Short-term Migration and India’s Employment Guarantee

Posted on March 22, 2014 by

 The National Rural Employment Guarantee Act (NREGA) is one of the world’s biggest anti-poverty public workfare programmes, provisioning for 100 days of guaranteed employment in a year to every rural household in India. The idea behind this programme has been to generate employment opportunities for the rural unskilled workers who remain unemployed or under-employed due to seasonality of agriculture and for the creation of rural assets. Ultimately, this programme intends to smooth consumption and eventually reduce the level of poverty.

nrega_20120116

Figure 1: NREGA work (http://www.outlookindia.com/printarticle.aspx?279467)

In his CSAE seminar of the 4th February, 2014, Clément Imbert presented a joint paper with John Papp which studies the effect of the NREGA on short-term migration. He further examined the connectedness between work availability and the likeliness of migrants to work for NREGA, and examined the importance of seasonality in these decisions.

The possible links between the NREGA programme and short-term migration is explained by a simple model which identifies the individuals who are likely to reduce their time spent working outside the village as a result of the NREGA programme. It splits time endowment between work within and outside of the village. It predicts that a migrant leaves his village for work if the net return from working outside is greater than the earnings one get from spending entire time within the village. Following the introduction of government work at fixed minimum wage, migrants will spend more time in village and work for government programme provided daily wage offered is greater than net earnings per day from outside work. And people will stop migrating if the wage offered under NREGA is more than marginal earnings per day outside work and if the total earnings from in-village work including NREGA is more than net earnings from in-village work in the absence of NREGA and outside work together.

In order to test their model, Clément Imbert and John Papp use survey data from a reportedly high out-migration area sampled 705 households living in 70 villages at the border of three major states of India- Rajasthan, Madhya Pradesh and Gujarat. The participants in the age-group 14-69 years have reported to migrate 28 percentage points more against average 3 per cent for rural India. To capture the seasonality effect of NREGA on short-term migration and participants’ likeliness to work for NREGA, individuals were interviewed for one complete agriculture year.

The descriptive statistics show that the NREGA work is concentrated during lean season of summer. And a quite significant proportion of adults – as high as 80 per cent – expressed desire to work more for NREGA. Among those who do not want to work for NREGA, 67 per cent are engaged in other works inside the village, specifically during Monsoon season which is the main time for agriculture activity.

Migrants mostly do jobs of short-term nature and work for multiple employers at different wages. Introduction of government employment via NREGA succeeded in reducing the migration for 20 per cent of adults. Further, during summer 2009, 88 per cent of the migrants reported that they would have worked more for NREGA had it been available.

The regression estimates reveal that education and salaried adults are less likely to want work for NREGA. Further, migrants are 15 percentage points more likely to report willingness to work for the programme. Importantly, working for the NREGA is negatively correlated with time spent outside the village: one day increase in NREGA work corresponds to a fall of around 0.20 days outside village time spent.

The creation of employment under this programme varies across the country with some parts doing well against others. Using cross-state differences in implementation of NREGA across States’ borders, they perform an IV analysis to better identify the impact of NREGA on temporary migration. In their first stage regression, they find that adults in Rajasthan worked almost 9 additional days for NREGA compared to MP and Gujarat. Their second stage regression confirms the important impact of the NREGA programme on days spent outside village work: one day of additional NREGA work reduces migration approximately by 0.75 days. Moreover, this difference is noticeable for summer season during which most of the government work is provided, indicating the importance of seasonality in the decision to migrate temporary for work. However noting the other differences among adults living across these states, the differences in migration could be to a great extent due to these pre-existing differences and unrelated to NREGA.

In conclusion, government work seems an attractive alternative to migrants to date despite the wage offered under NREGA is as low as half of the wage received per day of work outside the village suggests that the migration costs is high. The study shows a significant impact of off-season work on private employment through its impact on short-term migration. Consequently, notwithstanding the welfare gains, the net income effect of the programme is much less than the wage offered by the programme.

Deepak Kumar is a visiting research student at the Department of Economics, University of Oxford from India on Commonwealth Scholarship. He is doing his PhD in economics from Jawaharlal Nehru University, New Delhi.

Share
Posted in Uncategorized | Comments Off on Short-term Migration and India’s Employment Guarantee

Early life circumstances affect later-life mental health in Ghana

Posted on February 6, 2014 by

The economic losses due to mental health disorders in low-income countries are staggeringly large. Depression alone generates an estimated loss of 55.5 million disability-adjusted life years (DALYs) in low- and middle-income countries. That number is less than a fifth as large—10 million DALYs—in high-income countries. Investment in prevention and treatment remains low, but developing country governments and aid organizations are beginning to turn their attention to mental health policy. For example, Ghana, where our study is based, passed a landmark Mental Health Act in 2012. It’s crucial, then, as the tide of policy begins to shift, to understand the origins of mental health disorders in low-income country contexts.

James Fenske, Anant Nyshadham, and I set out to do exactly that in a recent CSAE working paper titled “Early Life Circumstance and Mental Health in Ghana.” We study the relationship between early life conditions and adult psychological distress. Medical evidence suggests that some components of mental health are coded during fetal development. Changes to the fetal environment, if they alter or disrupt this coding process, may have long-lasting impacts on mental health. These “disruptions” may be particularly common in low-income populations, whose smoothing and coping mechanisms are limited.

The households we focus on are cocoa farmers. They, and millions like them across the developing world, are commodity suppliers to global markets. The wide and persistent price fluctuations that characterize these markets directly affect the livelihoods of smallholder suppliers, leaving households (and especially young children) vulnerable.

Cocoa is Ghana’s chief agricultural export commodity, and its price is a key determinant of farm households’ income in regions where it is produced. We show that in these regions, low cocoa prices at the time of birth substantially increase the incidence of severe psychological distress, as classified by the Kessler Scale, an internationally validated measure of anxiety-depression spectrum mental distress. We estimate large impacts of these price fluctuations. A one standard deviation drop in the cocoa price increases the probability of severe mental distress by 3 percentage points, or nearly 50 percent of mean severe distress incidence.

