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Microcredit, Income Assistance, and Households' Time Allocation to Self-employment

Date

2012-08-30

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Degree Level

Doctoral

Abstract

This study develops a model to explain why some households in the United States and Canada opt for microcredit (MC) that seems to decrease their utilities in the short term. Some microcredit participants allocate time to less-productive microenterprises rather than engage in paid work. The role of sequential lending is examined in understanding household participation in microcredit programs. Sequential lending means that a household's current use of microcredit gives it access to greater funds in the future. Under a multi-period model, the effect of current use of microcredit on future utilities is captured. To keep the analysis simple, households are assumed to live in two periods — the present and the future. The model acknowledges that households are heterogeneous with respect to their relative preference for income and leisure. Two types of households are assumed. The type-1 household has a high relative preference for income: the type-2 household has a high relative preference for leisure. Each household has a reservation utility, — the utility it would derive if it self-selected out of the microcredit program. The reservation utility derives from leisure and paid earnings (as well as from income assistance benefits in the case of income assistance recipients). Each household also faces a utility from self-selecting into the microcredit program. The microcredit is small, thus the current period utility from participating in the MC program may be less than the current period reservation utility. But with sequential lending, a current period participant will have access to a larger loan in the future and utility with that loan may increase beyond the reservation utility. Each household self-selects into the microcredit program only if the net present value of its anticipated utility with microcredit exceeds the net present value of its reservation utility. A household's likelihood of self-selecting into the microcredit program is an increasing function of its discount factor, its productivity in self-employment, and the size of future loans anticipated from current borrowing. On the other hand the likelihood of self-selecting into the microcredit program is a decreasing function of the cost of borrowing and the household's wage rate in paid employment. One of the interesting results of the model is that some households — in a bid to access the future loan — may obtain microcredit in the current period and repay it without having invested it in a microenterprise. The developed model is applied in explaining microcredit participation among income assistance (IA) recipients. IA recipients facing a 100% earnings tax rate will not allocate time to paid work because their entire earnings would be clawed back from the guaranteed benefit leaving no change in total income. If the household obtains microcredit and allocates time to a microenterprise, its utility would decrease because leisure would decrease and total income would not change under the 100% earnings tax rate. However, in the future period, the household would get a larger loan by virtue of past participation in the microcredit program. The loan could be large enough to generate profits beyond the IA eligibility point, in which case the household would break away from IA, total income would increase, and utility could increase to the point of offsetting any utility loss incurred in the preceding period. Therefore, an IA recipient facing a 100% earnings tax rate may obtain microcredit and allocate time to a microenterprise in order to access a larger capital in future, in anticipation of breaking away from the IA program. The analyses of time allocation among income assistance recipients produced a set of equations for comparing between the marginal effects of income assistance and microcredit on households incomes and utilities. This comparison is at the heart of ongoing proposals to replace income assistance with microcredit in a bid to reduce public spending on IA while encouraging IA recipients to work. Based on the marginal effects of IA and MC, this study prescribes the minimum rates of substituting microcredit for income assistance in order to ensure that affected households do not experience a short-fall in their incomes and utilities. The prescribed minimum rate is a positive function of the earnings tax rate in the prevailing IA program, and a negative function of the household's preference for leisure, as well as its marginal value product of capital.

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Keywords

Microcredit, Sequential lending, Self-employment, Income Assistance

Citation

Degree

Doctor of Philosophy (Ph.D.)

Department

Bioresource Policy, Business and Economics

Program

Agricultural Economics

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