing countries.” For example, debt relief for poor countries was a good thing, but signing documents in Paris to put old debts to rest doesn’t in itself feed or house the poor. And when donors hire their own nationals to train census takers or advise on power plant construction, recipient nations don’t see a penny of that money either.
As long-time idea-peddler, I admire Real Aid for its impact. Within a couple of years, the DAC expanded its aid statistics system to flag the sorts of spending excoriated by ActionAid. This then let the DAC zero in on aid money that actually crosses the border into a developing country, which they call Country Programmable Aid; it is a subset of ODA. To this day, the Real Aid report frames much of the debate over ODA definition, to the extent that some kinds of aid have become conventionally controversial. But I think that, in its drama, the report overreaches.
In my paper, I favor keeping some of the controversial categories and dropping others. I say:
Keep technical assistance. Yes, sometimes advisors give useless advice, but sometimes their work pays dividends, when they implant valuable knowledge in the minds of powerful, public-minded people Just like any other kind of aid, sometimes technical assistance works and sometimes it doesn’t. Nor is TA distinctive in being a kind of export of donor-country goods or services. All aid ultimately supports exports, being delivered in kind or in hard currency.
Keep administrative costs. It’s easy to lambast administrative overhead as bloat, unworthy of inclusion in the ODA tallies. In fact, I subtracted it from the first edition of the Commitment to Development Index. But Mark McGillivray showed me the error of my ways. Administrative functions such as monitoring, evaluation, and auditing are part and parcel of aid delivery. They are not excess.
Probably keep counting the subsidies in admitting foreign students to domestic university at low tuition rates. Surely if many of the students return after exposure to a new world of ideas, this can be transformational. I always think of Manmohan Singh, who studied economics at Cambridge in the ‘50s and presided over reforms as India’s finance minister in the ‘90s, which added trillions of dollars to cumulative national income. Whether the 1950s equivalent of ODA financed his studies, the mere possibility makes the point.
But don’t count the cost of hosting refugees in donor countries. It is laudable to house and feed people have just arrived in wealthy nations with little more than the clothes on their backs. But for statistics, a sensible line has to be drawn between foreign and domestic aid. And since most refugees, like my wife, will stay, aid to them crosses that line.
And exclude most debt relief. See recommendation 4 of my previous post.
And don’t count programs to educate citizens about global poverty. Maybe promoting “development awareness” in wealthy nations stimulates private overseas charity as well as public support for official aid. But the activity itself is not aid.
What to Add
Count development loans with near-market interest rates, such as from the World Bank’s flagship lending program, the International Bank for Reconstruction and Development. Recommendation 3 in my previous post explains.
Count guarantees and payments for performance such as COD aid based on provisioning. Traditional ODA consists mainly in grants and loans. Grantors take no financial risk; lenders take risk but fear it. One thread in the ODA redefinition discussion asks how to embrace financial instruments that themselves embrace risk. For example, some development assistance agencies issue guarantees to cover private lenders against default on loans for projects developing countries. CGD’s Nancy Birdsall, William Savedoff, and Rita Perakis advocate cash on delivery aid, which is like a guarantee except that it pays out on success rather than failure. Agencies making such contingent commitment need to set aside funds to prepare for possible payouts, called provisions. And they need to report these transactions on their financial statements. I favor counting as ODA the credits to provisioning accounts.
Count private overseas charity that is attributable to tax incentives. The Commitment to Development Index has long done this. For example for 2011, the method attributes $11.5 billion of the recorded $23.3 billion in private overseas charity in DAC nations to income tax deductions and credits that reward charity, and to lower taxes in some countries, which leaves more money in private pockets for private charity.
Count 100% of contributions to the UN peacekeeping budget, not 6%. The CDI does that too. Peacekeeping looks like aid: it costs money, can promote development, and takes place largely in developing countries. Surely posting 10,000 blue-helmeted troops to Liberia in 2003 to maintain a fragile peace contributed to that country’s development.
My spreadsheet tool lets you see what dropping the “conventionally controversial” categories does to donors’ aid totals. Most of the changes would not be dramatic. Administration accounted for 5.1% of ODA in 2011, technical assistance 4.6%, and the other categories for less. The proposed additions would have similarly incremental impacts.
Nevertheless, the ODA concept needs to evolve. If it does not, it will only fall more out of step with the times, putting its credibility at risk.
CGD’s recent publication of my paper on improving the statistical definition of Official Development Assistance (ODA) brought me into contact with several people involved with the ongoing review of this issue. (For the history of that process see my previous post.) Those conversations have stimulated my thinking. They have also helped me appreciate that among the questions in play, the hottest is how to count loans in ODA—where “hot” is some blend of complicated and controversial.
I wrote about loans in my last post. But I focused on arguing against factoring the probability of default into the assessed financial value of a loan. Here, I’ll explain some other loan-related recommendations. In another post, I’ll talk about other questions.
First, a conceptual preliminary, if you’ll forgive the pedagogy.
A fundamental (and uncontroversial) notion in the discussions of loans is that of discounting. As I explained to my son last night, if grandpa gives you $98 today that’s the same, in a certain sense, as him giving you $99 a year from now, or $100 two years from now, because if he gave you the $98 today, you could put it in your savings account where it will earn 1% interest. So we can say that $100 two years from now is equivalent to $98 today. To reach that conclusion we discount the $100 to the present using a rate of 1%/year.
When assessing a loan for ODA eligibility, the DAC effectively reviews all the payments that will be due on it over the life of the loan, discounts them to the present, and adds them up to produce the “net present value” of the debt service. If the net present value is less than 75% of the loan amount—in other words, if the “grant element” is at least 25%—then the loan is classed as ODA. This animated PowerPoint slide illustrates. Because of the discounting, payments due far in the future count less. In fact, because the DAC uses what now looks like a very high rate, 10%, payments due in 30 years hardly matter, counting against the loan at only 5.7 cents on the dollar.
If you understand discounting then, you can understand these four recommendations for reforming how DAC computes the contribution of development loans to foreign aid totals.
Recommendation 1: Subtract interest from ODA
Under the status quo, having cleared the 25% grant element threshold and entered the kingdom of aid, a loan affects ODA totals in these ways:
Disbursements on the loan increase ODA, in the years in which they happen.
Repayments of principal reduce ODA, as they happen. (This explain the “net” in “net ODA.”)
Payments of interest…don’t count at all.
I think the exclusion of interest arose from a historical analogy between net ODA and net Foreign Direct Investment, a standard accounting concept that nets out return of capital to the source country but ignores repatriation of earnings.
But ignoring the “earnings” on development loans makes no sense in aid accounting. As I argued almost exactly 10 years ago, when Ghana writes a loan payment check to Japan, it matters little for the finances of either party whether the check says “interest” or “principal” in the memo field. The gain is the same for Japan, as is the cost for Ghana. So interest received should be subtracted from ODA.
Recommendation 2: Just count the grant element
There are two natural ways to enter loans into ODA. One is on a cash basis, which is what the DAC does now. As money goes in and out, ODA gets debited and credited (except that the DAC leaves out interest).
The other way is on an accrual basis, which I favor along withmanyothers. If the payments on a $4 million loan cost $3.17 million after discounting back to the present, as in my PowerPoint example, then just the $0.83 million difference—the grant equivalent of the loan—would be booked as ODA, upon disbursement.
The chief disadvantage of cash accounting is that it forces the DAC to demarcate an arbitrary boundary between loans that are “concessional” (aid-like) enough to count as ODA and those that are not. Currently it draws the line with that 25% grant element threshold. One can imagine pairs of loans that are nearly identical, yet one has a grant element of 24.99% and one has a grant element of 25.01%. Despite their similarity, one would be ODA and one not.
In contrast, accrual accounting dispenses with the need for arbitrary lines. The loan with the 24.99% grant element could be added to ODA at 24.99 cents on the dollar while the 25.01% loan could be added at 25.01 cents on the dollar. The two loans would have virtually identical impact on the borrowing country and virtually identical impact on ODA statistics, which is how it should be.