Perhaps the best way to summarize the relationship between prices in early life and adult mental distress is through the following figure. We graph real cocoa prices over the birth years of individuals in our data. On this time series, we superimpose the rate of severe mental distress for each birth year cohort in cocoa regions relative to the same rate for the same cohort in non-cocoa regions. This trend tells us the extent to which the relative rate of mental distress across these regions fluctuated over birth cohorts. There is a clear negative relationship between the two: when cocoa prices at birth are high, the relative rate of mental distress is low, and vice versa.

 

price_severe

What drives the large and long-lasting impacts we uncover? We find evidence consistent with the hypotheses that maternal nutrition, reinforcing childhood investments, and adult circumstance are all operative channels of impact. We also take a careful look at selective fertility and mortality, both of which could explain some part of the mental health impact. Our results suggest that fertility does indeed respond to cocoa prices, but that selective fertility cannot account for the bulk of our estimated effects. Since this issue arises in essentially every “fetal origins” study, we suggest several ways in which future studies could both deal with selection as well as estimate the extent to which it explains the long-run impacts of early life shocks.

We hope our results will aid in the design of better prevention policies for mental health disorders in the developing world. We also show that certain groups are more susceptible to long-run mental health impacts, and thus should perhaps be targeted by policy interventions: impacts are largest for men, for farmers, and for the Akan, the biggest ethnic group in Ghana.

In sum, mental health disorders constitute a substantial problem across the developing world, with regard to population health as well as the economy. We show that in addition to ongoing efforts by governments to improve mental health care infrastructure, attention must be devoted to tackling the long-run causes of these disorders, particularly in vulnerable populations like agricultural commodity producers.

Achyuta Adhvaryu is an assistant professor of business economics and public policy at the University of Michigan’s Stephen M. Ross School of Business. His co-authors, James Fenske and Anant Nyshadham, are assistant professors of economics at the University of Oxford and the University of Southern California, respectively.

Share
Posted in Policies to Protect the Poor | Tagged , | Comments Off on Early life circumstances affect later-life mental health in Ghana

How do African incomes compare to the rest of the world?

Posted on December 23, 2013 by

How poor are people in Sub-Saharan Africa compared to the rest of the World? International comparisons of GDP per capita do not provide an answer to this question because they ignore within-country inequality (i.e. every individual in a country is assumed to have the same level of income) and because GDP is not the same as disposable income, which more accurately reflects living standards.

In a recent analysis of the global income distribution, Branko Milanovic and I have compiled a new database of more than 550 household surveys between 1988 and 2008. Household surveys collect information on disposable income. Because there are few household surveys in Sub-Saharan Africa before 1993, we concentrate on the period between 1993 and 2008 in this blog post. Our data come mostly from the World Bank’s PovcalNet database, which we supplement with data from the Luxembourg Income Study. Every person in the world is assigned the average income of his or her income decile (in the country of residence). Incomes are measured in per capita terms and adjusted for purchasing power parity differences across countries.

Average per capita incomes in Sub-Saharan Africa (SSA) have barely changed over this 15-year period, moving from $742 to $762 per year (measured in 2005 Purchasing Power Parity-adjusted USD). When we exlude South Africa and the Seychelles, we actually see a decline from $608 to $556, which makes SSA the poorest region in the world (even more so than than India). Sub-Saharan Africa ( stillexcluding South Africa and Seychelles) is also the second most unequal region after Latin America & Caribbean. However, while in this group of African countries differences between countries account for almost 30% of inequality (as measured by the Theil-L index), they only explain 7% of observed inequality in Latin America. That is, the dispersion in average incomes across countries is very important in Sub-Saharan Africa. Nevertheless, high levels of inequality within countries is still common: in 2008 six African countries have a Gini index in excess of 50% (Central African Republic, Rwanda, Swaziland, Seychelles, South Africa, and Zambia).

By contrast to slow growth rates in SSA, between 1988 and 2008 average incomes trebled in China, increased by 34% in India and by 68% in the rest of Asia. Because different regions have developed at such different speeds, the regional composition of the global income distribution has changed dramatically between 1993 and 2008 (Figure 1). To construct Figure 1, we divided the world distribution in 1993 and 2008 into 20 income groups (or income ventiles), each representing 5% of world population. Figure 1 shows where the people in each of these income groups live. Note that the ventile categories refer to different money amounts in 1993 and 2008, so the fact that the richest Indians were in the 15th ventile in 1993, but only in the 14th ventile in 2008, does not imply that their incomes declined.

lakner1

In Figure 1 we can clearly see the upward movement of China. In 2008, the top income group in China reaches as far as the 17th ventile (i.e. between 80th and 85th percentile), compared with between 70th and 75th percentile in 1993. At the same time, by 2008 China had grown out of the poorest 5% of the world population while in 1993 it made up almost 30% of the population in that income class. Because our database consists of country-deciles (in the case of China, separated by rural/urban), this means that the average income of the poorest Chinese decile exceeds the global income cut-off for the poorest 5%. However, if we had a continuous Chinese distribution, it would of course be possible that some Chinese would have incomes below that cut-off.

Another way to illustrate the relative performance of Sub-Saharan Africa is to compare the position of its various country-deciles in the global distribution over time. This reshuffling in the global distribution arises precisely because different countries (and different deciles within these countries) have developed at very different speeds. For every decile in the national distribution, Figure 2 shows the position in the global distribution in 1993 and 2008. The top-left panel shows the remarkable upward movement of China, which we already discussed: for example, the richest 10% living in urban China jumped from the 73rd percentile globally to the 83rd percentile. The top-right panel shows how Côte d’Ivoire and Ghana have developed very differently.

