Free «Impact of Micro Credit Facilitation on Wealth Distribution» Essay Paper

Introduction

Currently, inequality in income distribution and significant poverty are notable features of economic development in the modern world. According to some estimates, there are roughly 1.4 billion people that live in the extreme poverty, i.e. internationally defined poverty line with only $1.25 per day per person (Chen and Ravallion 2008). Those people that live in the extreme poverty in the majority of cases are in the low income countries or least economically developed countries (Naudé et al. 2009). If per capita level of income is lower than $905 yearly, the country is classified as low income country. Currently, there are 53 countries in the world that are considered to be low income according to the international classification. Among those low income countries, more than half (34 countries) are located in Sub-Saharan Africa.

At the same time, income is unequally distributed not only between but within countries as well. For example, on the individual level in the world the richest 10% of people own 85% of global household wealth. More than half of the richest 10% of the world population live in the United States and Japan (Davies 2008; Naudé and McGee 2009).

 

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There is intensive discussion in the literature about the inequalities in the income distribution both within and across countries and the factors that affect them. A lot of scholars believe that the underlying reasons of wealth disparities are the shortcomings of the capitalism (Baumol et al. 2007), particularly in the entrepreneurship. Whereas it is not arguable that entrepreneurship has a considerable positive impact on creation of new jobs, improvement of innovations and competition (Sun 2003), there is evidence in the literature that entrepreneurship is associated with According to Leibenstein (1968), inadequate supply of entrepreneurs in the presence of current structural market imperfections may be one of the explanations of increasing inequalities in the wealth distribution. This idea was further supported and developed by Leff (1979). He stated that substantial success of entrepreneurship had caused problems that are constraining further economic development. Problems that are associated with entrepreneurship success include creation of “oligopoly capitalism”. Therefore successful entrepreneurship “has brought serious economic distortions…in the developing countries that have transformed factor market imperfections into product market imperfections” (Leff 1979, p.55).

Role of Micro Crediting in the Poverty Reduction

Globally, programs of micro financing are designed and developed to deliver financial help to poor people who find themselves outside the formal framework of the financial system. At the same time, institutions that provide micro financing suggest a wide range of information and consulting services other than micro financing. There are no disagreements in the literature about exclusively positive role of micro crediting in the reduction of poverty in society directly through the increase of income and consumption (Khandker 2005; Copestake et. al 2005). Moreover, there is consistent evidence that financial as well as social empowerment of the poor part of the population, particularly women, can substantially contribute to the human development overall.

A lot of programs in micro financing are targeted to the women. It is found that with the help of microcredit programs, women have more opportunities in the decision making process, ownership of different assets, and they are also more informed about current legal and political framework of the economic system (Hashemi, Schuler, and Riley 1996; Cheston and Kuhn 2002). As a result, this brings more rational and educated decisions of women with respect to their children’s education, health care, etc. Several studies have shown that children of those women are less likely to starve, be uneducated and fall ill less frequently (Wydick 1999; Afrane 2002). At the same time, this evidence supports the idea that programs in micro financing serve as an effective tool in the improvement of people’s welfare.

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There is widespread evidence about positive impact of micro financing on the poverty reduction. At the same time, there is some disagreement due to the fact that it is found that in some cases programs in micro finance do not help poor people to improve their social and economic situation. Fortunately, the majority of findings indicate that micro finance institutions provide considerable benefits for poor population in the form of increased income and eliminated social vulnerability.

Diversity of Micro Credit Programs

There are numerous programs in micro finance worldwide that are developed to help poor population in the improvement of quality of their life. Programs differ in scale and can be designed and developed on the local level and regional level in the country. At the same time there are a lot of global projects and programs developed by large international organizations that are designed to help poor countries, or poor people in the low income countries. For example, the World Bank, United Nations Capital Development Fund, International Labor Organization, United States  During last decade a lot of studies have been implemented to evaluate efficiency of the micro credit programs. Overall, there is consistency in the literature about the following aspects of the micro finance programs performance:

• There is substantial variation in the ability and capacity of micro credit institutions to reach poor population effectively.
• Even though some micro finance institutions show excellent financial performance, it does not always coincide with outstanding outreach to poor population with their programs.
• Achievement of poverty reduction is observed more among those institutions of micro crediting that largely focus their activity on that goal, compared to those institutions that considerably emphasize the role of finance.
• There is evidence of the evolutionary process in the sector of micro crediting. A large share of micro credit institutions have been focused on their own financial situation and its development and improvement while at the same time been unwilling to make substantial investments in the micro finance (World Bank 1998). Currently, the largest portion of the micro finance institutions neither establish their clientele composition about the intake nor perform evaluation of the program effectiveness in terms of the reduction of poverty. Therefore, development and use of modern tools is necessary for continuation of the evolutionary process of the nature of micro finance institutions in order to improve their capacity for the market analysis as well as its evaluation. In this situation short-run expenses will be covered by the achievement of the long-run social and economic goals.