That leads to…
Recommendation 3: Include in ODA development loans that are currently considered “non-concessional loans” because they fail to clear the 25% grant element threshold
If the previous recommendation is taken up, then even loans with only a small grant element can enter ODA—if at a few pennies on the dollar or euro or pound. Right now such loans are ignored in ODA even though they have financial cost for the lender and benefit for the recipient. Bringing them into ODA would rescue them from a statistical Bermuda Triangle.
Recommendation 4: Exclude debt relief oncompounded interest and fees on arrears
Under current DAC rules, a debtor can default on a low-interest loan, the interest and fees can accrue and compound at much higher interest rates, and then the creditor can write off all the additional debt and count the forgiveness as ODA—even though no money has moved. For lack of public data, the extent to which this happens is hard to determine; it appears to have been a major component of the big debt write-downs for Nigeria in 2006 and Myanmar in 2013. Counting these write-offs as ODA rewards donors for first maintaining that debtors ought to repay, so that the arrears can compound, then maintaining that they ought not to repay, so that arrears can be written off as assistance. I think that shouldn’t be the case.
The table below shows my estimates for the impacts of these changes on current aid totals. The first two columns are copied from the table in the last post. The first is Net ODA as a share of national income as currently computed by the DAC. The next column switches from discounting at 10%, which is high in today’s low interest rate environment, to more-realistic Differentiated Discount Rates. The third incorporates the recommendations above as well as I can. Recommendation 3 is mostly not simulated for lack of data. For recommendation 4, all debt relief is excluded, for lack of details on what kinds of debt are being cancelled.
As before, France is the big loser. Portugal also takes a hit. But some donors happen to benefit from the shift from cash to accrual accounting because loan repayments they received in 2012 are no longer subtracted from their ODA.
Although interesting, the impacts on ODA totals are less important than the impacts on incentives. Together, the four proposals in this post would bring realism to the DAC system for counting as loans as aid. They would better align the reward for the donor, in the form of a higher ODA total, with the benefit for the recipient. This would create incentives to increase ODA in ways of most financial value for the recipient, rather than least short-run cost for the donor.
In recent years, the interdisciplinary nature of global health has blurred the lines between medicine and social science. As medical journals publish non-experimental research articles on social policies or macro-level interventions, controversies have arisen when social scientists have criticized the rigor and quality of medical journal articles.
Not to be melodramatic, but the official system for counting foreign aid is in crisis. The longstanding mathematical rule determining whether a loan’s interest rate is low enough to qualify it as aid has gone out of sync with the times. The rule’s benchmark interest rate of 10% per year was reasonable when adopted in 1972, but not now. Today, wealthy governments can borrow below 3%, lend a couple percent higher, come in well under the 10% bar, and count the potentially profitable lending as aid.
Some countries—notably France and Germany—started doing that much more after the financial crisis brought interest rates low in 2008. Others have grown alarmed at the practice. Richard Manning once chaired the Development Assistance Committee that oversees the tabulation of aid (Official Development Assistance, or ODA); in the Financial Times last year, he characterized the Franco-German practice as “get[ting] away with murder.” At this writing, the donors who govern the DAC are in open, if circumspect, disagreement about when a loan should count as aid. As a result, different donors are counting their aid by different rules. That cannot stand.
Manning’s successor, J. Brian Atwood, recognized the threat to the credibility of ODA statistics. In 2011–12, he pressed the DAC members to confront and heal the rupture. The drama played out behind closed doors, climaxing (at least for now) at a December 2012 ministerial meeting in London. France and Germany rejected proposals to abandon the 10% benchmark in favor of more realistic benchmark interest rates. The donors managed only to agree to disagree, to promise a bit more transparency on the disagreement, and to instruct the DAC staff to study the issue with an eye toward resolution by 2015.
After 18 months of consultation and analysis, the staff are returning to the Committee with issues and options. The next six months will be critical in determining how the conflict is resolved, and how the concept of foreign assistance evolves in year to come. The integrity and credibility of ODA as a statistical concept hang in the balance.
In a new CGD policy paper, I analyze the loan issue, develop proposals, and simulate their effects on donors’ aid totals. I take positions on other questions that have arisen in recent years in discussions of the definition of ODA, such as whether private charity should count as aid—more on that in a later post. And I created a “what if” spreadsheet tool that that lets you see how definitional changes would affect donors’ aid totals. (Requires Excel. After downloading, click “Yes” or “Enable content” at any warnings, which are caused by code embedded in the spreadsheet.) Finally, a Tableau dashboard presents data on disbursements of loans whose inclusion in ODA is at stake.
I’ll devote the rest of this post to the issue that brought us here. I estimate that $9 billion in lending counted as ODA in 2012 would not have been under lower and more realistic benchmark interest rates--$4.6 billion from Japan, $3.0 billion from France, and $1.3 billion from Germany.
The argument is smart. But I side against it. My reasons:
The ODA statistics already incorporate default—after it happens. When a borrower fails to make a promised payment on a loan, the lender’s ODA goes up because the return flow that would have subtracted from ODA does not materialize. Likewise, writing off a loans that were not considered ODA pulls it into the ODA column. The ODA system would double-count if it factored in default risk before and after the fact. The 10% benchmark rate that is admitting the loans France and Germany defend is embedded in a structure that counts default after the fact.
Factoring in default risk would reward high-interest loans to the poorest countries. This would contradict the norm that poorer countries should get cheaper loans, embedded for more than 50 years in the structure of institutions such as the World Bank. A 15% loan to a shaky borrower such as Sierra Leone might well generate a loss for the lender over its lifetime. Does that make the loan a good idea?
Default is not a zero-sum game. To understand my point, imagine an extreme case. Suppose France could choose between giving Senegal a grant of €50 million or a one-month loan of €100 million at 0% interest, with a 50% chance of repayment. Going by the Franco-German argument, these two options would have equal expected economic cost for France and equal expected economic value to Senegal. But they would not. If Senegal defaulted, the French government would turn from a beneficent donor to an insistent loan collector. The default might trigger provisions in the loan agreement allowing France to charge penalties and market-rate interest, which would steadily compound the debt. Any debt forgiveness would take years and, France would insist, be negotiated at the Paris Club, where all the rich-country creditors unite on one side of the table to face poor debtors singly. Fiscal and economic uncertainty in Senegal would rise. Thus the pure math of a default risk calculations does not capture the economic stakes for the borrower.
Incorporating default risk using formulas virtually all DAC members have endorsed (for estimating subsidies embedded in export credits) would reject about half the recent French and German “ODA” lending as ODA anyway. (Nearly all Japanese lending would clear this hurdle though. To see this, click Yes under “Factor in default risk?” on the right side of the Tableau dashboard.)
I propose an interesting exception, however: when deciding whether a loan is costly enough to count as aid, donors should be allowed to factor in the risk of default ifthe loan contract substantially embraces that risk. For example, the loan terms would eschew late fees and higher interest in the event of default. Payments could be automatically reduced if prices of the borrower’s key commodity exports fell, as proposed by Pierre Jacquet, Daniel Cohen, and Helmut Reisen. Or the contract could promise arbitration in a bankruptcy court–like Sovereign Debt Restructuring Mechanism, an idea mooted by the IMF’s Anne Krueger in 2002, and recently revived by Brookings and the IMF.
Such loans hardly exist now. Embedding a reward for them in the definition of ODA could make them common, helping to prevent debt crises in poor countries.
In addition to shifting incentives, changing the definition of ODA shifts donors’ aid totals. The table below shows the consequences of just one change, the same as in the Tableau graphs: instead of benchmarking loans against the archaic 10% rate, benchmark against the OECD’s Differentiated Discount Rates. DDRs reflect current borrowing conditions for donor governments and include a 1% spread for administration. Currently they are around 3–4% for the European Union, Japan, the UK, and the US. (Technical note: this change retains the DAC’s requirement of at least a 25% grant element.)
Most donors are hardly affected by the change because they do little aid lending. France’s total would fall because much of its current lending hardly looks aid-like when the interest rates France charges are compared to the interest rates France pays when it borrows on the bond market. Yet Japan, which also does a lot of aid lending, would gain. Why? It too would see much of its current lending excluded from ODA. But many loans that Japan made years ago would also be expelled from the ODA realm, and the repayments that Japan is now receiving on those loans would no longer be subtracted from its current ODA total. For Germany, these two effects about cancel out.