In 1993, Côte d’Ivoire was substantially richer than Ghana. As a result of the decline in Côte d’Ivoire and the growth in Ghana, this ranking reversed by 2008 (2003 in the case of Ghana). Incomes in both Swaziland and Uganda grew strongly over this period. In Swaziland, the income groups around the middle of the distribution have gained most, although inequality remains very high (Gini index of 51%). Tanzania and Nigeria have both slid down the global income distribution.

lakner2

Our analysis shows that over the last 20 years Sub-Saharan Africa has lagged behind compared to other regions. As a result, an increasing proportion of the poorest people in the World live in Africa. While the region as whole has lagged behind, some countries – and some income groups within those countries – have been more successful than others. Of course this also applies globally. Hence our paper suggests natural case studies, both amongst African and other similar countries, to derive policy implications.

Share
Posted in Institutions and Growth | Tagged , | 1 Comment

A new way of measuring the different benefits of going to school

Posted on December 13, 2013 by

Photo by Eric Socolofsky, licensed under Creative Commons Attribution-NonCommercial-ShareAlike 2.0 Generic (CC BY-NC-SA 2.0)

Designing effective schooling policies requires understanding what motivates school enrolment decisions. This partly explains why so many empirical studies have attempted to measure the wage benefits that individuals receive from an additional year of schooling (or the rate of return on schooling investment). Until quite recently, most such studies found that the returns to schooling decreased as students advanced to higher schooling years: the schooling-earnings profile was concave. More recent studies suggest that the shape of this earnings profile has changed from concave to convex: the returns to schooling are now relatively low for early schooling years and only start to increase at higher schooling years. This convex shape is particularly pronounced in African labour markets.

Theoretical models of human capital investment have been slow to adapt to this new evidence. Most such models maintain the assumption that the earnings profile is concave, and also that schooling enrolment decisions are made by individuals who have perfect foresight about future wage offers and schooling costs (either monetary or psychological). Under these assumptions, the only benefit of an additional year of schooling is the wage increase associated with the current school year. However, such models find it difficult to explain why most individuals in African countries choose to complete early, low-yielding schooling years, but then decide to drop out before completing the more advanced, higher-yielding years.

If the earnings profile is actually convex then this endows lower schooling years with a second benefit: the option of continuing on to more advanced schooling years. Furthermore, acknowledging that schooling decisions are made with imperfect foresight about future wage offers and schooling costs means that there is also a second option value to schooling: even if a student anticipates dropping out of school after the current year, staying in school will allow them to proceed to the next year of schooling if it turns out that either outside wage offers or schooling costs turn out to be lower than expected the next year. The fact that these two option values make earlier school years more beneficial can potentially go some way in explaining the pattern of enrolment decisions we observe.

Recent theoretical models have relaxed the concavity and perfect foresight assumptions and speculate that these option values may be important determinants of enrolment decisions. In our recent CSAE working paper, Francis Teal and I1 go one step further and develop a decomposition technique2 that calculates the relative importance of different benefits of completing additional schooling years, including both types of option value. These components are then estimated on a sample of workers with a highly convex schooling-earnings profile, and who face considerable uncertainty regarding future wage offers: young, black South African men.

Plotting these three benefits across the different schooling levels gives us the graph below. The line indicates the height of the stacked components, which represents the total discounted expected value of investing in a particular schooling year (expressed in terms of current period log earnings). The higher the net expected value of a specific schooling year, the more likely potential learners will be to enrol in this year of schooling.

rulof1

In our model, the immediate (or myopic) benefit of additional schooling is initially low, but then gradually increases with additional years of primary and secondary schooling. This expected benefit turns negative after years 12 of education, at which point the relatively high wage and employment benefits are more than offset by the large estimated costs of tertiary education. The relatively small myopic net benefit of completing early schooling years is dominated by the larger positive option value associated with the convexity of the earnings profile.

By far the most important reason why young black South African men choose to complete primary and early secondary school, despite the relatively low returns associated with these investments, is the promise of higher returns further up the schooling ladder. The option value attached to uncertainty regarding future wage offers and schooling costs is quite small at low schooling levels, as most are quite certain that they will enrol in school again after the current schooling year. However, as learners approach completed secondary school and the margin between expected costs and benefits starts to shrink, the uncertainty option value increases along with the uncertainty about next year’s enrolment decision. Individuals now attach more value to the opportunity to observe next period’s school cost and wage offers before deciding whether or not to leave the school system.

Most young, black South African men choose to complete primary and early secondary schooling years despite the relatively low returns associated with these investments. Our results show that rationalising these decisions requires large option values of early schooling levels (which are mainly associated with convexity rather than uncertainty), as well as a schooling cost function that increases steeply between schooling phases.

 

[1]Rulof Burger is a Senior Lecturer at the Economics Department, University of Stellenbosch. Francis Teal is a Research Associate, CSAE.

[2] The technical details of this technique can be found in the full paper.

Share
Posted in Jobs, Finance and Skills | Tagged , | Comments Off on A new way of measuring the different benefits of going to school

Lessons from macro-prudential policy in emerging markets

Posted on November 21, 2013 by

Last week, Donald Kohn, current member of Bank of England’s Financial Policy Committee and former Vice Chairman of the Board of Governors at the FED, gave a seminar at Oxford University on a key challenge faced by policymakers today: how to make macro-prudential regulation (MaPP) work. The policy debate with the students and academics in the seminar room was placed largely, if not exclusively, in the context of the advanced industrial countries. However, emerging markets, having suffered earlier and more frequent financial crises, have had greater experiences with macro-prudential and other policies aimed at ensuring financial stability. As such, emerging markets can also offer valuable lessons.

Why Is Macro-prudential Policy Needed?

Macro-prudential policies aim to dampen the pro-cyclicality of the financial system and to reduce cross-sectional systemic risks, partly by introducing measures to address liquidity and capital shortages, and partly by addressing issues of banks being ‘Too Big to Fail’. The global financial crisis has highlighted that using a mix of micro-prudential regulation, supervision, and market discipline to address potential risks at the level of individual financial institutions does not suffice for financial stability. Neither are traditional macroeconomic management policies (e.g. monetary policy and fiscal policy) necessarily able or the most effective in containing (the build-up) of systemic risks.