Social and Economic Impacts of Micro Crediting

Introduction of the micro credit programs is essential for poor population from both economic and social perspectives. First of all, the direct impact of micro financing is observed through the increase of income of poor people in the short run. Rise in the amount of financial resources that are available for the poor households or individuals in the short run or medium term provides them with increased number of possibilities including opportunities to increase consumption of basic goods and services that were not accessible to them without micro financing.

At the same time, receiving micro financing by poor people is also associated with indirect social improvements. There is a lot of evidence in the literature that those people that have participated in the micro credit programs are generally less vulnerable to various unexpected events (Zaman 2000). Moreover, despite the limited number of findings, there still is consensus about substantial and significant positive impact of micro credit program participation on the health status, nutrition status, attendance of primary schools, as well as improvement of the level of awareness of legal and political framework among the poor people (Wright 2000).

Target Group of Micro Crediting

Even though there is no consensus about precise definition of the extreme poverty level, the majority of researchers find that programs in micro finance are not designed for everyone. It is important to note that entrepreneurial skills and talent are required for implementation and running a successful micro firm, and prospective clients are equally wiling and capable to take on a debt. Whereas this is true across all poverty groups, it is obvious that micro finance institutions will have the greatest impact on the poorest share of the poor population.

It is found that mentally ill people and people with poor health, the destitute and other similar groups of poor people that belong to the minority share of the people who live in the extreme poverty are not appropriate as a target audience for effective micro credit program. In order to attain better results, these groups of people have to be approached with direct social assistance.

On the other hand, programs in micro finance can be rather effective for a broad range of micro finance consumers. They can be those poor people who are in the bottom half of people below a poverty line set in the country. According to the CGAP classification these people generally have no property of land and their access to the basic social services is very limited.

Interestingly, there is evidence in the empirical literature that no inverse relationship between the entrepreneurial ability and level of poverty of the client of micro finance institution is found. Borrowing patterns as well as the propensity to save are found to have similar characteristics among the clients of micro credit institutions from different poverty levels (Zaman 2000). The financial performance of those micro finance institutions that are focused on the poorest clients is found to be comparable with the financial performance of the micro finance institutions that are not focused on reaching the poorest at all (Khandker 1998).

Not much evidence is found that clients of functioning micro firms or those who are currently employed (in the literature they are often defined as economically active people) constitute the only beneficiaries of the micro finance programs (Zaman 2000).

Therefore, it should be noted that effectiveness of the micro credit programs in the poverty reduction and, hence, equalizing distribution of wealth among the population largely depends on the target audience of those programs. In general, a program is found to be more successful if it is focused on the poorest share of the population that are at the same time economically active and possess entrepreneurial ability in order to handle the borrowings and improve their financial situation. If people are sick and socially vulnerable in the extreme, then direct social assistance would provide more benefits.

It has been pointed out in a lot of studies and researches that poor people have an opportunity to improve their social and economic situations. Moreover, researchers emphasize that in order to attain improvement and reduction of poverty, micro finance programs have to possess certain characteristics.

Even in cases when a micro finance program is well designed, there still is a probability that it will have a positive impact on the improvement of life of the poorest part of the population if it does not specifically intend to outreach them with the help of corresponding product design as well as targeting (Wright 2000). Evidence shows that if there is no targeting tool, the poorest share of the population will not be reached at all or they will be inclined to keep themselves out of it due to not seeing themselves as program participants (Navajas et. al 2000).

There is a consistent tendency of clients moving towards the top of the clientele group, and, as a result, micro credit institutions pay less attention to the needs of the poorest share of their clients. Due to this the proportion of the poorest people among the clients of the micro credit establishments diminishes over time (Navajas et. al 2000). Therefore, only those micro finance institutions that develop their programs focused on the needs of the poorest shares of the population are more likely to preserve them as their clients.

