Microcredit in specific factor model framework

A Discussion on Professor Yunus's Two Concepts : Microcredit & Social

Business

ASM SHAKIL HAIDERDoctoral Researcher of Economics, University of Southampton, UK

Lecturer (on leave), BRAC University, BangladeshChair & CEO, YIP Foundation

Microcredit In Specific Factor Model Framework

ASM Shakil Haider

Introduction

• Theoretical approach of introducing microcredit in the Specific Factor Model

• Objective of the research is to study the effect of introducing microcredit on development and growth in different economies (Large or Small) under the Specific Factor Model

Outline

• Microcredit and previous research on microcredit• Specific Factor Model and research on the model• Proposition• Channels of Capital Flow to the Developing

Countries• Research Evidence of Capital Flow to Developing

Countries• Conclusion

Microcredit

• Extension of very small loans towards poor people who are not qualified to get the access of traditional credit due to the lack of collateral, not having any steady employment and a verifiable credit history.

• Loans are given to these poor people that they can become self employed.

Microcredit (Continued)

• The modern micro credit concept was first started by the Grameen Bank during 1970s and the main initiator of this was Professor Muhammad Yunus.

• Muhammad Yunus started the project in a small village of Bangladesh by giving small loans from his own money in a very low interest rate to the poor people.

Microcredit(continued)

• This loan successfully helped the poor to start their own small business/self employment and helped to exit poverty.

• This brilliant concept later on has been introduced to Latin America (1986) and several developing countries and resulted in greater economic development and growth.

• In 2006, Mohammad Yunus was awarded Nobel Peace Prize for this work of providing microcredit services to the poor.

Previous Research on Microcredit

• According to Islam (2009), microcredit can be more potent to reduce insecurity and poverty through its indirect, broader impact conducing to a more egalitarian initial endowment distribution which is needed for take off towards an equitable growth process.

• The paper came to such conclusion through examining the role and complementariness among the several microcredit and micro saving programs.

Previous Research on Microcredit(Contd..)

• Ahlin and Jiang (2008) found that microcredit can reduce poverty and thus can lead to development.

• In their model they referred to “winner graduation (earn above average return on self employment)” and “savers graduation (earn average return on self employment and gradual saving takes place)”.

• Study showed savers graduation play leading role for future development through micro credit.

Previous Research on Microcredit(Contd..)

• A study by Rashid et al. (2004) showed an empirical evidence (based on Bangladesh) that there is room to increase agricultural productivity by providing financial services (microcredit) to the small farmers through micro lending institutions.

• It helps them to cultivate more HYV crops which ultimately ends up in agricultural growth.

Previous Research on Microcredit(Contd..)

• Pitt and Khandaker (1998) found that microcredit has a positive impact on the clients.

• Kono and Takahashi (2010) concluded in their study that microfinance is developing in a promising direction and it is on its way to reach the full potential.

Specific Factor Model

• Originally discussed by Jacob Viner (1931) and it is a variant of the Ricardian model.

• Sometime referred as Ricardo-Viner model.• The model was formalized in a general

equilibrium terms by Samuelson and Jones (1971).

• Also known as the Short Run version of the HOS model.

Specific Factor Model

• Basic Assumptions:

2 Goods : Agricultural (Food) Manufactured Goods

3 Factors of Production: Land (Specific to Agro Sector) Labor (Mobile factor) Capital (Specific to Manufacturing Sector)

Specific Factor Model

• Technology Faces Diminishing marginal productivity

• Full employment • General equilibrium

Total Labor (L) for the Economy

w* w*

VMPLM VMPLF

VMPLFVMPLF

LM LF

Specific Factor Model In a Closed Economy

Profit Rent

Previous Research on SFM

• In most of the research Labor was the mobile factor; capital and land were fixed factors.

• Thompson and Francis(2009) used unskilled and skilled labor as mobile factor and capital as industry specific.

• Tariff elimination can cause lowering the wages of both skilled and unskilled wages and increase the skilled wage gap.

• Industry output and capital absorbs the negative impact of falling tariffs (mostly in protected industries)

Previous Research on SFM (Contd…)

• Liu (2010) used the SFM framework to explain the impact of offshoring on factor price and welfare.

• He used unskilled labor as a mobile factor; skilled labor and land as specific factor.

• His study showed that through offshoring specific factors are benefitted where the mobile factor is hurt (wage gap increases).

• Welfare loss of home country is also possible.

Previous Research on SFM (Contd…)

• Thompson (1985) in his research used capital as a mobile factor, labor and land were used as specific factor.

• He figured out factor price equalization and reciprocity relationship.

• Suggested, capital flow might have positive elasticity (not infinite) and will depend on the risk premium.

Previous Research on SFM (Contd…)

• Another study of Thompson (1987) suggests that an increase (decrease) in capital factor price causes capital to inflow (outflow) to (from) that country in a general equilibrium framework.

Proposition

• Whether it is possible to show the positive effect (development and growth) of Microcredit through the Specific Factor Model or not.

• Assumptions:2 Industry: Manufacturing and Food (Agriculture)

Proposition (Contd…)

• Assumptions (continued)3 Factors:Skilled Labor (Specific to Manufacturing sector)Unskilled Labor (Specific to Food sector)Capital (Mobile Factor)

• Technology faces diminishing marginal return • Full employment and General equilibrium.

