Elsevier

World Development

Volume 32, Issue 7, July 2004, Pages 1247-1264
World Development

Microenterprise Occupation and Poverty Reduction in Microfinance Programs: Evidence from Sri Lanka

https://doi.org/10.1016/j.worlddev.2004.01.009Get rights and content

Abstract

The microenterprise earnings of microfinance clients in southeastern Sri Lanka are linked to their initial incomes. Poorer clients face geographic, financial and sociocultural barriers to entry to the most promising microenterprise occupations, leading them to select low-value activities with poor growth prospects. In semi-urban areas, poverty impacts could be strengthened by supplementing loans with nonfinancial interventions encouraging poor clients to select higher-value occupations. In arid rural areas, where microenterprises face severe market and infrastructure constraints, microenterprise development is unlikely to facilitate poverty exit.

Introduction

Most observers agree that in the right circumstances microfinance can increase household incomes, but its impact on poor clients remains controversial. Several recent impact evaluations have emphasized the nonuniform distribution of benefits. Most households are better off with microfinance, but income impacts vary in magnitude and durability, and a sizeable proportion of clients find that their post-credit incomes stagnate or fall (Copestake, Bhalotra, & Johnson,. 2001; MkNelly and Dunford, 1998, MkNelly and Dunford, 1999; Mosley, 2001; Sebstad & Chen, 1996; Todd, 2000). Initial income has been identified as a key determinant of impact. An influential cross-country study found that loans produce the greatest percentage increases in the incomes of “upper-poor” and nonpoor borrowers who are close to or above national poverty lines. The “extreme”––or “core-poor”––the poorest 50% or thereabouts of those in poverty––were not only less likely to participate in microfinance programs; when they did participate their post-credit incomes were less likely to increase. Moreover, such increases as occurred were often too small and short-lived to enable sustainable poverty exit (Hulme & Mosley, 1996). Subsequent studies provide further evidence of a relationship between initial income and microcredit impact (Hashemi, 1997; Rahman, 1997; Zaman, 1999).

Income promotion through microenterprise lending remains the primary strategy of most microfinance institutions (MFIs), including many which serve poor clients. For poverty-focused MFIs, the questionable efficacy of microenterprise lending at the low end of the income spectrum makes impact monitoring particularly important. If their interventions are not effective, or are producing differential outcomes in different client groups, they need to know why. An understanding of the reasons for low poverty impacts yields important information for program design and targeting. It may be feasible to improve impacts by redesigning services to better meet the needs of poor clients, within the limits imposed by the need to maintain institutional viability. On the other hand, the poor commonly face nonprogram obstacles to microenterprise development, in the form of unfavorable market environments or inadequate physical infrastructure, over which MFIs have little influence. In such circumstances, a more socially beneficial allocation of resources may result from targeting less-poor borrowers who derive greater benefits from microenterprise loans or, for MFIs which choose to maintain a poverty focus, reorienting their activities away from income promotion in favor of protectional or nonfinancial interventions.

This paper examines the underlying causes of the income-related impact gap, a topic which has received surprisingly little scholarly attention, given its implications for the effectiveness of microenterprise lending in reducing poverty. It investigates the reasons for disparities in microenterprise earnings among clients of two MFIs in southeastern Sri Lanka. As expected, the microenterprises of less poor clients do better than those of the poor. Another important finding is that poverty impacts are differentiated by location: poor clients in semi-urban areas have considerably greater opportunities than their rural counterparts to exit poverty through microenterprise development services. The semi-urban/rural differential raises important policy issues for the MFIs, which provide a useful and highly valued service to their near-poor and nonpoor clients, but face challenges in meeting the needs of the poor. There is considerable potential for improving impacts on the semi-urban poor by encouraging the take-up of high-earning microenterprise occupations. In arid rural areas, however, where market and infrastructure constraints virtually rule out poverty-clearing microenterprises, the utility of microenterprise development for poor clients is more problematic. Support for rural microenterprises helps to alleviate some ill-effects of poverty––although it has little impact on poverty incidence––but its benefits are offset by significant risks and costs for borrowers and lenders, and the generation of negative externalities.

The paper is structured as follows: Sections 2 The research context and methodology, 3 The clients and their microenterprises describe the research context, methodology and findings. Section 4 discusses the reasons why poor clients earn less from their microenterprises, identifying geographic, financial and sociocultural barriers to entry which deter them from selecting higher-value occupations. Section 5 evaluates the MFIs' services to poor clients and makes the case for a stronger promotional focus on the semi-urban poor.

Section snippets

The research context and methodology

The research was conducted in Hambantota district, a remote region on Sri Lanka's southeastern coast, 250 km from the metropolitan Western Province and the national capital, Colombo. The district is one of the country's poorest regions, ranking well below the national average on household income, employment, literacy, and access to electricity, safe water and sanitation (United Nations Development Program, 1998). An estimated quarter of its population of 558,000 is semi-urban, living in and

The clients and their microenterprises

This study draws on the classification typology developed by the Asian Development Bank and others, which groups microenterprises into low-return “survival” activities and higher-return “entrepreneurial” activities. Entrepreneurial microenterprises are larger, more highly capitalized, employ more labor and use more sophisticated technologies. They tend to operate continuously rather than intermittently, reinvest rather than consume surpluses, and have lower closure rates. They are usually

Why the poor select survival activities

As the preceding discussion showed, entrepreneurial microenterprises appear to offer a route out of poverty for the poor (although not the extreme-poor), but the vast majority continue to opt for survival activities. Rural clients in particular appear to face significant barriers to entry to the entrepreneurial occupations. This section discusses the geographic, financial and sociocultural factors which influence of these factors occupation selection. The relative importance varies between

The challenge of serving the poor

SEEDS and the WDF have traditionally targeted a poor, predominantly rural constituency of single-season farmers, landless laborers and fishing communities, but the composition of the membership base has shifted in recent years toward less-poor clients in semi-urban centers and the Uda Walawe settlements. Among the sample, only 37% of new members joining during 1996–99 were below the poverty line, compared with 65% of those who joined before 1996, and the proportion of new clients from arid

Conclusion

In summary, evidence from the Hambantota sample does not support claims that microenterprise credit is a broadly effective solution to poverty, although it can work well for clients who are close to the poverty line and live in environments with the conditions necessary to sustain high-value microenterprises. As occupation selection is a key determinant of poverty exit, interventions encouraging the semi-urban poor to select entrepreneurial occupations are likely to further improve their

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