My hope is that the combination of modest impacts for most donors, the splintering of the major ODA lenders into winners and losers, and the need to restore the integrity of ODA measurement will make the sort of change modelled above politically realistic. For sure though, France won’t concede without a fight.
If the DAC fails to agree by next year on a credible fix for the current inconsistencies, then I expect that outsiders will rise up to run the numbers in ways that make more economic sense, threatening the DAC’s reputation as the authority on ODA.
[Update: Matt Flannery, CEO and Co-Founder of Kiva, replied to this post as a guest blogger. Kiva has also changed its site, and I have blogged more.]
This post is so long it needs an executive summary.
Executive Summary/Long Story Short
Kiva is the path-breaking, fast-growing person-to-person microlending site. It works this way: Kiva posts pictures and stories of people needing loans. You give your money to Kiva. Kiva sends it to a microlender. The lender makes the loan to a person you choose. He or she ordinarily repays. You get your money back with no interest. It's like eBay for microcredit.
You knew that, right? Well guess what: you're wrong, and so is Kiva's diagram. Less that 5% of Kiva loans are disbursed after they are listed and funded on Kiva's site. Just today, for example, Kiva listed a loan fepor Phong Mut in Cambodia and at this writing only $25 of the needed $800 has been raised. But you needn't worry about whether Phong Mut will get the loan because it was disbursed last month. And if she defaults, you might not hear about it: the intermediating microlender MAXIMA might cover for her in order to keep its Kiva-listed repayment rate high.
In short, the person-to-person donor-to-borrower connections created by Kiva are partly fictional. I suspect that most Kiva users do not realize this. Yet Kiva prides itself on transparency.
Truth hidden in plain sight
I hasten to temper this criticism. What Kiva does behind the scenes is what it should do. Imagine if Kiva actually worked the way people think it does. Phong Mut approaches a MAXIMA loan officer and clears all the approval hurdles, making the case that she has a good plan for the loan, has good references, etc. The MAXIMA officer says, "I think you deserve a loan, and MAXIMA has the capital to make it. But instead of giving you one, I'm going to take your picture, write down your story, get it translated and posted on an American web site, and then we'll see over the next month whether the Americans think you should get a loan. Check back with me from time to time." That would be inefficient, which is to say, immorally wasteful of charitable dollars. And it would be demeaning for Phong Mut. So instead MAXIMA took her picture and story, gave her the loan, and then uploaded the information to Kiva. MAXIMA will lend the money it gets from Kiva to someone else, who may never appear on kiva.org.
Moreover, the way Kiva actually works is hidden in plain sight. On the right of Phong Mut's page, you can see that MAXIMA lent her the money on September 8 and listed her on Kiva on September 21. So while Kiva is feeding a misunderstanding, it isn't technically hiding anything.
And finally in Kiva's defense, its behavior is emblematic of fund-raising in microfinance and charity generally, and is ultimately traceable to human foibles. People donate in part because it makes them feel good. Giving the beneficiary a face and constructing a story for her in which the donor helps write the next chapter opens purses.
The pleasure of giving
Our sensitivity to stories and faces distorts how we give, thus what charities do and how they sell themselves. What if the best way to help in some places is to support communities rather than individuals? To make roads rather than make loans? To contribute to a disaster preparedness fund rather than just respond to the latest earthquake? And how far should nonprofits go in misrepresenting what they do in order to fund it? It is not an easy question: what if honesty reduces funding?
The big lesson is that the charities we observe, the ones whose pitches reach our retinas, are survivors of a Darwinian selection process driven by our own minds. An actual eBay venture called MicroPlace competes with Kiva; but MicroPlace is more up-front about the real deal. Its page for sample borrower Filadelfo Sotelo invites you to "invest in the organization that helped Filadelfo Sotelo: Fondo de Desarrollo Local" (FDL). This honesty is probably one reason MicroPlace has badly lagged Kiva. Who wants to click on the FDL icon when you can click on a human face?
Nicholas Kristof once tweeted that he "Just made a new microloan on www.kiva.org to a Nicaraguan woman. Great therapy: always makes me feel good." We should not feel guilty about the pleasure of giving. It should not just be eating your brussels sprouts. Indeed, Kristof might argue that Kiva.org's ability to make the user feel good is its greatest strength, for it draws people into an experience that stretches their horizons, educates them about global poverty, and entices them to contribute money they might otherwise spend on potato chips.
Still, we should take responsibility for how our pursuit of that pleasure plays out. Surely it is better to invest in an institution such as FDL without requiring it to incur the expense of posting pictures and stories of every borrower. Historically microcreditors have scaled to reach millions of people by cutting costs to the bone. Surely it would be better for us to give in a way that allows the microfinance institutions to put more of their limited energies into helping poor people manage their difficult lot and less into making us feel good.
I do not know the full answer to this conundrum, this tension between the need to draw donors and operate efficiently. Still, subtle dissembling makes me uneasy, perhaps because good intentions so often go awry. If a charity obscures how it operates, should we trust its claims about its impacts?
My wife Mai heard someone say that the world needs both playwrights and critics—if more playwrights. I treasure this observation because, as this blog must make obvious, I'm a critic. I can testify that being a critic can be bruising, especially when the playwrights you critique are alive. It's solace to think that the world needs me.
But the observation also helps me appreciate playwrights. They are the people who create things that weren't there, the people who are a tad insane in the sense that they confuse fantasy and reality. They see something in their mind's eye and believe they can make it real. Precisely because I am not like them, I hold playwrights---visionaries---in some awe. The most skillful, passionate, and lucky of them "put a dent in the universe" as Steve Jobs said. (An early employee described Jobs's uncanny ability to create a reality distortion field that altered bystanders' perceptions of the technologically possible.) Without playwrights, we might be still living in caves. At least, we wouldn't have iPhones.
We also probably wouldn't have the Grameen Bank, BRAC, and dozens of other successful microfinance institutions (MFIs) made by driven visionaries. And we wouldn't have Kiva, the person-to-person microcredit web site founded by Matt Flannery and Jessica Jackley.
On the other hand, without critics---analysts driven to understand the world rather than change it---we might not have mastered electricity. So we needed them too to get to iPhones. Critics and playwrights are yin and yang. Of course the two essences exist within all of us.
Critics seem to parse matters into quantities and concepts while playwrights seem to speak, and perhaps think, more in pictures and stories. (Or am I over-reaching here?)
The Kiva story
Like most innovations, Kiva is not entirely new. Rather, it is an ingenious fusion of older ideas. One is child sponsorship, which Save the Children pioneered in 1940. A family in a rich country sends $10 or $20 each month to a designated child in a poor country via a charity. In return, the family receives a photo and an update at least once a year. When I was perhaps eight, my family sponsored Constance, a Greek girl about my age, through Save the Children. I remember looking at her solemn face in two successive black and white portraits, trying to judge how much she had grown in a year.
Child sponsorship grew explosively in the United States in the 1990s, thanks mainly to groups with names like the Christian Children's Fund, Children International, and Childreach (now Plan International). Then an exposé in the Chicago Tribune in March 1998 brought it crashing down (hat tip to Tim Ogden). Starting in 1995, editors and reporters at the paper sponsored a dozen children in such countries as Guatemala and Mali. Then the reporters tracked down the children:
The Tribune's yearlong examination of four leading sponsorship organizations...found that several children sponsored...received few or no promised benefits. A few others received a hodgepodge of occasional handouts, such as toothpaste, soap and cooking pots. Some got clothing and shoes that frequently did not fit.
Sick children were sometimes given checkups and medicine, but not always.
One child, a 12-year-old Malian girl sponsored through Save the Children, died soon after being sponsored, although the charity continued to accept money on her behalf for nearly two years after her death. A subsequent investigation by Save the Children found that at least two dozen other sponsors had sent the charity money on behalf of dead children in Mali for varying periods of time, in two cases as long as five years.
