Microfinance and income inequality: New macrolevel evidence

• Published date: 01 May 2019
• Author: Manuel Perez‐Trujillo,Silvia Rico Garrido,José Maria Larrú,Maricruz Lacalle‐Calderon
• Date: 01 May 2019
• DOI: http://doi.org/10.1111/rode.12573

REGULAR ARTICLE

Microfinance and income inequality: New

macrolevel evidence

Maricruz Lacalle-Calderon

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José Maria Larrú

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Silvia Rico Garrido

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Manuel Perez-Trujillo

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1

Universidad Autónoma de Madrid,

Spain

2

Universidad San Pablo CEU, Madrid,

Spain

3

Universidad Católica del Norte,

Antofagasta, Chile

Correspondence

Maricruz Lacalle‐Calderon, School of

Economics and Business, Department of

Economic Development, Universidad

Autónoma de Madrid, Módulo 4,

Despacho 307, Avda. Francisco Tomás y

Valiente 5, 28049 Madrid, Spain.

Email: maicu.lacalle@uam.es

Abstract

This paper addresses the empirical question of whether

microfinance has any impact on income inequality at the

macrolevel. Very little research has been conducted on

the relationship between the macrolevel scale of microfi-

nance and income inequality over time in a country and

across countries. Based on panel‐data techniques, with

annual data from 85 countries from 2001 to 2012 and a

broad theoretical framework on microfinance and inequal-

ity, we provide empirical evidence that suggests that

increases in the macrolevel scale of microcredit in a

country contribute to reducing income inequality within

that country over time. Finally, since microfinance may

be endogenous, we used instruments from the existing lit-

erature to control for this problem.

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INTRODUCTION

Microfinance—that is, financial services

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targeting small‐scale entrepreneurial activities of the poor

who may otherwise be financially excluded—has grown significantly in all the regions of the

world since the 1970s and has become a major policy tool aimed at promoting economic develop-

ment, job creation, social cohesion and inequality reduction (Balkenhol & Guézennec, 2014; Euro-

pean Commission, 2012). Research recognizes that partnerships between microfinance institutions

and the formal financial sector to create an inclusive financial system for the poor can achieve the

aforementioned objectives (African Development Bank, 2006; Demirgüç‐Kunt, 2014). Despit e all

of these policy recommendations, little empirical research has been conducted to identify the

impact of microfinance at the macrolevel,

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probably owing to the lack of reliable macrodata on

microfinance, which have only recently become available (Bauchet & Morduch, 2010; Imai, Gaiha,

Thapa, & Kobina Annim, 2012).

DOI: 10.1111/rode.12573

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© 2018 John Wiley & Sons Ltd wileyonlinelibrary.com/journal/rode Rev Dev Econ. 2019;23:860–876.

To date, quantitative analyses of microfinance programs have been almost exclusively limit ed

to microevaluations

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conducted with microdata from different countries and contexts, making it

difficult to generalize these analyses’conclusions (Hermes, 2014). Specifically, macrolevel

research into the impact of microfinance activities on income inequality has remained large ly

under‐explored. To our knowledge, only two papers analyze the inequality reduction effect of

microfinance at the macrolevel (Hermes, 2014; Kai & Hamori, 2009),

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and both are cross‐sectional

studies. As a result, very little is known about the relationship between the macrolevel scale of

microfinance and income inequality over time in a single country and across countries.

This paper attempts to fill this gap and clarify this unresolved issue by using panel‐data tech-

nique—general method of moments (GMM) system (Arellano & Bover, 1995; Blundell & Bond,

1998)—to provide deeper, more detailed quantitative analysis of the macrolevel relationship

between microfinance and inequality. In comparison with previous papers, this technique incorpo-

rates the autoregressive nature of inequality. The analysis also takes advantage of the sample used,

enabling us to consider the effect of individual heterogeneity over the estimates to improve consis-

tency of the relationship. Our specific goal is to test whether microfinance has a significant effect

on income inequality reduction over time, an issue especially relevant in the context of the Tenth

Sustainable Development Goal: “reduction of inequalities”(United Nations, 2016).

In line with previous literature, our results find that microcredit have a positive impact on

inequality reduction. However, this paper advances understanding of this impact and contributes to

the literature in three ways. First, using a system GMM technique with annual data for 85 coun-

tries from 2001 to 2012, we investigate the extent to which the macrolevel scale of microcredit in

a country contributes to reducing income inequality within that country over time. Second, by

employing a broader theoretical framework on inequality than previous papers, we take into

account more controls in order to reduce omitted‐variable bias. Third, we address endogeneity and

reverse causality problems (Kraay, 2015). We use the term “endogenous”to indicate that we are

unable to identify the direction of the causality for these particular covariates. That is, a positive

value for the estimated coefficient on microfinance may be consistent both with inequality raising

the level of microfinance and with microfinance spurring inequality. Such potential endogeneity of

the microfinance variable should be controlled for. Moreover, like the existing empirical literature,

we recognize the potential for problems of endogeneity or omitted variables between microfinance

and some macroeconomic conditions (Ahlin, Lin, & Maio, 2011). Our analysis includes measures

to prevent such problems.

The rest of the paper is organized as follows. Section 2 illustrates and theoretically justifies the

potential effects of microfinance—as a tool for financial depth—in reducing income inequality.

Section 3 presents the data and methodology used. In Section 4, we use a panel‐data model to

explore the relationship between microfinance and inequality. We find a negative and statistically

significant association between these two variables. Section 5 offers some conclusions.

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MICROFINANCE TO REDUCE INCOME INEQUALITY

Inequality may be one of the most important macroeconomic problems. As a result of unfair lack

of opportunities, inequality is important not only for its adverse moral consequences for a popula-

tion, but also because it hampers processes of economic growth, and negatively and disproportion-

ately affects the income growth of the poor (Milanovic & Van Der Weide, 2014; Stiglitz, 2012).

Since Schumpeter (1934) highlighted the importance of financial intermediation in promoting

innovation and growth, financial deepening—extending financial intermediation—has generally

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