Microfinance, Microentrepreneurship and Misallocation

Rigorous evaluation studies have shown microfinance to have moderate take-up and modest impacts on income, profits, and returns to capital. However, recent evidence on heterogeneity in the impacts of microfinance, i.e. large positive impacts for households with prior businesses or higher initial productivity levels, suggests potential allocative inefficiency of resources. Further, in the presence of labour market constraints such as lack of job opportunities or high search costs, individuals select into subsistence or low-return entrepreneurship by necessity (or involuntarily). This exacerbates the misallocation of resources in terms of both occupational choice as well as investments in businesses. This project evaluates to what extent heterogeneity in the take-up of microfinance, due to selection at both the extensive margin (entrepreneurship type) and intensive margin (enterprise size and investments), and heterogeneity in its impacts on entrepreneurs explain the impact of microfinance on allocative inefficiency within occupational choice and investments.

To answer this question, Bahety and Ngoma will use data from several microfinance RCTs. These datasets will provide measures of outcomes (such as occupational choice of being a wage worker or an entrepreneur, enterprise size and investments, profits, incomes), access to microfinance, and relevant covariates (such as initial wealth, entrepreneurial ability, labour market productivity and credit and labour market frictions). The randomised access to microfinance in the experimental datasets ensures that the treatment effects estimated in this study are unbiased and, hence, lends internal validity while the different settings in which these experiments were implemented provide an opportunity to carry out external validity tests to the study. The researchers will model a heterogeneous agent occupational choice model in a closed local economy with labour and credit market frictions and then will use methods of moments estimation techniques to structurally estimate heterogeneity in treatment effects of microfinance.

Using experimental data from different contexts, this project will provide policymakers with a wider snapshot of entrepreneurship, local economies, and market dynamics in lower-income countries, and with greater external validity. In addition, identification of different entrepreneur types using labour- or credit-market, or firm- or individual-level characteristics will help in understanding the trends in labour markets and returns to capital which are crucial for unlocking private sector development. Further, the analysis on heterogeneity in take-up and impacts of microfinance will benefit policymakers in terms of targeting and screening policies to achieve higher returns on capital and allocative efficiency. Importantly, the focus on women in these experiments will also help to explore gender differences in microentrepreneurship. Lastly, this study will help analyse the importance of microcredit in much tighter credit and labour market contexts, which is relevant to policymakers tackling the COVID-19 pandemic.


Girija Bahety

Tufts University

Marina Ngoma

Tufts University