There was more to the story. Clover and John Dixon of Bellingham, Washington, received faked New Year's letters from a West African child who had died in a donkey cart accident. Sponsorship peddlers sent heart-string-tugging appeals for extra $25 contributions on birthdays, Christmas, Easter, and the purpose-built International Hug Day. Childreach ran a disastrous experiment in Ecuador with a novel intervention called "microcredit." Local workers embezzled funds; in protest, borrowers burned loan documents.
Tension between experience and reality
Undoubtedly some hard-sell charlatanry was at work. But the problem was deeper than that: a tension between creating the psychological experience of connection that raised money and the realities of fighting poverty. Often the fairest and most effective way to help poor children is by building assets for the whole community such as schools, clinics, and wells. Often charities contract with locals to build these things. Often things go wrong because of corruption, bad luck, or arrogance among outsiders thinking they know what will work. In the best cases, charities learn from failure. All these factors break the connection between giving and benefit, sponsor and child. But admitting that would have threatened the funding base:
"For a segment of the public, there will be nothing else that will reach those people the way that child sponsorship does," says Charles MacCormack, the president of Westport, Conn.-based Save the Children, the nation's oldest and best-known sponsorship agency.
As MacCormack puts it, "An awful lot of people who sign on to a personal human being will not sign on to a well."
"[The charities] are addicted to it, because if they stop, they lose their identity as Save the Children," says Michael Maren, a veteran aid-agency worker in Africa and author of "The Road to Hell," a book critical of private foreign assistance organizations including Save the Children.
"That's their thing," Maren says. "They invented it. That's their problem. The Catch-22 is that the only way to raise money is sponsorship, but that is not the way to development. The show is the biggest part of what they do. So, they say, let's keep the show going, but try to find ways to make it better."
Matt Flannery penned a history of Kiva's first two years for MIT's innovations journal in 2007. Two years later, he wrote a second installment in the same periodical. Flannery's authentic, conversational voice makes both articles readable and engaging. As he tells his own story, he comes across as an approachable man of vision, passion, and action.
Flannery tells how another Kiva ingredient, microcredit, first mixed in his mind with child sponsorship. Fittingly, it happened through hearing a story:
One night, [Jessica] invited me to come hear a guest speaker on the topic of microfinance, Dr. Mohammed [sic] Yunus. Dr. Yunus spoke to a classroom of thirty people and shared his story of starting the Grameen Bank. It was my first exposure to the topic and I thought it was a great story from an inspiring person. For Jessica, it was more of a call to action that focused her life goals.
Some months later, Jessica went off to East Africa to perform "impact evaluations" for the Village Enterprise Fund, which works intensively with poor farmers, providing grants (not loans) and training to help them start business activities. Jessica's work gathered data on indicators of poverty among participants, asking "questions like 'Do you take sugar with your tea?' and 'Do you sleep on a mattress?'." The couple kept in touch by phone. Then came the epiphany:
When the words “Sponsor a Business” entered our phone conversation, it set off a chain of ideas. We had both grown up sponsoring children in Africa through our church and families. Why not extend the core of that idea to business? However, instead of donations, we could focus on loans. This seemed like a dignified, intellectual, and equitable extension that appealed to us at this point in our lives. Instead of benefactor relationships, we could explore partnership relationships. Instead of poverty, we could focus on progress.
Soon after, Matt joined Jessica in Africa. He brought his video camera, which embodied the third key ingredient in Kiva, information technology. "I planned to spend most of my time making a short documentary of small business stories. I was also intent on investigating the viability of our new idea."
Back in the United States Matt and Jessica began their impressive passage across the desert in pursuit of their vision. She networked for advice and support. He built the website after-hours, and eventually quit his job. Together they wrote the business plan.
Once the site was ready, we needed loan applications in Africa to post on the site. That’s where our friend Moses came in. Moses Onyango is a pastor in Tororo, Uganda, whom Jessica had stayed with after I left. Moses is a community leader in Tororo and is highly connected to the Internet. We had been in close contact over the past year and Moses was ready to post and administer the loans of seven entrepreneurs in his community....
Once Moses had posted the seven businesses, the site was ready to go. We sent out an email to our wedding invite list and waited to see what would happen. We emailed about 300 people, and all seven businesses were funded in a weekend. That was April 2005, and we raised $3,500 in a few days. We were blown away; everything worked.
Right there, Kiva hit the tension in the sponsorship---more currently, "person-to-person" (P2P)---model: the need to find and post enough stories to keep up with demand. It led instantly to fraud, though Matt Flannery didn't know it when he wrote the two-year history. As he recounts in the four-year history, a Kiva Fellow (volunteer) sent to Uganda discovered that Moses was producing many stories about individual borrowers the easy way, from whole cloth. Flannery flew to Uganda:
I spent two weeks organizing a clean-up operation. We hired accountants and lawyers. I spent hours with Moses, trying to figure out exactly what happened. He was very apologetic, but our conversations didn’t go anywhere. The money had vanished into a series of bad investments and a new house. Moses had a growing family. His new son was named for me: Matthew Flannery Onyango.
Admirably, Kiva went public with the information:
...we alerted our users that not all of their funds made it to the intended recipients....The reaction from our user base was telling. Overwhelmingly, they thanked us for our honesty and poured their refunds back into loans to other MFIs on the site. They reinforced an important lesson: whenever possible, be completely transparent. Transparency pays huge long-term dividends.
If you are running an organization and are considering withholding valuable information from your customers, just don’t. There are a million reasons to withhold information. Lawyers will warn you about liabilities. Marketing people will preach about tarnishing the brand. Investors will encourage you to look bigger and better than you are. Most of this is just tired and outdated thinking.
Operating transparently is a great way to keep an organization accountable for its actions. Before you act, ask yourself: would you be OK doing this if you had to tell your entire user base about it? Would you be proud if your actions were described on the front page of the New York Times? These are great tests that I often use to vet a decision.
Flannery describes the "story factory." Running one---collecting and posting stories---imposes a significant expense on MFIs but is evidently offset by the low 2% 0% (hat tip Ben Elberger) interest rate that Kiva charges on capital:
Out in Cambodia, I got to watch firsthand how a sophisticated MFI gets content on the site. It is quite an operation….
In the field, loan officers carry Kiva questionnaires along with a host of other loan documents. When they visit a village, they gather women and tell them about the opportunity to apply for a loan. If a woman decides to apply, the loan officer takes down information on paper---some for the Kiva site and some for other business purposes. The Kiva questionnaire asks for information that interests lenders. For instance, how many children do you have? And how will the loan make an impact on your family? This is all done in the local language---Khmer. They also take photos of the applicants.
Returning to the branch, the loan officer enters the data into a computer and sends the information---via Yahoo! Messenger---to the Kiva coordinators at the headquarters in a major city. Kiva coordinators are typically young, Internet-savvy males who get paid a few thousand dollars a year. It is a desirable job and about ten of them are now working in Phnom Penh. We train them in the art of synthesizing the Kiva questionnaire into a readable narrative; then they spend their days writing stories and uploading pictures.
As a kid, I would write letters to [sponsored] children a few years younger than me in Africa and South America. I imagined my letters being delivered to a thatched-roof hut halfway around the planet. It sparked my imagination and gave me a sense of connectedness. Through Kiva, we can provide some of that to a new generation of kids.
Looking back now, I imagine that the transaction wasn’t as simple as I had thought. A lot of intermediaries were involved, lending a certain production quality to the experience. Plus, it was expensive. Delivering the child sponsorship experience was often as expensive as the child sponsorship itself. At Kiva, it’s not as simple as it seems, either…
innovations invited to Sam Daley-Harris, who was central to teaching Americans about microfinance and serves on Kiva's advisory board, to comment on Flannery's four-year retrospective. While praising Kiva's "profound contribution to the field of microfinance and international development," he worried about the transaction costs, and noted one other concern:
...there is still a bit of deception in the notion that the moment that a loan is funded, the client in Kenya or Cambodia receives his or her microloan with those particular dollars. Indeed, there are real people receiving real loans to start or grow real enterprises, but if a client in a remote village qualifies for a loan, the MFI will not likely make that client wait for the Kiva lenders to put up that last $25. Said another way, loan funds are fungible, and a larger MFI on Kiva’s website will use Kiva’s loans as one important source of their lending pool, but it’s not actually those precise dollars going to that precise client.
