The Cross-Border Transfer of Low Income Business Models

Institutions and the Global Growth of Microfinance Joshua K. Ault University of South Carolina 1

Dissertation

• • • Applies concepts from the “cross-border transfer” literature to the study of business models in low income and subsistence markets Uses microfinance business model to test and extend those ideas – Quantitative study of the global growth of microfinance across 139 countries – Qualitative study of model adaptation in 3 countries (Ethiopia, Uganda and US ) This presentation provides preliminary results for the quantitative study 2

Agenda

• • • • • Theory – Emergent research stream on business models in low-income markets – Cross-border transfer literature Phenomenon – Microfinance as widespread, innovative business model – How well does microfinance travel?

Hypotheses – Microfinance will grow best in countries similar to Bangladesh (informality, moderate stability) Methodology and Results – Found that institutions matter in the global growth of microfinance Next Steps – Qualitative analysis of adaptation and change of microfinance model 3

Emergent Research Stream into Low-income Business Models

• • • – – Untapped market of 4 billion (Prahalad, 2005) Potential of $13 trillion in spending power Reaching these markets improves economic and social conditions – Adaptation of business model is needed Need to understand local environment (London and Hart, 2004) – Can you adapt and still reach 4 billion people?

Some argue that social & business cases overstated (Karnani, 2007) – Issue of scalability rarely addressed, but critical to further knowledge and practice – Little empirical research to test competing claims 4

The Cross-Border Transfer Question

• • Literature often formulates the question as

whether

there is a business case for low-income business model This study focuses on the question:

under what conditions

does a business case hold?

– Goes beyond identifying models that work to understanding their diffusion – What works in one society may not work in another – Questions of scalability, adaptation and strategy 5

Perspectives on the Cross-Border Transfer of Business Models

Summary Representative Authors CAGE Distance

Cultural, administrative, geographic, and economic differences will determine capital flows Ghemawat (2007); Tsang & Yip (2007)

Institutional Distance

Differences in institutional profiles will determine knowledge transfer and entry mode Institutions provide resources and capabilities for some models but not others Kostova (1999); Xu & Shenkar (2002)

Comparative Institutionalism

Guillen (2001); Aguilera & Jackson (2003); Westney (1987)

Focus

Trade, FDI MNC/Subsidiary Transfers, Entry Mode Organizational Models, Emerging Economies, Adaptation

Roots

Business Economics Neo-Institutional Theory Historical/Comparative Institutionalism 6

Implications for the Transfer of Low Income Business Models

1.

2.

– How does institutional “fit” affect the transfer of low income business models across national boundaries?

Will the microfinance business model “fit” in every low-income society?

– How does adaptation affect transferability?

Will the microfinance business model adapt to “fit” different environments?

– – What adaptations will occur?

What are the microprocesses by which this occurs?

Quantitative study focuses primarily on the first question 7

The Case of the Microfinance Business Model

• • Microfinance “provides very poor families with very small loans to help them engage in productive activities or grow their tiny businesses” (Microfinance Gateway, 2008).

Microfinance presents a unique empirical setting to address these questions – Business model has been developed over 30 years of experimentation – Transferred across multiple countries – Transitioning from non-profit to for profit 8

Development of the Grameen Model

• • • • Began in 1976 as an academic research project in the village of Jobra, Bangladesh – Yunus, an economics professor found the western theories he was teaching “maddeningly irrelevant” for Bangladesh (Bruck, 2006) Three years of observation of the environment, experimentation, and trial and error to match the model to the institutional conditions in Jobra Expanded out of Jobra in 1979 with the sponsorship and support and of the Bangladeshi Central Bank and national banks In just 30 years, has transferred to numerous countries across the globe 9

Grameen Business Model (2008)

• • •

Clientele

Exclusive focus on the very poor Exclusive focus on rural population Emphasis on women • • • • • •

Loan Characteristics

Small (~$75 on average) Relatively high interest rates (~20%) Non-collateralized/ undocumented Intended for income generation Usage is self-determined Insistence on repayment (no charity) • • • • • • • •

Governance Mechanisms

Group lending Borrower homogeneity Compulsory savings Weekly repayment schedule Progressive lending Decentralization of authority and decision making (low-level staff) Borrower training program Complete transparency in all transactions • • • •

Organizational Characteristics

Legally registered Financially sustainable Private sector Broader social agenda Sources: Grameen Foundation (2008); Grameen Bank (2008) 10

General Group-Lending Model (Beyond Just Grameen)

• •

Clientele

Focus on the poor Emphasis on women • • • • •

Loan Characteristics

Small (< $1,500) Relatively high interest rates Non-collateralized/ undocumented Usage is self-determined Insistence on repayment • • • • •

