Microfinance Can Raise Incomes: Evidence from a Randomized Control Trial in China* Shu Cai, Albert Park, Sangui Wang† November, 2019 Abstract This study evaluates the impact of a randomized control trial (RCT) in China that introduced externally funded village credit funds in poor, rural villages. In contrast to recent RCT-based studies that have failed to find evidence of significant increases in income from microfinance interventions, we find that the Chinese program significantly raises household income and reduces poverty. We explore possible explanations as to why the estimated impacts may be greater in China: lump-sum repayments, lower interest rates, less access to formal credit before the program, and greater potential returns from off-farm employment opportunities that are credit-constrained. Keywords: microfinance, program evaluations, randomized control trial JEL Codes: D12, D22, G21, I32, O16 * We thank Richard Freeman, Maitreesh Ghatak, John Gibson, Bob Gregory, Li Han, Guojun He, Joe Kaboski, Chris Udry, and Sujata Visaria for their helpful comments and suggestions, as well as comments from seminar or conference participants at ABFER, CCER summer institute, HKUST, Korea University, Peking University, SWUFE, U Bristol, UCSD, University of Delhi, U Michigan, and Wuhan University. The financial support of the National Natural Science Foundation of China (71703058) is gratefully acknowledged. All errors remain our own. † Cai: Institute for Economic and Social Research, Jinan University ([email protected]); Park: Department of Economics, HKUST ([email protected]); Wang: Renmin University of China ([email protected]). 1 1. Introduction Microcredit has been regarded as highly successful in fighting poverty (Morduch, 2005). However, recent studies based on randomized control trials find no transformative impacts of microfinance on increasing income (Angelucci et al., 2015; Attanasio et al., 2015; Augsburg et al., 2015; Banerjee et al., 2015; Crepon et al., 2015; Karlan and Zinman, 2011; Tarozzi et al., 2015). This finding casts doubt on the role of microfinance in reducing poverty and raise discussions among researchers and policy makers. In this study, we evaluate the world’s largest microcredit program – a village banking program in China. We undertake a randomized control trial (RCT) similar to those conducted by the aforementioned studies, and find substantial increases in income from both self-employment activities and wage employment activities in areas where the program has been introduced. In 2006, China’s national government initiated the village banking program to reduce poverty. The main component of the program is that each recognized poor village would receive 150,000 yuan (US$24,000) from the national government as the initial capital of a self- organized village bank. Households in the program village can borrow from the village bank to finance their income-generating activities. The program began among trail villages, and then expanded gradually to other poor villages across the country. By the end of 2013, the program had covered 19,400 villages in 1,407 counties of China’s 28 provinces. To evaluate the impact of the village banking program, we conducted an RCT among 10 counties in five provinces in 2010, which is authorized by the State Poverty Alleviation Office in charge of implementing the program. In each county, we randomly selected three out of five candidate villages to participate in the experiment. A baseline survey prior to the intervention 2 collected information regarding the demographics, income, consumption, and production investment and revenue from 30 households randomly selected in both treatment and control villages. Two years later, the same households were interviewed again in a follow-up survey. Our evaluation suggests that the village banking program increases the likelihood of borrowing for production by 15 percentage points. Households from treatment villages plant more cash crops and invest more in inputs of feedstuffs in animal husbandry than those in the control villages. Revenues and profits from their agricultural activities have increased in response to the program. Different from Crepon et al. (2015), we find the program also increases the employment income of households in the treatment villages. Further analyses suggest that households allocate more of their labor force to employment activities outside their home township, particularly employment activities beyond their home province, while they allocate less labor to employment activities within their home township. This leads to significant increases in employment income, since the wage rate of employment in foreign provinces (usually coastal areas) is much higher than that in rural villages or nearby townships. Eventually, the village banking program raises households’ total income and reduces the rate of poverty significantly. The expenses on consumption increase as well, particularly for the consumption of durable goods and housing services. The improvement in living standards is confirmed by subjective assessment of quality of life and life satisfaction. In our main specification, we drop one county due to late implementation in treatment villages and trim 1 percent of the observation to reduce the influence of possibly spurious outliers on the estimates. However, the results are robust to either of the two restrictions on the estimation sample. We also examine the robustness of the inference to address potential 3 problems of multiple tests and the small number of clusters. For most outcomes, our judgement on the statistical significance is robust based on p-values that adjust for multiple hypotheses tests or randomization inference. To understand why microcredit may raise income in China, we first test the hypotheses that the estimated impact of microcredit on income depends on factors relating to loan terms and site context. More specifically, it decreases with repayment frequency, interest rate, saturation of financial market, and ratio of time spent on employment activity (an indicator of labor market imperfection) using meta-analyses to compare results across countries. After justifying these hypotheses, we assess each of the factors to ascertain the substantial impacts on income of microcredit found in China. We conclude that lump-sum repayment, lower interest rate, less access to formal credit before the program, and greater potential returns from off-farm employment opportunities that are credit-constrained are important factors for a microcredit program to be effective in raising income. We also examine the heterogeneity in treatment impacts across different counties of the same Chinese population. Given that the implementation of the village banking program follows the guidelines of the national government, there is not much variation in loan terms, such as repayment frequency and interest rate. But we can examine heterogeneity along contextual factors of the study sites, including the saturation of the financial market and the imperfection of the labor market. The results suggest that the impact of microcredit access on income decreases with the ratio of time spent on employment activities and the availability of formal loans before the intervention. These echo the findings from meta-analyses, and confirm that whether microcredit can raise income depends on market conditions of the sites. 4 This paper contributes to the literature in several ways. First, we find that the extension of microcredit encourages households to seek employment farther away, which leads to an increase in employment income, a fact that has not been documented in studies of programs in other countries. Crepon et al. (2015) found that access to microfinance boosts businesses profits, but leads to a decline in employment income. Overall, income does not change significantly. In a companion study, Cai (2018) shows that the microcredit program increases migration by household members in treatment villages, especially in villages with a low level of assets and high migration costs. The abundant off-farm employment opportunities and liquidity constraints on migration contribute significantly to the increase in employment income in China. Second, the paper complements previous studies by implementing an RCT to evaluate a microcredit program in a country that has not yet been studied in the literature, and the scale of the program makes it a significant case study for research on microcredit. Third, the paper contributes to recent discussion about the external validity of an intervention. By using meta- analyses across countries and examining heterogeneity in the impacts across subpopulations within China, we show that the role of microcredit in raising income relies on the characteristics of loan terms and the market conditions of study sites. These may have implications for policies on the design and targeting of programs. The paper is organized as follows. In Section 2, we introduce the village banking program, the experimental design, the context of the surveyed villages before the program, and the data employed. Section 3 presents the empirical strategy for identification. Section 4 reports the estimated average intention-to-treat effects on credit, investment, income, consumption, etc. In Section 5, we conduct a meta-analysis by comparing our study with other studies that have 5 evaluated microcredit programs. In Section 6, we examine the heterogeneous treatment impacts by exploring contextual variation within our study.