As I noted at the top, Sam is right. In fact, I wrote a little program in Excel to extract data from kiva.org. It shows that for September 2009, only 4.3% of loans were disbursed after Kiva users had fully funded them through the site. And probably some of those the local lender had already committed to make before Kiva users had funded them. And in a new report on what happens to investors when microfinance institutions collapse, Daniel Rozas computed from data on kiva.org that the failure of just three lending institutions caused 93% of all Kiva defaults to date. No doubt many of those institutions' borrowers were faithfully repaying at the time of collapse. Conversely, if a borrower defaults, the lender will often cover for him in order to maintain a good reputation on Kiva. So whether you get your money back as a Kiva user depends overwhelmingly on the solvency of the lenders, not the borrowers.
Kudos for transparency
Kiva deserves kudos for being transparent enough for Rozas and myself to extract such data. But I wondered whether Kiva might become the Save the Children of P2P microcredit, the reasonably responsible pioneer who is imitated and overtaken by less scrupulous actors who pull the whole industry down a muddy slope into hucksterism. So I checked out MYC4, Wokai, and Babyloan (motto: "micro credits, great stories"; and no, it doesn't make loans to babies: it's French). To my surprise they were morehonest about the P2P relationships they (seem to) forge. Here's Babyloan in enjoyably imperfect English:
Note: Babyloan works as a REfinancing platform and not as a direct financing system. It can happen that the MFI already "advanced" the microcredit to the entrepreneur when you make the online social micro loan. Indeed, as we are still in a launching phase and particularly for seasonal projects , we did not want to make the realisation of the project "dependant" on the Internet users' good will and click. Babyloan is no microfinance reality show of ! However, we limit the funding time of the project not to create too much time discreprency between the projet and your micro loan, so your money is really used to finance the project. After the delay of 3 months maximum , we send all the money even if the funding has not been completed by the Internet users. The MFI will complete the funding.
So these sites are refinancing mechanisms. Kiva-linked microlenders make loans, then "sell" them to Kiva and its users. Might we rescue the P2P conception by observing that the lenders make their loans anticipating refinancing on Kiva? Yes, but only partly. Kiva limits itself to providing at most 30% of any lender's capital. So a lender will make at least three loans for every one it chooses to post on Kiva (hat tip to Molly's dad).
Kiva brings microcredit and microchips to child sponsorship. Like sponsorship charities, it is all about stories: it was inspired by them and it succeeds by telling them. As a result, it operates in a pincers between the giver's desire for personal connection and the costs and constraints that imposes on business of serving poor people. In fact Kiva can be seen as an ingenious finessing of this old tension. Technology has brought down the cost of transmitting stories and images.
Indeed, Kiva's P2P connections are more solid than those of child sponsorship 15 years ago. The people in the pictures, we can assume, really do get microcredit. Following in the Tribune's footsteps, Nicholas Kristof tracked down one of his borrowers, a Kabul baker, with little difficulty.
On the other hand, the P2P connection comes at a cost, is one-way, and is partly synthetic. The baker was surprised by the encounter because he had never heard of Kristof. For his part, Kristof might be surprised to learn that most of the Kiva loans he helped fund were disbursed before he saw them on Kiva. And the cost of collecting the baker's story, translating it into English, taking his picture,and uploading it over a balky Internet connection may still be significant relative to the small loans and the great needs in Afghanistan.
So how bad is this?
Is it so terrible that Kiva modestly misleads in order to raise money for a cause about which it is passionate? No. But as a critic I offer these points:
As I have discussed in connection with the interest rates on loans, the test of disclosure is whether people get the message. Technically, you see on Kiva's site that most loans are disbursed before they are funded. But the How Kiva Works page creates the opposite impression, and my casual survey of Kiva users reveals widespread misunderstanding. In the wake of the Tribune scandal, sponsorship organizations adopted standards on disclosure, among other things, in order to "preserve and protect the trust of sponsors and other donors by ensuring the accuracy and transparency of each [child sponsorhip organization]’s approach to child sponsorship and the manner in which its sponsorship funds are used." In this respect, Kiva is violating its stated ideal of transparency and ignoring a lesson from its family history.
Kiva may fear that complete honesty would undermine growth. If so, they might be right. But I am optimistic that Kiva will make and survive the leap of faith in its users. So take this interesting, small hypocrisy as the camel's nose under the tent, a way into the larger theme of how our behavior as donors rewards charities for distorting and contorting themselves. Why has Kiva succeeded by doing microfinance as opposed to community-level projects such as well and school construction? Such construction would stray from the P2P construct. Why has it succeeded by doing just credit despite the longstanding idea that services such as savings are at least as valuable and less dangerous? Because only well-regulated institutions should hold other people's money; building them is hard and is neither photogenic nor atomizable into P2P.
And why has Kiva, like most other microcredit fundraisers, succeeded while mythologizing the power of microcredit? You already know: storytelling works. Indeed, the most misleading thing about kiva.org is not obfuscation about sequencing that this post has dwelled upon but the smooth telling of the simplistic story about microcredit. In this Kiva is not unusual. The borrowers are all "entrepreneurs" even though we know the poor often use loans to pay for food or school. Meanwhile, as I have discovered over the last year, the evidence on the effects of microcredit on poverty and empowerment is rather ambiguous. "Kiva lets you lend to a specific entrepreneur, empowering them to lift themselves out of poverty." What part of that home page slogan is grounded in reality?
Carol Adelman, among others, has argued that private philanthropy is superior to government aid in many respects because it is more flexible and subject to a market test. But we see here that we all, as private philanthropists, have our irrationalities too. Private aid therefore cannot perfectly substitute for public aid. No doubt it is best to do some of each, while striving to improve both.
Don't get me wrong: sarcastic headline aside, I'm not in favor of the exploitation of children. However, I feel moved to speak against a recent push, I guess led by Hugh Sinclair, to insert a ban on child labor into the lending policies of microfinance institutions (MFIs), microfinance investors, and such accrediting programs as the Smart Campaign and the Seal of Excellence. The concern behind this movement is serious: that microcredit is financing, thus increasing, the exploitation of children. So the cause it leads to is understandable: a push for policies to break any such link.
Legality. Hugh argues that child labor is wrong because it is illegal in many countries with microfinance. Excellent point! In fact, most microfinance clients are engaged in illegality one way or another: squatting on city land to build houses the width of a queen-sized bed, failing to pay taxes on their meager earnings, failing to register their tiny businesses with the authorities... So to expunge microfinance of scofflawery, we need to shut it all down. Seriously, Hernando de Soto showed how, at least in Latin America, elites have purposely complicated the law in order to make formality---legality---a privilege rather than a right. Being poor means you are almost automatically illegal. Thus legality is a wobbly compass microfinance.
Ethics. We are all descendants of children who survived to adulthood only by laboring, whether as farmers or herders or gatherers. Only with their labor could the family subsist. I look forward to the day when there is no child on earth for whom this is the best choice. But we are not there yet. And we are not as close as you might think. Going by the numbers, the world has made great progress getting kids into school. However, a huge number of these children aren't learning very much. So how quick should we be to tell parents struggling under circumstances far different from our own what the right choice is? Many of them agree with you on the value of education. Whether it is best to put their children in the schools they can afford today is another matter.
Evidence. The effect of microfinance on child labor is an empirical question, whose answer will probably vary by context. On the hand, microfinance sometimes stimulates at-home businesses, leading parents to pull kids out of school and employ them at home. On the other, it gives parents a new way to finance school fees, providing them the discipline to set aside money each week for this purpose.
The evidence, like the ethics and the legal argument, is ambiguous. A good non-randomized study in Thailand found credit to increase child labor. One in Guatemala found the opposite. (Hat tip to Hugh for both.) The randomized studies, which I trust more, have mostly found little impact. In Hyderabad microcredit availability did not lift or lower the number of kids in school. In Manila, loans made no difference for the average response to "Any Household Member Helping in Family Business?" Ditto, essentially, in Mongolia. In Morocco, children worked 5.05 hours/week in areas with more microcredit versus 4.88 in areas without, a difference that is not statistically significant; meanwhile the number of children per family in school was slightly but statistically higher in the microcredit treatment areas, at 0.76 instead of 0.73.