Governance Mechanisms

Group lending Savings Frequent repayment schedule Progressive lending Decentralization of authority and decision making (low-level staff) • • •

Organizational Characteristics

Legally registered Focus on profitability Private sector Sources: Westley (2007), Center for Global Development (2006), Robinson (2001), CGAP 11 (2008); MiX (2008)

Microfinance Designed and Tied to the Institutional Environment

• • Designed for institutions different from those in developed countries – A model specifically designed to work in environments with poor “institutional quality” – Institutional environments differ

across

emerging and developing countries as well Comparative Institutional Advantage - “The institutional structures of a particular political economy provide firms with advantages for engaging in specific types of activities there” (Hall & Soskice, 2001: 37) – Does the microfinance model have a comparative advantage in certain types of institutional environments? 12

Informal Economic Systems

• • • Informality: – “Those actions of economic agents that fail to adhere to the established institutional rules or are denied their protection” (Feige, 1990) Literature suggests microfinance is designed as an

informal

lending model (Servon, 2002) – However, microfinance institutions embrace certain

forms

of informality, but not others – E.g., Group lending and no collateral,

but

legally registered – Need to understand differences in

types

of informality to understand the transfer of microfinance across borders Transfer not just about market size, but also institutional conditions 13

Literature Has Developed Around

Types

of Informality

• •

Horizontal

informality (North, 1981; Acemoglu & Johnson, 2005) – E.g., Informal housing contracts in Peru (De Soto, 1989)

Vertical

informality (North, 1981; Acemoglu & Johnson, 2005) – E.g., Bribing officials in Zaire (Portes, 1994; Evans, 1995) 14

Horizontal Informality

• • Use of informal means of contracting between actors – Likely to be high in institutional contexts where the state is ineffective in facilitating economic exchange – In formal systems, state acts as arbiter of contracts (North, 1981; Acemoglu & Johnson, 2005) Microfinance most suited for contexts where the state does not enable formal contracting – While informal mechanisms are viable, they have a cost relative to formal mechanisms – These costs limit the advantages of informal mechanisms in formal systems 15

Hypothesis 1

High The greater the strength of contract enforcement at the national level, the weaker the growth of national-level commercial microfinance lending. Low Informal Lending • Poor customers • Lack of collateral • Small loan sizes 16

Political Stability as Moderator of Horizontal Informality Type

• Literature identifies at least three types of horizontal informal contracting (Portes, 1994) – Growth (ex: Italy) • Often legal enterprises working in stable communities • Gain advantages in flexibility through networks • Often subcontract to, and competes with, the formal sector – Survival (Ex: Bangladesh) • Some uncertainty, less stability • Very small enterprises with few ties to formal sector • Actors rely on reputation-based social arrangements – Violent and criminal (Ex: Zaire) • High uncertainty • Power and connections create high returns (i.e. wealth redistribution) • Truck and barter transactions 17

Best Institutional “Fit” for Microfinance is “Survival” Informality

• • Absence of formal state regulation will not necessarily lead to the type of informal contracting most suitable for microfinance – Ability of communities to either confer status on individuals or ostracize them is the key governance mechanism in the microfinance model – Presence of pre-existing social pressure in economic relations acts as a source of institutional advantage for microfinance Survival informality most likely to provide this resource – Not just lack of formal enforcement, but also some degree of stability in the state 18

Hypothesis 2

National-level political stability will moderate the relationship between contract enforcement and microfinance lending such that the effect will be greatest at medium levels of stability. That is, the moderating effect of stability will be curvilinear.

High National System of Exchange Formal Informal

Growth Embedded in formal contracts Survival

Low

Violent 19

Vertical Informality

• • Informality that is designed to hide or avoid state intervention – Determined by the degree to which the state provides checks against abuse by political elites (North, 1981; Acemoglu & Johnson, 2005) – Unlike with horizontal informality, there are few alternative mechanisms to circumvent abuse by elites – Actors forced underground (Portes, Castells, & Benton, 1989) Microfinance: – Not like loansharking, which is conducted without reference or recourse to legal system – Whereas loansharking derives from bottom-up demand, microfinance derives from top-down supply (Schreiner, 2001) 20

(Hypothesis 3)

High Legal Registration • Access to formal capital • Licenses for savings The greater the constraints on abuse by political elites at the national level, the greater the growth of national level commercial microfinance lending Low 21

Preliminary Analysis

• • 9-year longitudinal, cross-sectional study of 139 countries using random-coefficients modeling (RCM) – RCM is “an extremely powerful tool of comparative analysis” – Controls for causal heterogeneity (Beck, 2006) Variables – Dependent variable: number of commercial microfinance borrowers per capita (MiX) – Independent variables: • •

