A Second Nobel for Economics

The Norwegian Nobel Committee awarded the 2006 Nobel Peace Prize to the Grameen Bank, a for-profit business, and its founder, Bangladeshi economist Muhammad Yunus. The Committee's citation lauded Grameen Bank's innovative efforts to reduce poverty through micro-lending schemes that provide some of the world's poorest citizens with access to credit. So, what's microcredit and how do Yunus and Grameen use it to reduce poverty?

Citizens of developed countries like the United States take credit access for granted. With a stable source of income or a bit of collateral, like a house or a car, an American can take out a loan to start a business, remodel the bathroom, or buy an engagement ring.

Access to credit in less developed countries is far scarcer.

Poor peoples' incomes are inherently less stable and often too low to qualify for lending. The ill-defined property rights in many developing nations make it difficult for poor residents to prove that they own the housing or land that they occupy. Lacking income and legitimate titles to what little collateral they actually have, the credit prospects for most of the world's poor seem bleak. As a result, traditional credit schemes ignore low-income entrepreneurs whose business ideas can help their communities escape poverty.

Yunus had the vision to develop a lending model that could reach low-income entrepreneurs in Bangladesh. He realized that collateral requirements provided borrowers with a strong incentive to pay back their loans rather than defaulting and losing their property. To ensure that poor borrowers faced an equally strong incentive to repay their loans, Yunus replaced collateral with the borrowing circle.

The borrowing circle consists of 5 people--the initial borrower, and four friends who agree to help with loan payments if the going gets rough. (The friends may take out loans as well.) Should the borrower default, all four friends lose access to credit until the loan is repaid in full. Replacing collateral with social pressures worked remarkably well, helping people expand or launch small business ventures. Read this New York Times article to find out more about Yunus and the Grameen Bank.

1. Grameen Bank is a for-profit business, but is it profitable? According to the article, what's the U.S. dollar value of Grameen’s loans since 1983?

2. According to the article, how many borrowers has the Bank served? What percentage of Grameen’s loans is paid back? How do Grameen’s payback rates compare to those of traditional banks in Bangladesh?

3. Why might social pressures provide a greater incentive to repay loans than the threat of losing collateral? What's the downside of defaulting in the Grameen scheme versus a traditional, collateral based scheme?

4. How might credit access change the social standing of Bangladeshi women?

5. How does Yunus feel about relying on charity to battle poverty?

Coincidentally, the Aplia Econ Blog recently asked whether microcredit will reduce poverty.

Will Microcredit Reduce Poverty?

Most people in developed countries can easily use their assets to secure credit. With a stable source of income or a bit of collateral, like a house or a car, an American can take out a loan to start a business, remodel the bathroom, or buy an engagement ring.

Access to credit in relatively poor developing countries is far scarcer.

Poor peoples' incomes are inherently less stable and often too low to qualify for lending. The ill-defined property rights in many developing nations make it difficult for poor residents to prove that they own the housing or land that they occupy. Lacking both income and legitimate titles to what little collateral they actually have, the credit prospects for most of the world's poor seem bleak.

Enter microcreditors. As Tyler Cowen describes in his latest Economics Scene column for The New York Times, microcreditors are non-profit, for-profit, or government organizations that lend small sums to people in poor communities. The microloan recipients open businesses, improve their homes, or pay medical bills--using the loans to invest or consume as they see fit. Read Cowen's commentary to find out more about the benefits and controversies surrounding microcredit in India.

1. According to Cowen, microlenders like Spandana offer poor Indians better rates than traditional money lenders. How do the lending practices of microcredit organizations differ from the practices of traditional money lenders? How does Spandana use community pressure to maintain high repayment rates among its loan recipients? What other incentives encourage borrowers to repay the microloans?

2. Why do some state officials in India oppose the practices of microcreditors like Spandana? According to Cowen, what would legal caps on interest rates do to the solvency of microcreditors? How might legal caps on interest rates change the borrowing habits of India's poor?

3. Cowen visited Hyderabad--a metropolis of over 6 million residents. He suggests that microlending works fairly well for poor people in this urban setting. How might the feasibility of microcredit change in a rural setting? Rural residents in developing countries earn income from farming--a relatively risky vocation because of price volatility and unpredictable weather. Would repayment rates among rural residents likely be higher or lower than those among urban residents? How would traveling to rural settings affect the way microcreditors monitor repayment?