An exception appeared in Bosnia & Herzegovina. Among less-educated, and presumably poorer families, microcredit caused more 16--19-year-olds to work at home, where "home" often meant "farm." As I blogged before, it is not easy to second-guess poor families in the midst of a major economic crisis if they use credit to invest in their farms, perhaps in more livestock, and put these near-adults to work.
Principals and agents. Now, one could retort that even if microfinance does not press children into labor on average, it still must do so sometimes. After all, how comforted would you be if I told you that microcredit does not increase slavery on average? And microfinance increases child labor in some cases, then one can argue that MFIs should vow never to finance such exploitation, and that microfinance investors must demand such vows in return for funds.
I do hope that microfinance officers don't leave their ethics at the home, that if they find a child laboring in great duress, and they know that a loan would make things worse, then they will not lend. But in general, microfinance, especially group microfinance for the lower-income clientele, has succeeded by not taking much interest in clients' business. Monitoring clients takes time, time costs money, and higher costs lead to higher interest rates. Anyway, trying to determine what people do with their loans or savings withdrawals is often a fool's errand because of fungibility. Moreover, as Hugh's book dramatizes, reality tends to diverge from rhetoric as one moves along the microfinance investment chain---from individual investor, to investment fund, to MFI headquarters, to field practice. MFIs may say they have banned loans for child labor, and MFI investors may buy that reassurance rather easily---but should we believe them? It will be a great achievement if a program like the Smart Campaign can reliably monitor and certify microfinance field practice as being transparent and non-coercive. I think it is a goal too far to certify what is being done with microfinance in each household. Microfinance investment funds promising to rid their portfolios of child labor will be setting the stage for hypocrisy.
This issue exemplifies a larger problem in international aid and philanthropy. A donor that enters a country with plans to make loans or drill wells or build roads cannot understand, much less control, many of the consequences of those interventions. Often local political structures undermine intentions: bed nets meant to be donated to the poor are pilfered and sold to the highest bidder. Pouring microloans into an Indian slum will perturb the paths of thousands of families. In some, more children will walk out the door each day, headed for the local schoolhouse. In others, more will be enslaved at looms (though I do wonder how much of the most vile child labor occurs in household-level enterprises). In the face of diversity and uncertainty of the outcomes, donors can either proceed or not. I think they'll do best to base their choices on the evidence---which looks pretty good in this case---and a general theory about how the intervention contributes to development. Roads, for example, do harm as well as good, but in many cases clearly more good. Similarly microfinance (if the credit is administered in moderation) is a generally useful service that can give people more control over their lives. Some will use that control for ill, but that doesn't make giving the poor more options a bad idea.
This working paper by CGD research fellow David Roodman provides an original synthesis and exposition of the literature on a particular class of econometric techniques called "dynamic panel estimators," and presents the first implementation of some of these techniques in Stata, a statistical software package widely used in the research community. Stata is designed to encourage users to develop new commands for it, which other users can then use or even modify. In this paper, Roodman introduces two commands, abar and xtabond2, which is one of the most frequently downloaded user-written Stata commands in the world. Learn more
One popular statistical software package in academia is Stata. CGD has always used it, and thus so have I. As my colleague Mead Over pointed out, Stata's business model is an interesting mix of private and public goods provision. The private corporation profits by cultivating a public free-software community on top of its core product. Stata sells you the main program, which includes commands to perform all sorts of analyses. People outside the company write add-on commands and share their code freely, all in return for...the satisfaction and prestige of seeing others use their work.
Stata has worked over the years to reward such sharing. One step was the founding of the Stata Journal (and before that the Stata Technical Bulletin) to give academics a venue to leverage their coding labors into career-boosting publications. A more recent step was the institution of an annual award for the best contributions to that journal in the previous three years. The first award was announced today. The recipient is: me.
The prize is awarded to David Roodman specifically for two outstanding papers in this journal:
How to do xtabond2: An introduction to difference and system GMM in Stata (Roodman 2009b)
Fitting fully observed recursive mixed-process models with cmp (Roodman 2011)
The titles alone are exciting I know! Ungated CGD versions here and here. My two papers were fortuitously timed for the period of this first award.
Born in Indianapolis, Indiana, in 1968, he grew up in Hanover, New Hampshire, and Binghamton, New York. Roodman’s formal education ended in 1990 with a Bachelor’s degree in theoretical mathematics from Harvard College. After years at the Worldwatch Institute and on a Fulbright in Vietnam, he arrived at CGD in 2002 knowing little about econometrics. He discovered that a great way to learn econometrics is to code it. His contributions to the Stata community since then were motivated by a desire to replicate and scrutinize complex, influential studies in development economics, which led him to write xtabond2, cmp, and other packages; and motivated by a pedagogic bent, which led him to document the packages and their mathematics in the Stata Journal.
I am humbled and happy about the award.
I wrote the first program as part of my appraisal of the literature on whether foreign aid causes economic growth. (See the technical Anarchy of Numbers and this non-technical guide for the perplexed.) At the encouragement of David Drukker of StataCorp, I then wrote my paper about the program.
As I blogged in 2009, the second paper documents a program I wrote in order to replicate the Pitt & Khandker study of the impact of microcredit in Bangladesh. It's the most beautiful program I've written. Philosophers argue about whether mathematical ideas are discovered or invented. The concept of this program, cmp, is so elegant that I feel like it was there waiting to be discovered.
I echo the end of the award announcement:
As editors, we are indebted to...a necessarily anonymous nominator for a singularly lucid and detailed précis of Roodman’s work.
I've followed an unusual track at CGD, teaching myself econometrics by coding it, doing so primarily in order to be an annoyingly demanding consumer of econometrics, trying to decide which studies to believe, abrading some people along the way. I feel fortunate to have had the opportunity to grow and contribute in this way, to realize my peculiar latent potential. But especially in the early years, I also felt bashful about this strange path---real economists are trained to produce research not just be annoying consumers of it---even as I felt compelled to cut that path. The validation is appreciated.
Of course, writing cool code is not the same as improving lives, which is CGD's reason for being. I only hope that the tools I have made, through their use in the hands of others, have in some small way advanced social science, especially as it relates to helping the world's poor.
I'm seen as an expert on microfinance. I'm writing a book about microfinance. I blog about microfinance. I go to microfinance conferences. So you'd think I know what microfinance is. But I'm not sure I do.
Refers to institutions that specialize in making very small loans to very poor persons in developing countries. Instead of using collateral to assure repayment, these lenders harness social pressure within the borrower's community. ...
The provision of small loans (microcredit) to poor people to help them engage in productive activities or grow very small businesses. The term may also include a broader range of services, including credit, savings, and insurance.
The main idea seems straightforward: micro = really small, so microfinance is financial service in small amounts for poor people.
The last definition, from PBS, adds a twist: a reference to the lender's purpose---to support microenterprise. That's a vestige of the term's evolution. In 1971, Intel released the first microprocessor, the 4004. (There followed the 8008, the 8080, the 8086 and 8088, the 80286, 80386, the 80486...then the branded Pentium series.) By 1973, "microprocessor" had appeared in the American newspaper of record, and around then, I think, "micro-" gained currency. Jeff Ashe told me that it was a volunteer for Accion's program in Recife, Brazil, named Bruce Tippett who in 1974 coined the term "microenterprise" or "microbusiness" to describe informal businesses run by poor people. Accion lent money to the microenterprises in Recife, leading to the phrase "microenterprise credit." Much later (does anyone know the history?) came the term "microcredit." Hans Dieter Seibel says that he coined "microfinance" in 1990 to signify the conceptual expansion beyond credit to savings and insurance. But through much of the 1970s and 1980s, what we call "microcredit" was termed "microenterprise credit."
I think most knowledgeable people in the world microfinance (however defined) have moved beyond the equation of microcredit with enterprise. (Alas Kiva's web site hasn't: ever borrower there is an "Entrepreneur.") It is widely recognized that poor people use credit for many things besides investment, that this is often a good thing, and that money is so fungible that you can't really tell people what to do with it anyway. I, at any rate, am not confused on this point: microfinance should not be defined by the lender's purpose.