Contract Enforcement:

World Bank’s “Doing Business Project” “Enforcing Contracts

Political Stability:

Kaufman, Kraay, and Mastruzzi Stability and Absence of Violence” (2006) “Political •

Covariates:

Per-capita GDP, Literacy 22

Countries Plotted by Informality and Stability with Number of Microfinance Borrowers Indicated

Number of microfinance borrowers > 25 per thousand citizens Number of microfinance borrowers < 25 per thousand citizens 23

Model and parameter Final Level 1 model Intercept Linear Trend Quadratic Trend Cubic Trend Final Level 2 model GDP per Capita (intercept) Literacy (intercept) Informality (intercept) Stability (intercept) Stability 2 (intercept) Informality X Stability (intercept) Informality X Stability 2 (intercept) GDP per Capita (slope) Literacy (slope)

Informality (slope)

Stability (slope)

Stability 2 (slope)

Informality X Stability (slope)

Informality X Stability 2 (slope)

Model Results

df a

Parameter estimate b SE 131 1104 1580 1580 -0.25

0.91

0.17

-0.01

0.28

0.16

0.14

0.01

95% CI lower bound c 95% CI upper bound c

F

Value d -0.80

0.60

-0.10

-0.03

0.30

1.22

0.44

0.01

-0.92

32.01 ** 1.90

1.00

1104 1104

1104

1104

1104

1104

1104

131 131 131 131 131 131 131 0.24

-0.19

0.00

-0.28

0.06

-0.01

-0.05

-0.42

0.34

0.46

-0.21

-0.35

-0.28

-0.22

0.34

0.26

0.31

0.36

0.26

0.28

0.19

0.19

0.15

0.18

-0.20

0.15

0.16

0.11

-0.43

-0.70

-0.61

-0.99

-0.45

-0.56

-0.42

-0.79

0.05

0.11

0.18

-0.64

-0.59

-0.44

0.91

0.32

0.61

0.43

0.57

0.54

0.32

-0.05

0.63

0.81

-0.60

-0.06

0.03

-0.01

7.59 ** 0.44

3.40

0.48

3.67

0.81

4.10 * 9.29 ** 0.17

3.73 *

1.49

4.51 *

0.98

4.11 *

24

Results: Hypothesis 1

• • Microfinance most likely at

high

levels of informality Coefficient for

Informality

= 0.46

– –

F

= 3.73

P

< 0.05

25

Predicted borrowers per thousand population for each year as a function of Informality (I).

9.00

8.00

7.00

6.00

5.00

4.00

3.00

2.00

1.00

0.00

1998 1999 2000 2001 2002 2003 2004 2005 2006 High I Mean I Low I

26

Results: Hypothesis 2

• • Tests the interaction between informality and the squared term for political stability – Microfinance most likely at

high

levels of informality and

medium

levels of political stability – Hypothesized sign is for coefficient is negative (interaction is with an

inverted-

U shape) Coefficient for

Informality X Stability 2

– –

F

= 4.11

P

< 0.05

= -0.22

27

Predicted borrowers per thousand population for each year as a function of the Informality (I)/Stability (S) interaction.

2 0 6 4 12 10 8 High I Med S 1998 1999 2000 2001 2002 2003 2004 2005 Low I Low S High I Low S Low I Med S Low I High S High I High S 2006

28

Robustness

• • • • Fully-pooled longitudinal models – Panel-corrected standard errors with AR(1) disturbance – Heteroscedasticity-consistent standard errors Additional covariates – Regime type – Openness to trade – Population Alternate measure for stability – State Fragility Index (Polity IV) Results similar 29

Next Steps

1.

2.

3.

4.

5.

Extensions to the quantitative model – – Vertical Informality Distance measures Study 2: Adaptation of the microfinance model – Uganda, Ethiopia, USA Informality framework Non-profit vs. for-profit models – Answer not yes/no, but when and how Reverse transfer of models from developing to developed countries 30

General Implications for Sustainability Research

• IB literatures are clear that transferring “best practices” across national boundaries is highly complex – E.g., Bringing European best practices on environmentalism to the U.S. will likely have similar issues – Cross-cultural differences in conceptualizing sustainability – These cross-national differences have implications for the scalability, growth, and profitability of sustainable initiatives 31

Conclusion

• • Ultimate goal is to eradicate poverty, protect the environment, achieve peace, eliminate disease, etc.

– Need to break broad goals into component parts – Social case, business case, and sub-issues My research focus is on middle range theory about what works, when, and under what conditions – Poverty eradication – Business case for poverty eradication – Transferability of business models across societies 32