As such, macro-prudential policies are promising (for an early analytical review of the need for MaPP, see Brunnermeier, et al (2009) and Hanson, Kayshap, and Stein (2011)). Their use does require, however, a clear identification of the fundamental causes of systemic risk. Systemic risk can be cyclical—whereby financial institutions and markets over-expose themselves to risks in the upswing of the financial cycle and become overly risk averse in the downswing, rendering the entire financial system vulnerable to booms and busts. Or it can be cross sectional—whereby individual institutions’ actions and problems can have spillover effects on the rest of the financial network. While both types of risks can arise from as well give rise to externalities and market failures, appropriate policy tools can vary between the two (Allen and Carletti (2011), Bank of England (2011), and Schoenmaker and Wierts (2011) provide alternative classifications of market failures).

The Macro-Prudential Toolkit

Table 1 categorizes the possible macro-prudential policies by the intended target and method, namely a) capital and provisioning requirements; b) quantitative restrictions on bank balance sheets; c) quantitative restrictions on borrowers, instruments or activities; d) taxation of activities, and e) other measures such as accounting changes, changes to compensation, etc. (for another classification of MaPP see Bank of England (2011), and IMF (2011)).

rox2

 

In thinking about different types of MaPP, most analysts find it useful to distinguish among measures that consist of correcting those factors that contribute to the adverse financial sector dynamics (such as the pro-cyclicality of Basel capital requirements); measures that aim to reinforce the resilience of the financial sector to such cycles—i.e., capital buffers; those that aim to dampen the amplitude of the cycles (which constitute the bulk of the measures countries have used so far); and finally those that aim to ensure the internalization of the spillovers/externalities by financial agents to dampen the build-up of the dynamics in the first place (De la Torre, 2011).

Macro-prudential Policies at the Bank of England

Donald Kohn’s message at the seminar was that the Bank of England is trying to mitigate systemic risk using micro-prudential policy tools in a new way – setting standards so that agents internalize risk, and preventing the buildup of tail risk, – while also coordinating macro-prudential policy with monetary policy. Kohn stressed the importance of thinking about the interaction between monetary policy and macro-prudential policy, and their possible trade-offs. For example, tighter regulation in form of more intensive macro-prudential policy can have feedbacks on consumption, putting even more pressure on monetary policy to go even further. Therefore, it is very important, in his view, that macro-prudential policy is carefully complemented by appropriate macroeconomic policies, as well as other financial sector measures. In light of diminishing the possible trade-offs, Kohn stressed that the BoE’s Financial Policy Committee and the Monetary Policy Committee share board members, in order to enhance policy coordination.

What about the Emerging Markets?

The policy debate is in general taking place largely in the context of the advanced industrial countries. However, emerging markets face different conditions and have key structural features that can have a bearing on the relevance and efficacy of the policy measures being discussed. Also important, emerging markets have had much greater experiences with macro-prudential policies, primarily because they have also experienced more pronounced business and financial cycles. This greater pro-cyclicality is due to their greater exposures to international capital flow volatility, commodity price shocks, and other risks, and external and internal transmission channels that operate more adversely (for more details on sources of risk in emerging markets, see Claessens and Ghosh, 2012).

rox1

 

This issue has been recently extensively explored in a World Bank publication entitled “Dealing with the Challenges of Macro-Financial Linkages in Emerging Markets”. The book, a comprehensive collection of articles by Hyun Shin, Viral Acharya, Stijn Claessens, Swati Ghosh, and others, discusses the challenges of dealing with macro financial linkages, and explores the policy toolkit available for dealing with systemic risks with particular reference to emerging markets.

Empirical Evidence on the Effectiveness of MaPPs in Emerging Markets

There are five things to notice in the empirical research on the effectiveness of specific macro-prudential instruments. First, substantial research on the effects of MaPP looks at tools targeting the real estate sector, and documents a positive relationship between limits on LTV or debt-to-income (DTI) ratios – particularly when they are actively managed – and house price dynamics. This link is found to be significant in both industrial and emerging market countries (Claessens et. al (2013) for a large set of EMs, Crowe et al. (2011a), and Igan and Kang (2011) for Korea). The problem with these results is that many countries either do not have time-varying LTV ratios, or they are not available at all. In the cases when they are available, some LTV ratios are not mandatory, but rather just guidelines.

Second, work on emerging market countries suggests that limits on foreign currency lending are also effective in smoothing large swings in credit and bank capital over time, with strong examples coming from Central and Eastern European countries (IMF, 2013).

Third, there is evidence that dynamic provisioning might act as a buffer, rather than as a counter-cyclical capital tool. Research suggests it can strengthen both individual banks and the banking system as a whole, even though it seems to have only a limited impact on restraining credit growth (Fernandez de Lis et. al (2012), Columba et al. (2012)).

Fourth, there is tentative evidence that other counter-cyclical buffers (such as reserve requirements, or restrictions on profit distribution) used in part for financial stability purposes may have been successful in smoothing private sector credit growth and in stabilizing capital flows (Montoro and Moreno (2011) for the case of Latin America).

Finally, although macro-prudential policies help mitigate increases in bank leverage and asset growth (dimensions of financial sector vulnerability) in the upswing, few macro prudential tools help stop declines in these bank variables in adverse times (Claessens et. al, 2013). These results suggest that macro-prudential tools are best used as ex ante tools. That is, for reducing the buildup in bank risks in boom periods, rather than for mitigating declines when the cycle turns.

The current global conjecture with global liquidity driven by lax monetary policy in advanced economies renders the topic of macro prudential policies in emerging markets even more important and pressing than usual. Learning from the experience of emerging markets and the effectiveness of tools used there can shed light on how to adapt such tools to prevent the build-up of systemic risk in advanced economies.

Share
Posted in Institutions and Growth | Tagged | Comments Off on Lessons from macro-prudential policy in emerging markets

Banking in Africa: taking stock and looking forward

Posted on November 18, 2013 by

Banking in Africa has undergone dramatic changes over the past 20 years. While dominated by government-owned banks in the 1980s and subject to restrictive regulation – including interest rate ceilings and credit quotas – financial liberalization, institutional and regulatory upgrades and globalization have changed the face of financial systems across the region. Today, most countries have deeper and more stable financial systems, though challenges of concentration and limited competition, high costs, short maturities, and limited inclusion persist.