But here's a bigger source of confusion, a circa-2000 tally of accounts at "Alternative Financial Institutions," which generally aim to serve people too poor to interest commercial banks:
The "MFIs" heading on the first data column stands for "microfinance institutions." This study by Robert Christen and Rich Rosenberg opened a lot of eyes to a wider terrain of financial services for the poor. There are postal banks and state agricultural banks and credit cooperatives and credit unions and more. In assembling the data set behind these totals, Bob and Rich confronted questions of taxonomy. They had to group institutions and label the groups.
The results of their labors force two questions: Is "microfinance" narrower than "financial service in small amounts" after all? If so, what distinguishes microfinance?
Some possible answers to the second question:
Microfinance is non-governmental and non-profit. Except not. The biggest institution generally considered to be doing microfinance, BRI, was government-owned at the time of its ascent and is now privatized and for-profit.
Microfinance works with groups of people, not individuals...except there is such a thing as individual microfinance. That's what BRI does, and lots of Latin American MFIs do it too.
Microfinance clients are poorer. Could be. But do know that clients of all the other kinds of institutions are better off? In fact, by and large, microfinance clients are themselves not the poorest of the poor.
Microfinance institutions operate in a business-like way. Even non-profit MFIs strive to cover their costs. But lots of MFIs are losing money. And in many cases this is by design. Charities often subsidize their microcredit operations to hold interest rates down or compensate for the inefficiencies of small programs.
Let me head off some criticisms before I continue. First, people can define words however they want. I'm not interested in arguing over the true meaning of "microfinance" or criticizing how anyone uses it. Second, what dictionaries or reflecting humans mean by a word can differ from what it means in practice, when people allocate funds, perform analysis, write regulations, convene conferences. I'm interested in what the term tends to mean in practice. My book is about whether microfinance works; I'd like to pin down what I'm talking about and what readers think I'm talking about. Third, defining words is not judging approaches. I can exclude some method of providing financial services from my definition without denigrating that method.
Here's how Bob and Rich defined microfinance in their study, in 2004:
This paper uses "microfinance institution" and "MFI" narrowly, referring to NGOs [non-governmental organizations], non-bank financial institutions (NBFIs), and commercial banks that specialize in microfinance, as well as separate microfinance programs in full-service banks. "Microfinance" as used in this definition refers to financial services designed for lower-income clients using the new delivery methodologies developed during the last twenty-five years.
Pragmatic---but unsatisfying, because it begs the question of what distinguishes those methodologies.
Commercial banks Banks with a full banking license. In some countries, the term “universal banks” or other terms may be used. Majority government- and stateowned banks should be included in this category to the extent that they perform a broad set of retail banking functions and are regulated and supervised in the same manner as privately owned banks.
Cooperatives, credit unions, and mutuals Financial institutions that are owned and controlled by their members (customers), regardless of whether they do business exclusively with their members or with members and nonmembers.
Specialized state financial institutions Specialized state-owned institutions are extensions of the government whose main purpose is to lend support to economic development and/or to provide savings, payment, and deposit services to the public. They include postal banks, government savings banks, SME lending facilities, agriculture banks, and development banks.
Microfinance institutions Institutions whose primary business model is to lend to (and possibly take deposits from) the poor, often using specialized methodologies such as group lending.
This seems reasonable. But its interesting that BRI, which Marguerite Robinson says led the "microfinance revolution," is not a microfinance institution in in the CGAP classification but a commercial bank. Evidently a lot of microfinance is done by non--microfinance institutions.
My best shot at defining microfinance? I'll take two:
The business-like provision of financial services to the poor.
Provision of financial services to the poor in ways that depend on outsiders, especially socially motivated ones, for finance and advice.
The first definition resonates with the "business model" phrase in the CGAP typology. I think it works pretty well because even though there are probably thousands of tiny microfinance programs that won't even try for financial self-sufficiency, the broad thrust of the movement has been to cover most costs through interest charges in order to scale up. This is what makes the large MFIs so unusual in the spheres of foreign aid and international philanthropy.
Last Thursday in Uruguay, at the opening plenary of the FOROMIC conference, I offered a version of my second definition. I'm not sure it went over very well. But I think there's something to it. It seems that a money-losing NGO making small loans to groups of poor people is doing microfinance, while a money-losing Chinese government program making small loans to groups of poor people is not? As far as I can tell, when most people say "microfinance" they are thinking of something like the first, not the second.
What is the key difference? I wonder whether it is that the NGO must raise money from outsiders, probably foreigners. BRI didn't raise money from the west, but it took a lot of advice, paid for by the U.S. government and provided by the Harvard Institute for International Development. Roughly speaking, under this definition, microfinance is what microfinance investment vehicles invest in. It is what Kiva users lend for. It tends to include Village Savings and Loan Associations, because these are organized by Oxfam or Care or CRS, but not the quite-similar informal groups that form without outside help.
And "microfinance," so defined, is the class of interventions for which the impact debate matters, the class for which it is most important to ask: does it work? Outsiders do not generally ask whether informal savings groups or commercial banks "work" in the sense of increasing development. Basically, it's none of their business. But microfinance is their business.
Again, I'm just trying to find the pattern in how people use this word, not defend it. What do you think?
[I am honored to host Matt Flannery as my first guest blogger. My October 2 post about Kiva generated copious commentary and tweeting. Accepting a guest strays somewhat from the construct of this blog, but seems highly appropriate in this case.--David Roodman]
This is Matt Flannery, Co-Founder and CEO of Kiva.
I recently read and enjoyed David’s article “Kiva Is Not Quite What It Seems”. The article is well-written and thoughtful, and has generated a lot of passionate responses. I'm writing here because I thought it would be helpful to hear from Kiva, as part of this dialogue, to increase understanding about what Kiva does and where it is going.
I see Kiva as a public property, “owned”, in a sense, by its three main constituents---the entrepreneurs, the lenders and the MFI partners, all of whom we serve. It is a delicate balance to serve all three at once. Sometimes it may seem that, for a particular decision, one has to benefit at the expense of the others. However, this is a short-sighted way of looking at things.
I firmly believe that, in the long run, each of Kiva’s constituencies want the others to be well-served, as they are all inter-connected, and rely on each other in their shared efforts towards poverty alleviation. What is needed to create this environment of mutual support is rich communication, promoting greater understanding around the challenges and needs of each constituent.
The Kiva website serves as the hub for that communication to take place. However, large gaps in communication still remain. We at Kiva have a long way to go to increase the level of understanding between the three parties and this article sheds some light on certain areas where we can improve.
Most prominently noted in David’s article is the challenge of communicating to our user base regarding the mechanics of how Kiva functions. Most of Kiva’s users have very casual knowledge of microfinance. In fact a large percentage of them had never heard of microfinance before Kiva and had never donated or lent to an international cause. This presents a major challenge in terms of simultaneously educating them and empowering them to make an impact in our field.
Our approach to this challenge has been to provide a very easy way to engage users, and provide a wealth of information to them as they become more curious. The oversimplified nature of our home-page reflects this broad strategy. Certainly the Kiva homepage does not describe the nuances of microfinance or Kiva's approach. In fact, it largely ignores the details. However, it is our intention to provide every last detail of the mechanics of Kiva to those curious users. My hope is that, for those that care to delve deeper, users can learn all they need to know---and more---by looking at our website alone.
A main focus of the article has to do with the fact that most of Kiva's loans are disbursed before they are funded on the Kiva site, which is true. The article points out, rather accurately, that most lenders on the site do not understand this. It goes on to imply that Kiva is taking an active role in perpetuating this misperception.
My response to this critique is two-fold. First, I believe that allowing pre-disbursal is necessary for the success of this model. Second, I think we can do better at educating our users about how and why this is the case.