Total Capital (K) for the Economy

r0 r0

VMPKM VMPKF

VMPKFVMPKM

KM KF

Specific Factor Model In a Small or Large Closed Economy (Mobile Capital)

Wage Wage

OF

OM

Specific Factor Model in a Small or Large Closed Economy

• VMPKM = Value Marginal Product of Manufacturing Sector

• VMPKF = Value Marginal Product of Food Sector

• r0 = Equilibrium Interest rate

• KM = Capital Used Manufacturing Sector

• KF = Capital for Food Sector

Specific Factor Model in a Small or Large Closed Economy (Contd…)

• But in reality due to lower income and no collateral, unskilled labors do not have access to credit or charged a very high interest rate against credit.

• This higher interest rate is shown in the next figure as r1.

• The wage triangle is the small triangle for the unskilled labor of Food sector.

r0 r0

VMPKF

VMPKFVMPKM

K0M

K0F

VMPKM

r1

K1F K1

M

Specific Factor Model In a Small or Large Closed Economy

OFOM

Wage

Specific Factor Model in a Small or Large Closed Economy (Contd…)

• If we introduce the microcredit in this model which offers a lower interest rate (r MC ) for the unskilled labors of Food sector, the total capital available to the unskilled workers increasing.

• Wage triangle for the unskilled workers is now the bigger triangle

• Capital has been re allocated from the manufacturing sector to the Food sector.

• Higher interest rate in the manufacturing sector.

Wage

Wage

VMPKF

VMPKFVMPKM

VMPKM

r1

r MC

r0

r MC

KMCF

KMCM

K1F K1

M

Specific Factor Model with Microcredit ( Small or Large Closed Economy)

OFOM

Specific Factor Model with Microcredit in a Small Open Economy

• Now if we allow to flow capital from outside of the country , the capital will flow to manufacturing industry up to the point where the interest rate (r2 ) equalizes to r MC

• Here we hold the assumptions of world interest rate is equal to r2 .

WageWage

VMPKF

VMPKFVMPKM

VMPKM

r1

r MC

r 2

KMCF K2

M

r MC

VMPKM

VMPKM

Specific Factor Model with Microcredit (Large Open Economy)

OM OFO’M

A

Wage

Wage

VMPKF

VMPKFVMPKM

VMPKM

r1

r MC

r 0

KMCF K2

M

r MC

VMPK’M

VMPKM

Specific Factor Model with Microcredit (Small Open Economy)

OFO’M OM

B

Channels of Capital Flow to the Developing Countries

• The capital can flow in two ways-

Portfolio Investment

FDI

Research Evidence of Capital flow to Developing Countries

• Ahmed and Gooptu (1993) concluded that capital flow towards developing countries had increased 17% where middle income developing countries were getting most of the increased capital flows.

• Ito et al. (2009) in their study found that, developing country with more open capital market experience lower volatility (due to swift policy responses and betterment in institutional framework)

Research Evidence of Capital flow to Developing Countries (Contd…)

• Jongwanich (2009) mentioned in his study that the global financial crisis caused a significant slowdown to the G3 capital markets which resulted in pulling back the capital from those markets and invested in Asian markets (e.g. India, China ).

Conclusion

• Development and Positive growth effect of Microcredit can be explained through the SFM.

• Introduction of microcredit in this framework can cause the capital inflow to the developing economies and cause the growth to both the agriculture and manufacturing sector.

• A small open economy can be benefitted more through this framework.

Outlook

• Mathematical proofs• Both FDI and Portfolio investment can be

modeled.• Empirical research based on the proposed

model.• Policy reform for Small or Large open

economy.

Reference• Ahlin, J. and Jiang, N. (2008), “Can Micro-Credit Bring Development?”, Journal of

Development Economics, vol. 86 (1).• Ahmed, M. and Gooptu, S. (1993), “Portfolio investment flows to developing

countries”, Finance & Development, vol. 30 (1), pp. 9-12• Islam, N. (2009). “Can Microfinance Reduce Economic Insecurity and Poverty? By

How Much and How?”, Economic & Social Affairs, DESA Working Paper No.82 • Ito, H., Jongwanich, J. and Hagiwara, A.T. (2009), “What makes developing Asia

resilient in a financially globalized world”, ADB Economics, Working Paper No. 181 • Jongwanich, J. (2010), “Capital mobility in developing Asia: Does it respond to

financial crisis?”, ASEAN Economic Bulletin, vol. 27(1), pp. 27-54• Kono, H. and Takahashi, K. (2010),” Microfinance revolution: Its effects, innovations

and challenges”, The Developing Economies, vol. 48 (1), pp. 15-73• Liu, Y. (2010), “A Specific Factor Model of Offshoring”, Ninth Annual Post Graduate

Conference Proceeding, Leverhulme Centre for Research on Globalization and Economic Policy (GEP), University of Nottingham

Reference

• Pitt, M.M., and Shahidur R. K. (1998), “The Impact of Group-Based Credit Programs on Poor Households in Bangladesh: Does the Gender of Participants Matter?” Journal of Political Economy, vol. 106 (5), pp. 958–996.

• Rashid, S. , Sharma, M. and Zeller, M. (2004), “Micro lending for small farmers in Bangladesh: Does it affect farm households’ land allocation decision?” Journal of Developing Areas, vol. 37 (2), pp. 13-29

• Thompson, H. and Francis, J. (2009), “Tariff elimination and the wage gap in an industrial specific factors model.” Review of International Economics, vol. 17(3), pp.447-460

• Thompson, H. (1985), “International Capital Mobility in a Specific Factor Model”, Atlantic Economic Journal, vol. 13(2), pp. 76-79

• Thompson, H. (1987), “A review of advancements in the general equilibrium theory of production and trade”, Keio Economic Studies, vol. 24, pp. 43-62