In a recent CSAE working paper, we take stock of the current state of banking systems across Sub-Saharan Africa and discuss recent developments including innovations that might help Africa leapfrog more traditional banking models. Our analysis shows a glass half-full rather than half-empty.  Figures 1 and 2 summarize this assessment. Figure 1 shows that the median African country has a significantly shallower financial system than the median non-African country, as measured by three different standard measures of financial depth.  Figure 2, on the other hand, shows that the median African country has made marked improvements over the past decade across all three indicators. And if one drills deeper, one can see that this improvement holds across the whole distribution, not just for the median country. Obviously, when talking about financial systems in Africa, one has to take into account the enormous variation within the region, which also implies different challenges for countries at different levels of economic and financial development, of different sizes and of different economic structures.

tor

 

tor2

Using other indicators of financial depth confirms the assessment that African banking systems have still some way to catch up. Recent data on the use of financial services by households and enterprises show lower access to and use of financial services.  Banks in Africa are less efficient than in other parts of the developing world and focus on the short end of the yield curve.  On the other hand, African banking systems have proven stable and resilient to global financial shocks in the recent crises. Greater stability is also illustrated in the aggregate balance sheet indicators of African banks, with very high levels of liquidity and capitalization, corresponding to the relative low level of intermediation.

While sharing many characteristics of non-African developing countries, many African financial systems face the quadruple problems of (i) small scale, (ii) high political and economic volatility, (iii) high incidence of informality, and (iv) governance challenges in both private and public sectors. As pointed out by previous analyses, this makes African economies unlikely hosts for efficient and stable financial systems. The combination of these four challenges might also explain why benchmarking exercises that relate country-level financial development to an array of country characteristics fail to explain why African banking systems are less developed than those of other low-income countries.

Critically, these challenges underline the need for innovative solutions in deepening and broadening financial systems in Africa. Recent papers have documented the success of some of these innovative approaches in fostering financial inclusion and deepening across the continent. Kenya’s Equity Bank has expanded its branch network and focused its business model on the provision of financial services to population segments that are typically ignored by commercial banks, with a resulting increase in financial inclusion in the country. Several randomized control trials in Kenya and Malawi have shown how commitment savings accounts can not only help overcome social barriers to savings, but also increase investment and entrepreneurial productivity. An experiment in Ghana showed that rainfall insurance counters farmers’ risk aversion and improves decision making, though effects were largest when insurance was combined with subsidized capital. Finally, mobile-based payment systems can reduce the costs of sending remittances and facilitate risk sharing within the country, as illustrated in the case of the Lake Kivu earthquake in 2008 in Rwanda, which caused individuals living outside the affected area to transfer a large and significant volume of airtime to people living close to the earthquake’s epicenter. Evidence from Niger and Zambia shows that electronic cash transfer via a mobile based system can work as alternative to traditional payment systems, with positive effects on households’ consumption patterns.  These are only a few examples of the financial innovation across the region, in the form of new providers, new products and new delivery channels, that is so critical for financial deepening and inclusion.

Documenting these different innovations and their effects provide a richer picture than the aggregate indicators provided in Figures 1 and 2. However, they also point to a broader challenge for African banking systems: maintaining the momentum towards deeper, more efficient and more inclusive financial systems without losing the stability they have gained over the past decade.

Researchers have helped document the advances of African banking systems over the past decade. But more challenges await for analysts and policy makers alike, including (i) the challenge of long-term finance to meet African investment needs in infrastructure and housing, (ii) the expansion of the financial inclusion agenda from micro- to small enterprises, (iii) an appropriate context-specific response to the regulatory reform wave coming out of Basel, (iv) the challenge to reap the benefits from globalization while minimizing risks, and (v) the political economy of financial sector reform.  While the glass of financial sector development in Africa is indeed half full rather than half empty, there is a lot more to fill!

Share
Posted in Institutions and Growth | Tagged | Comments Off on Banking in Africa: taking stock and looking forward

A loan shark in sheep’s clothing? Is commercialization of microfinance bad for borrower welfare?

Posted on November 12, 2013 by

Photo by Peter Haden, licensed under Creative Commons Attribution 2.0 Generic (CC BY 2.0) license

After years of positive media attention and a Nobel Peace Prize for Muhammad Yunus and Grameen Bank, it’s been hard to miss the recent controversy surrounding the microfinance industry. Critical media reports have highlighted the role of high interest rates and the potential psychological burden caused by pressures to repay. In particular, many have questioned whether increasing commercialization of the microfinance sector has led to exploitation of poor borrowers. Indeed, Muhammad Yunus himself has spoken out against commercialization, condemning what he perceives as a “mission drift” amongst microfinance practitioners.

Against this background, CSAE recently had the honour of welcoming Professor Maitreesh Ghatak to present a paper (joint work with Jonathan de Quidt and Thiemo Fetzer ) addressing the crucial question as to how commercialization and market structure in microfinance might affect borrower welfare.

Modelling modern-day microfinance

The reality of microfinance in 2013 is one of multiple lending organisations, some for- and some not-for-profit, engaged in varying degrees of competition depending on the location and regulatory environment. This is a far cry from existing theoretical models, which typically assume zero-profit lenders and thus all surplus accruing automatically to borrowers, and in this more complex world the welfare implications of microfinance are much less clear-cut. Thus it is timely and most welcome that this paper tackles issues of commercialization, market power and welfare head-on.

To do so, the authors theoretically model and compare outcomes under a benevolent NGO, a for-profit monopolist, and perfect competition amongst for-profit firms.[1] Furthermore, they speak directly to the issue of the welfare of clients, by departing from the literature’s traditional focus on repayment rates and instead also considering interest rates and (most importantly) an explicit measure of borrower welfare. Finally they simulate the model using the MIX market data, to get an idea of the potential magnitude of the theorised effects.

Results

The authors find that as long as there is perfect competition, welfare under for-profit lenders is likely to be similar to that under a benevolent NGO (although outreach is likely to be lower under perfect competition, since credit is rationed due to lack of information sharing across firms). Thus the first main result is that commercialization per se does not entail a reduction in borrower welfare.