When Kiva started in 2005, we were working with a pastor in Uganda who had no other source of funding for loans. As he relied on Kiva funding only, it was easy and necessary to wait for the Kiva funds before handing out loans, thus all of the first loans on Kiva were disbursed after they were funded on the Kiva website. In addition, our early Field Partners in 2006 and 2007 also needed to wait for the money because they had no other sources of funding. Post-disbursal was the norm at Kiva in the early days. A lot of the writing, and graphics, on our site, were produced during those early days. For instance, the "How Kiva Works" page was created to describe the Kiva model in the days before pre-disbursals.
As Kiva grew, and millions of dollars poured in through the website, we began to work with larger MFIs who could handle the sums of debt capital that the Kiva Lender community was able to offer. As loans began to fund quickly, MFIs began to expect and depend on Kiva loans being funded. Instead of waiting, MFIs began to disburse these loans in advance, assuming that the funding by Kiva Lenders on the website would take place. Good MFIs are client-driven. To make their clients wait unnecessarily would have been bad customer service. So, for many of our Field Partners, pre-disbursal became the norm.
Rather than outlaw this practice, which allowed MFIs to be more efficient and better serve their clients, Kiva decided to just make the practice transparent on the website, and to let the lenders decide whether to fund a pre-disbursed loan or to withhold. Hence, we created a system whereby MFIs were required to list the disbursal date on each and every "Make a loan" page, beside the rest of the information we considered important for lenders before making the decision to lend. This was our way of communicating this important detail to our users. We also listed detailed descriptions of the mechanics of Kiva in the Help Center, for those curious about loans that have already been disbursed. Kiva Our Fellows also blogged about this practice and created videos explaining how the process really worked. These, we believe, were great efforts at increased transparency.
However, we can still do better. And this brings me to my second point, where I agree with Mr. Roodman. The "How Kiva Works" page, at the time of this piece, was rather inaccurate because it implied a sequence where entrepreneurs get funding only after a loan is funded on the site. Although the "Make a Loan" pages contained the disbursal date, the "How Kiva Works" page was over-simplified to a fault. To address this, in the short term, we updated the page last week. It now contains more detail with regard to pre-disbursals. You might want to check it out. [See how item 2 has changed since this 2008 version--DR.]
This was just a short-term patch on a problem we had let linger on the site since the early days. In the future, we will update that page and others to bring more clarity to the new user on how things currently work. So, this is one situation where constructive criticism has contributed to a strengthening of Kiva as an organization. I'd like to thank Mr. Roodman and the readers of the article for their help here.
There are a couple other areas that I would like to clarify.
The article also claimed that "Kiva charges 2%" on loans made through the platform, to our MFI partners. This is not true. In fact, Kiva does not charge any interest to its MFI partners, and passes along 100% of the loan funds raised on the site to its MFI partners. That was just an innocent mistake on the part of the author.
Further, I want to assert that Kiva doesn't fear that complete honesty would undermine growth! In my humble experience, I've learned that honesty creates stronger bonds between the organization and its constituencies. Time after time, this lesson has been reinforced, and it is a lesson which affects many operational decisions within the organization to this day.
Kiva doesn't believe that lending is a silver-bullet, poverty alleviating mechanism. We do believe, though, that lending is one meaningful tool in a larger set of tools that the development community can use to alleviate poverty. Currently, the lending experience is highlighted on our website, while "plus services" such as savings and education are not. This doesn't mean that we don't believe they are beneficial or that they wouldn't be successful on the web. Last year, I spent a few weeks in Cambodia and witnessed dozens of women who were given a savings account for the first time, thanks to our MFI partners there. Rather than save under the mattress, they were creating accounts with an MFI. In a dangerous place like Cambodia, this is an incredible service.
I can imagine that one day Kiva will highlight savings and education on our site. At this early stage, we haven't been able to create the functionality to enable that. Getting lending right has been quite challenging, as you can imagine. Once we feel like we have nailed that experience, you can imagine that other services will be offered through Kiva.org. Many of our partners already offer such services to their clients and we are open to help fund those services at some point in the future. However, it may be a while before this expansion takes place as our current product has a great deal of potential still to achieve.
One of the contributions that Kiva has made is to demonstrate that empathy increases generosity. The pictures and stories on the Kiva site increase understanding between various parties that would otherwise operate in completely different universes. When understanding increases, so does empathy. When empathy increases, so does generosity. People are inherently more generous towards people and causes they understand.
Kiva has played a small role in increasing understanding between the constituencies on the site. However, we have a long way to go. As technology spreads throughout both the developed and the developing world, I hope to see the strength of the connections increase as well. You can imagine that, as wire transfer costs decrease, we could see a loan funded on Kiva the day that it is disbursed. You can also imagine that deep lender to borrower communication can be widespread on the Kiva site. Kiva has entered the game early and there is so much further to go.
I will conclude with a compliment to Mr. Roodman. I really enjoyed his article and, in particular, I learned about the history of child sponsorship in greater detail. We have much to learn from that history. We can learn what worked well with child sponsorship and also what we should avoid.
In particular, we need to avoid playing the role of "playwrights", as the article describes. In my experience, there is no greater play than reality. Any attempt to fictionalize falls short, and never does reality the service that it deserves. With the help of technology, I don't think Kiva needs to repeat the failures of child sponsorship. We don't need to be playwrights on the Internet. We are going to do our best to avoid that trap, but certainly value the ongoing help of a critical and engaged user base along the way.
In recent years, the interdisciplinary nature of global health has blurred the lines between medicine and social science. As medical journals publish non-experimental research articles on social policies or macro-level interventions, controversies have arisen when social scientists have criticized the rigor and quality of medical journal articles.
CGD fellow David Roodman and Jonathan Morduch a landmark evaluation of the impact of microcredit on poor households in Bangladesh. They replicate the study's statistical analysis and put an end to the controversy surrounding it by showing that it fails to rule out reverse causation. A positive association between microcredit and household spending, for example, may merely indicate that richer families borrow more. With these studies in doubt, solid academic evidence that microcredit reduces poverty is even scarcer than previously understood.
This working paper by CGD research fellow David Roodman provides an original synthesis and exposition of the statistical theory behind one of the most influential studies of the impact of microcredit on borrowers (Pitt and Khandker, Journal of Political Economy, 1998). The present paper also documents Roodman’s program, called cmp which for the first time makes it easy for other researchers to apply these methods. The program implements a "maximum likelihood" estimator for "fully observed, recursive, mixed-process systems of equations," and runs in the commercial statistical analysis package, Stata.
The econometric quest for evidence on aid effectiveness continues. Practitioners in the $80 billion-a-year aid enterprise care about their work and hanker for objective evidence that they are helping. In this working paper, CGD research fellow David Roodman argues that there is a clear aid-growth relationship, but instead of being positive and running causally from aid to growth, it is negative and runs from growth to aid--aid, that is, as it is usually measured: as a fraction of GDP. Roughly speaking (and not surprisingly!), when GDP goes up, aid/GDP goes down. Roodman argues that choices that economists commonly make in running the numbers often flip the apparent sign and direction of the aid-growth link, making it appear that aid is raising growth.
The argument about whether foreign aid "works" rages on. Recently, Paul Collier sought a practical middle path between William Easterly's development pessimism and Jeffrey Sach's development boosterism. How can smart people draw such contradictory conclusions from the same data? This new working paper by CGD research fellow David Roodman answers this question by describing consensus where it exists and identifying sources of controversy. Roodman concludes that, while aid has eradicated diseases, prevented famines, and done many other good things, given the limited and noisy data available, its effects on growth in particular probably cannot be detected.
In this working paper CGD research fellow David Roodman explains how the four biggest developing countries -- Brazil, Russia, India and China, a group Goldman Sachs dubbed the "BRICs" -- stack up to their rich-country counterparts on the environment component of the annual Commitment to Development Index (CDI). He finds they generally perform well on greenhouse gas emissions, consumption of ozone-depleting substances, and tropical timber imports. Major weaknesses include low gas taxes, Amazon deforestation and heavy fossil fuel use.
In development economics, statistical analysis usually begins with data from many observational units--households, companies, or countries--over just a few time periods. Two analysis techniques are becoming popular for studying causal relationships among variables in this "short panel" setting but their implementation may produce false results. In this new working paper CGD research fellow David Roodman shows how inaccurate results can skew the development debate and offers some simple techniques for reducing the risks.