In the wake of the worst famine of Bangladesh of the post-World War era Professor Muhammad Yunus launched a microcredit experiment in 1976 to assist a group of poor, highly indebted households, in Chittagong, Bangladesh. This experiment, which was to later emerge as the Grameen Bank, marked the beginning of the modern-day microcredit movement. In the past few decades, microcredit has blossomed into a global phenomenon, culminating in the awarding of the Nobel Peace Prize for Muhammad Yunus and the Grameen Bank in 2006.
In popularizing microcredit, an important contribution of Muhammad Yunus has been his innovations in credit contracts that helped overcome such issues as adverse selection and moral hazard that traditionally bedevil the access of the poor to credit. By making the poor 'bankable', microcredit programmes have made a contribution toward fostering a degree of financial inclusiveness that did not exist before. Despite these successes--and a continued increase in micro-lending in developing countries--poverty shows few signs of abating in many poor countries. This persistence of poverty has generated widespread doubt about the effectiveness of microcredit.
There is a large body of empirical literature on the effectiveness of microcredit in alleviating poverty. A landmark study by the World Bank on Bangladesh suggested that microcredit had a significant impact on poverty: for every 100 taka borrowed by a woman, there was an 18 taka increase in consumption. While some studies found a similar positive impact, there were many others deliberating the same question who discerned little or no impact on poverty. The latter conclusion includes some recent studies that were based on randomized controls trials (RCTs).
This inconclusiveness of the literature largely reflects the weaknesses of current studies, as well as the coarseness of available tools for analysis. Past empirical literature, based on observational data, was often marred by various endogeneity issues and characterized by controversies over identification strategies, and instrumental variables. The RCT studies, which had no undergirding model and have yielded an exotic mix of results, have had their own share of inherent methodological issues.
In short, the recent empirical literature sheds little light in clarifying the outstanding policy issues. With its focus on the 'average', the empirical literature has suffered twin failures. First, it failed to go...