However, in the case of a monopolist, welfare is likely to be severely reduced compared to under a benevolent NGO or perfect competition. Thus the second and arguably most salient implication for policymakers is that whilst they shouldn’t necessarily be too concerned about commercialization broadly speaking, they should be very worried indeed about the potential for for-profit lenders to acquire market power.

Discussion and possible extensions

Such results are interesting and compelling. Moreover, the strength of the paper lies in its systematic and thorough approach and in the authors’ ability to bring well-reasoned insights from economic theory to elucidate this important debate; the emotiveness of which may have obscured some of the key issues in past discussions.

Building on this, to take the theoretical and policy debate to its next stages, it would be instructive to address certain issues which the paper in its current form does not.

Firstly (as the authors explicitly acknowledge) the model closes down one of the potential channels for commercialization to bring about welfare improvements, by assuming that all types of lender face the same opportunity cost of funds. An argument often cited by proponents of commercialization is that commercial lenders will have greater access to financial markets, decreasing their cost of funds and consequently easing credit rationing and improving outreach. On one hand, the empirical assertions in this argument remain largely undemonstrated; however, it would be useful for the authors to assess its potential quantitative significance for welfare comparisons, perhaps by calculating how much cheaper a monopolist’s cost of funds would really have to be in order potentially to surpass the welfare of a benevolent NGO.

Secondly, a significant part of media criticism has focussed on the psychological costs to borrowers caused by the threat of co-borrowers or lenders imposing sanctions in cases of repayment failure. This has been linked to stress and even suicide amongst microfinance clients . Yet whilst the authors do include the threat of social sanctions in their model, through a “social capital” term S which may be destroyed to punish reneging borrowers, this threat per se does not reduce borrower utility. Indeed, nor do actual sanctions, since they are never employed on the equilibrium path. In order better to address concerns about repayment pressure, the authors might consider introducing a mechanism for sanctions to cause actual disutility in their model; for example by having S stochastically destroyed as a result of noise in observing other borrowers’ outcomes, temporary preference shocks, or even uncertainty about one’s own investment opportunities. Furthermore, whilst in equilibrium such noise or shocks would presumably be zero in expectation, it is possible that there might still be implications for welfare comparisons across market structures.

Thirdly and finally, it would be interesting for future work to consider an alternative explanation for observed defaults and punishments, namely a behavioural story whereby borrowers have time-inconsistent preferences and some degree of naïveté about their own ability to save and repay in the future. Moreover, this might be embedded within a somewhat different model of microfinance, emphasising its possible role as a savings commitment technology: recent empirical work such as that of Banerjee et al. (2013) in Hyderabad has shown that a large proportion of microfinance borrowers may be borrowing to consume rather than invest; and the lack of grace period and the regular repayment instalments in a typical microfinance contract arguably indicate that borrowers must have some outside capital and may be using the product more like a mortgage rather than a pure investment loan.

If microfinance is viewed from this angle, then perhaps some lessons about market structure and borrower welfare might be drawn for example from Heidhues & Köszegi (2010)’s work on the mortgage market. These authors highlight how lenders can potentially take advantage of partially naïve borrowers by imposing large financial penalties when clients fail to stick to repayment schedules. Furthermore, they demonstrate that perfect competition is by no means a panacea for abusive credit pricing, since in fact firms are compelled by market forces to take advantage of consumers’ imperfect foresight.

It is unclear as to exactly which implications would carry through to a similar model of microfinance, but intuitively these kinds of concerns might tip the welfare balance away from perfect competition and back towards a benevolent NGO (although perhaps also lessening the welfare loss of a monopoly). Viewing clients as savers, for example along the lines of work by Karna Basu, may therefore be an important direction for future research on borrower welfare and the commercialization of microfinance.

[1]For the theorists amongst you: the authors take a framework of limited liability and ex-post moral hazard in the spirit of Besley & Coate (1995), emphasising the role of i) dynamic incentives and/or ii) social collateral in providing sufficient incentives to avert strategic default by borrowers. The key assumed difference between perfect competition and a benevolent NGO is that competing firms do not share information, and thus under perfect competition there is a possibility that a defaulter may be able to borrow again. This naturally leads to credit rationing in equilibrium.

Share
Posted in Institutions and Growth, Policies to Protect the Poor | Tagged | Comments Off on A loan shark in sheep’s clothing? Is commercialization of microfinance bad for borrower welfare?

World Development Report 2014: a missed opportunity?

Posted on November 5, 2013 by

Family in Guiuan, Samar, The Philippines, photo by Karlijn Morsink

The World Development Report is the flagship statement by the World Bank on development for the upcoming year. As someone who spends a considerable amount of time working on risk and insurance in developing countries, I was excited to see that the WDR2014’s title was ‘Risk and opportunity’. The ‘Opportunity’ part of the title is especially important because, to many, recent natural disasters and financial shocks have made ‘risk’ synonymous to ‘downside risk’, something that happens to systems and not to people. This is not the right way to think about risk, especially if we want to understand its link to opportunities. Risk is equally about ‘upside risk’ and the agency that people have to take advantage of opportunities.  It is thus about putting households’ decision-making under uncertainty at the center, allowing us to systematically think about practical policy options to better meet the needs of the poor. And what better way to do this than through the formal financial system?

Glancing through the contents of the WDR I was happy to find a chapter that was devoted to the financial system, distinct from the chapters on macroeconomic risk and global systemic risks. However, my initial excitement soon subsided as the policy recommendations coming out of the chapter on financial systems predominantly speak about the financial crisis and macro-prudential regulation, foregoing a systematic discussion of how financial services can stimulate poor households to take decisions that reduce risk-exposure and create equal opportunities in risk-taking.

While thinking about how this could have been done differently, I was reminded of a financial system’s primary function as described by Danthine and Donaldson: ‘the exchange of contracts and provision of services for the purpose of allowing the income and consumption streams of economic agents to be desynchronized’. Basically what they are saying is that a financial system comprising credit, savings and insurance institutions can create the necessary freedom for people to make decisions without a fear of being exposed to risk.

