Putting a good deal of stock in Easterly's (mostly positive) review, I've already ordered Poor Economics and am looking forward to giving it a read. However, here I only want to single out a bit of commentary from Easterly's review on what has been a development policy vogue for about a decade now: microfinance.
Targeted small loans to the poor have been oversold as a method of launching fledgling entrepreneurs into prosperity. Experiments showed that microcredit only nudged up the rate of new business-formation from 5% of households to 7%. Microloans are most often used for something else, such as financing the purchase of consumer durables or repaying debts to moneylenders. The problem is not that microcredit is a "failure" (both of the above are useful outcomes), but that its promises so often fall short. Messrs. Karlan and Appel note that in our own rich countries we don't expect that "every random man on the street" would be able "to conceive and manage a thriving small business." Nor would we "start lending money to random men on the street with that in mind." So why expect that with microcredit in poor countries?
Pioneered by Nobel Peace Prize winner Muhammad Yunus in Bangladesh in the later 1970s, microfinance offers small, non-collateralized loans within an impovershed community and relies on peer-pressure within the community (i.e., bascially the threat of stigmitizing and/or ostracizing deadbeats) to overcome adverse selection and agency problems. (In the case of Grameen, borrowers were predominantly women.)
By most accounts, Grameen was - and is - a success. However, Easterly notes that the reviewed books are especially on point in "criticiz[ing] over-promising and generalizing in the aid business." A moment's consideration will suggest that microfinance is most likely to deliver (a) in small scale applications (b) in specific contexts.
Easterly (drawing on the authors' quotations) concisely drives point (a) home. Microfinance (as is any finance) requires complementary entrepreneurial capital. While the stock of per capita (raw, potential) entrepreneurs can likely be considered similar in both developed and developing nations (Baumol, 1990), it still is likely a small percent of the population.
On the second point ((b) - in specific contexts), Pete Boettke over at Coordination Problem also has a post on the Easterly review and I'll just borrow his commentary.
I am less persuaded than these authors that the poor are irrational and self-defeating, and instead think analysts have not completely identified the incentives that the poor face. The behavior is self-defeating, but the cause is to be found not in their inability to weigh costs and benefits, but the context they operate in that produces myopia and self-defeating strategies for poverty alleviation. Context matters; history matters; ideas and beliefs matter; institutions matter; INCENTIVES MATTER.
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