Savings and Micro Credit

There is a general consensus in the literature that policy of savings facilitation is crucial. It is important due to the fact that there is currently a very high demand for it among the poorest people and at the same time savings are necessary to protect poor people from the seasonality of the cash flows as savings perform an insurance function. Moreover, securing a substantial amount of savings in the form of deposits strengthens financial discipline among the clients and ultimately it can yield collateral and become one of the sources for funds to the micro finance institutions.

However, savings from micro crediting can serve only as a minor tool for the development of considerable savings stocks. Protection of savings against seasonal stocks may provide opportunities like continuation of school attendance of children, receiving of medical treatment by the income earners and, as a result, minimizing their time out of work. However, savings from micro financing are still very slow in the process of wealth accumulation.

Synergy Effect of Micro Credit and Other Programs

There is consistency in the literature that combination of micro credit programs together with other programs developed for the poverty reduction creates substantial synergy effects. The benefits that are derived from micro finance programs, programs focused on the improvement of basic education, as well as primary health care are closely connected. Therefore it is not surprising that the impact of all kinds of programs can be increased when those programs are delivered to the poorest people simultaneously. Moreover, the marginal cost of supplying basic health care services and providing education can be considerably reduced in the cases when the framework for the micro credit programs implementation is developed and already in place. The services rendered by the programs have to be relevant to the needs of the poorest group in order to reach maximal synergy effect (Marcus 1999).

The majority of the researchers conclude that there is a difficulty in distinguishing the impact of a specific program that was developed to improve quality of life of poor people due to the fact that each program contributes substantially to the positive outcomes of others. However, even if the reason for defining pure impact of specific program can be theoretically grounded, it is hard to compare value of programs’ accomplishments that are attained with the help of different interventions in practice. Therefore, it should be taken into account that programs in micro financing in the majority of cases have proven to have a considerable immediate impact on a wide range of the poverty reduction elements including improvement of health care, education, nutrition, and increase of income.

Improvement of the basic health of the poor people is without doubt one of the most important points in the poverty reduction. However, at the same time, it should be strengthened by the improvement of income with the help of micro finance programs in order to achieve sustainable and long lasting results.

Similarly, providing the opportunity for poor people’s children to have access to the primary education is essential for the poverty reduction in general. However, without micro financing receiving benefits from it will be somewhat delayed.

Cost-Effectiveness and Financial Sustainability of Micro Credit

Programs in micro financing are favorable in comparison with other programs and interventions in terms of sustainability and cost effectiveness.

Micro finance programs are largely cost effective compared to other developmental programs aimed at poverty reduction. One of the advantages of the micro crediting is that investments of donors are recycled several times and also reused (Wright 2000). Comparison of micro finance programs to other similar programs have shown that former are considered to be a more cost effective tool in the poverty reduction unlike alternative programs, for example, targeted food interventions, formal rural financial interventions, as well as projects on the rural infrastructural development (Khandker 1998). Furthermore, as opposed to a lot of other development interventions, micro finance program costs have a tendency to diminish with the increase of the program scale outreach.

Sustainability is another advantage of micro credit programs. Unlike other developmental programs, micro finance projects have a high potential to become financially sustainable. This means that soon after the initial financial investment, less or no inputs are needed for every following client. Additionally to the research findings, there is extensive anecdotal evidence that those micro finance institutions that are focused on delivering services to the poorest clients on average attain considerably higher rates of repayments, unlike those micro credit institutions that are targeted at relatively richer clients. Moreover, it should be noted that small credits to poor people are more financially sustainable due to the smaller credit risk and the exceeding of the large loan unit cost by the unit cost of the small loan.

Conclusion

Income inequality is widely observed both within and across countries. A large share of the population in the world live below the extreme poverty line with no means for sustaining good health, providing children with education and satisfying their basic needs. Therefore, a large number of developmental programs have been developed and implemented by large international organizations. Entrepreneurship and micro credit facilitation are just some of the tools that have been established to exercise positive impact on the poverty reduction among the population of the countries.

Micro credit programs do not only provide economic benefits for the poor population. Along with the increase of income, they sustain educational attainment, support improvement of the health care, nutrition, etc.

Under the appropriate conditions programs of micro crediting can become an effective tool in the poverty reduction policy. At the same time, it should be noted that programs of micro crediting achieve the largest positive impact on the poverty reduction in cases of joint collaboration with other developmental programs.