Given this function, if WDR2014 is about opportunities and development, then we might expect to see these questions addressed in a chapter on the financial system:

  1. How financial services can help individuals, households and enterprises’ take advantage of opportunities when making decisions in a context of risk?
  2. How financial services can create more equal opportunities in risk-taking?

Unfortunately, only 8 out of the 323 pages in the report discuss ‘some market-failure related issues’ about supply and demand that influence access to financial services by the poor (and half of those pages are taken up by figures or boxes with case studies).

What went wrong? Why does the chapter on financial systems have such an ill-fitting focus on macroeconomic stability?

Some hints may come early on in the report, where the authors announce they are going to use a holistic approach because ‘individuals can’t overcome the obstacles to risk management they face on their own’. Combining several layers of analysis, the report covers everything from lack of information, cohesiveness, and connectedness in networks, flexibility and formality in enterprise management, fiscal risk, financial bailouts and humanitarian crises and even presents a box titled ‘When risk aversion becomes loss aversion’.

It is true that individuals can’t overcome the obstacles to risk management they face on their own and we need to consider how they are embedded within social,  economic and political systems but this does not mean that we can’t have an analysis which focuses on household decision-making and still produce internally consistent and coherent policy advice about these systems. While the attempt to be comprehensive is admirable, the result is that the report tends to be more descriptive than analytical. It randomly cites prominent researchers such as De Weerdt and Fafchamps (2011), Karlan, Osei, Osei-Akoto, and Udry (2012) and Mobarak and Rosenzweig (2013) while their work deserves to be recognized as part of an important and growing literature, which systematically analyzes how we can learn from traditional approaches to risk-management, informal financial mechanisms and information asymmetries to redesign financial services which allow us to redistribute some risk away from the poor and make the financial system more inclusive. This should have been presented in Chapter six.

Unfortunately Chapter six remains stuck in its macro approach, concluding that supply is low because low-income households are a risky target group, demand is low and financial companies are risk averse.

But what can we do about it?

In what ways can we provide insurance to credit providers to incentivize them to provide credit to low-income households?  How can we collect more reliable data to aid the pricing of insurance products against aggregate losses? How can we combine financial services with preventive technologies to reduce the probability of losses of risky clients? What products complement and not substitute traditional credit, savings and informal risk-sharing groups? In what ways can flexible insurance premium payment mechanisms answer to low-income households irregular cash flows? How can we offer premium subsidies without creating perverse incentives for insurance companies to improve the value of insurance products? These are all questions which might have been addressed in this chapter, but were not.

This is a shame, as these are all questions that are important for redistributing downside risk in order to create equal opportunities in risk-taking. Especially because to date, the opportunities of risk are accrued predominantly by the world’s rich, while the consequences of downside risk disproportionally affect the poor.

So for the next WDR, even though I understand that taking a holistic approach which represents the views of all stakeholders is a low-risk strategy, what we really needs is a riskier approach: a report which applies a consistent analytical framework and uses it to identify the opportunities available to the development world to make progress on that years theme.

Share
Posted in Institutions and Growth, Policies to Protect the Poor | Tagged | 3 Comments

The reverse couch potato effect: the impact of inspirational movies on aspirations and expectations

Posted on November 1, 2013 by

project

Documentary screening, iiG Programme (DFID funded) (Owner: Kate Orkin) – Licence: Attribution-NonCommercial 4.0 International (CC BY-NC 4.0).Link to Licence: http://creativecommons.org/licenses/by-nc/4.0/

 

Do people believe that they are in control of their future outcomes? And how do expectations of what can be achieved affect behaviour? And can we influence this? As the first speaker in the new season of the weekly CSAE Lunchtime Seminar, Stefan Dercon from DFID and Oxford University presented the first exciting results of a field experiment that addresses these questions. The study, conducted in 64 villages in rural Ethiopia, is joint work with Tanguy Bernard (IFPRI), Kate Orkin (University of Cambridge), and Alemayehu Seyoum Taffesse (IFPRI). Their first results show that a simple intervention has an impact on people’s aspirations and behaviour, and that interaction with peers plays an important role in this. This research is part of the iiG research programme, funded by DFID, and was supported by CSAE and the IFPRI Development Strategy and Governance and Markets, Trade and Institutions divisions. Funding for the documentaries was provided by Seven, as part of the Open Enterprise Solutions to Poverty.

Self-image, hopes and dreams matter, not only as part of well-being, but also for the choices that people make. The authors present results from earlier surveys that seem to suggest that a substantial number of poor people tend to choose the fatalistic options when asked whether they think each person is primarily responsible for his or her own success or failure in life or that success or failure is determined by destiny or fate. Furthermore, several studies have shown people fail to invest even though returns are sometimes very high. Aspirations and expectations seem to matter in whether the poor make the most optimal choices. But can aspirations and expectations be influenced?

This study tries to answer this question with a simple field experiment. As part of the experiment, six households in each of the 64 villages were shown four inspirational fifteen minute documentaries. These documentaries showed success stories of people with a similar background as the audience and a crucial element in each of these documentaries was that people made a choice that led to success. To control for effects associated to just viewing a movie on a projector screen (and the associated excitement), six households were shown an ordinary (less inspirational) soap instead as a placebo treatment. Finally, in each village six households that were not shown anything were surveyed as well, functioning as the control group. In the first two cases, participants received a bag of sugar after the screening, as an incentive to participate. In half of the villages, 18 extra households were selected to watch either the inspirational video or the placebo video, to assess the effect of having a larger group of peers that have watched the video.

“The Model Farmer”. Example of a documentary shown to the treatment group. Funding for the documentaries was provided by Seven, as part of the Open Enterprise Solutions to Poverty.

 At three points in time, the participants were surveyed: once just before the intervention, once just after and finally after six months. In these surveys, participants were asked about their aspirations (the level they wished to attain) and their expectations (the level they expected to attain) on four measures: their annual income in cash, their assets, their social status (whether people in the village ask them advice on their decisions) and finally the level of education of their oldest child. The authors find that the treatment has a positive and significant impact on expectations with respect to the control group (i.e. the group that did not watch anything) and the placebo group (i.e. the group that watched the soap) on most measures. The effect on aspirations is significant at the 5% or 10% level (depending on the specification) and seems mainly be driven by education.

But do these effects on aspirations and expectations also lead to changes in behaviour? The authors take four measures of behaviour: effort (the time spent in work and the time spent in leisure), investment in education, savings and hypothetical demand for credit (how many money they would ask for if an interest-free loan was offered). The last three measures have in common that they capture a “forward-looking element”: they ask about behaviour that has either a cost or a benefit in the future. The authors find a significant effect of the treatment compared to the placebo on the amount people saved (at the 5% or 10% level) and the hypothetical demand for credit. In case of the hypothetical demand, the effect was also significantly different from the control group. Peer effects seem to matter for investment in education and the time spent in work, but not for the other behavioural measures.

“The Fast Journey.” Second example of a documentary video shown.

The results of the experiment are surprising: an intervention that looks perhaps small and insignificant on paper, does seem to have a significant effect on expectations, aspirations and behaviour, according to the preliminary results. On most measures the impact of watching an inspirational movie is significant from not watching anything. In this case we could speak of a reverse couch potato effect: watching a movie could actually activate people. In case of savings and hypothetical demand for credit watching an inspirational movie is also significantly different from watching a presumably less inspiring regular soap (the placebo). Peer effects seem to matter and it would be great to see a further analysis of these in a future version of the paper.

Simon Quinn, the discussant at the seminar, welcomed the paper and raised some questions about the theoretical distinction between aspirations and expectations, and how this can be reconciled with the traditional microeconomic distinction between beliefs and preferences. Stefan Dercon answered that we should see aspirations as an aspect determining the choice set that people consider. Another more practical point raised was the question whether it is useful to increase expectations and aspirations (are people’s expectations and aspirations actually too low?) and whether we should be concerned about Hawthorne Effects: people being overly optimistic, hoping that this will lead to an increase in donor funding. The inclusion of the placebo treatment means that Hawthorne Effects are at least partially controlled for.

The authors have just put up a new version of the paper, in which some of the comments from the seminar have been incorporated. This version can be found here.

It was an exciting start of the CSAE Lunchtime Seminar series, in which scholars from all over the world are invited to present their latest work on economic development. The Seminar series are held every Tuesday at CSAE.

 

Share
Posted in Policies to Protect the Poor | Tagged , , , | 2 Comments

Formal savings access and informal financial transactions

Posted on October 28, 2013 by

Social networks and the analysis of peer effects are a current hot topic across academic disciplines. The idea that a structure beyond our own direct scope and understanding, i.e. the social network we are embedded in, significantly influences how our lives evolve has become increasingly popular in many academic fields, such as medicine, sociology politics and economics. This week’s CSAE seminar lunch series was honoured by a lecture given by Margherita Comola on how an increase in the access to formal funds through the government changes the network of informal financial transactions in Nepal. In particular, the data come from a field experiment that randomized access to savings accounts among all households living in 19 villages in rural Nepal (in the surroundings of Pokhara). The study makes use of a very elegant identification strategy developed by Bramoullé et al. (2009) that exploits the intransitive nature of the network data.

The paper is thus set at the intersection of several exciting research areas: For one, it is vital to illuminate whether an intervention that randomly offers some people access to formal finance has an impact on their savings behaviour. This is related to the fundamental question of how potential poverty traps can be overcome by offering individuals commitment devices. Secondly, it is interesting to investigate whether the households’ increased access to funds will have positive spillovers for their peers. Will they share part of their surplus? Will they use this opportunity to engage in more informal financial transactions? Lastly, it is critical to think about changes in the network of informal financial flows. Will I start lending money to other people with whom I have no current financial transactions?

One of the main results of the paper is that people receiving access to savings accounts engage in more informal financial transactions with their peers. In other words, as a result of the intervention, the financial flows in the network are increased and substantially altered. This is an interesting finding as the access to formal financial saving could have resulted in lower need for informal financial access. Yet, an intuitive explanation on this positive effect of the intervention is as follows: access to savings can foster asset accumulation. Hence, households with greater resources might increase transfers to others, for example as a result of altruism, or in anticipation of social constraints. Comola subsequently shows how the availability of several rounds of network data can be used to eliminate biases arising from the assumption that these networks are stable over time – which is prevalent in the economics literature, mostly due to data availability constraints. Clearly, taking into account that the intervention changes the network is critical in disentangling the true effect of peers[1]

Many challenges in the literature remain: Clear-cut evidence based on clean social network data and economically meaningful outcomes remains scarce. If network data is incomplete or error-ridden, then the validity of this empirical approach might not be given. It would be interesting to examine in future research whether the actual social network of individuals (e.g. one’s choice of friends or acquaintances) could be affected via government interventions.

Sharing norms and the resulting social constraints and other-regarding preferences are very appealing and simple explanations of the empirical findings that are not necessarily reliant on the changes in the network structure. It would be interesting to explore whether variations of such sharing norms at the village level play an important role for this paper’s results. Furthermore, it is interesting to explore whether this increase in informal financial transactions affects levels of trust or even other economic outcomes in the treated villages. For example, do these increased financial transactions affect peer effects in other domains such as consumption? Margherita Comola told me about an interesting and related study with data from Africa, where many of these outlined challenges in the literature shall be addressed in the future.


[1] This an important contribution to the difficult empirical task to overcome the reflection problem Empirical researchers face the problem that without intransitive network data they cannot disentangle whether people’s behaviour changes because of other people’s behaviour (genuine peer effect), their peers’ (exogenous) characteristics or a common shock (correlated effect) they are facing. Yet, in this methodology the effect arising from changes in the network was neglected. This smart idea by Marhgerita Comola is incorporated in her dynamic peer effect model.

Share
Posted in Policies to Protect the Poor | Tagged , , | Comments Off on Formal savings access and informal financial transactions