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The role of inequity aversion in microloan defaults

Published online by Cambridge University Press:  19 September 2019

MATTHEW R. JORDAN Open the ORCID record for MATTHEW R. JORDAN [Opens in a new window] ,
WILLIAM T. DICKENS ,
OLIVER P. HAUSER Open the ORCID record for OLIVER P. HAUSER [Opens in a new window]  and
DAVID G. RAND
MATTHEW R. JORDAN*
Affiliation:
Yale University, Department of Psychology, New Haven, CT, USA
WILLIAM T. DICKENS
Affiliation:
Northeastern University, Department of Economics, Boston, MA, USA
OLIVER P. HAUSER
Affiliation:
University of Exeter Business School, Department of Economics, Exeter, UK
DAVID G. RAND
Affiliation:
Yale University, Department of Psychology, New Haven, CT, USA Yale University, Department of Economics, New Haven, CT, USA Yale University, School of Management, New Haven, CT, USA
*
*Correspondence to: Yale University, Department of Psychology, 2 Hillhouse Avenue, New Haven, CT 06511, USA. Email: [email protected]
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Abstract

Microcredit – joint-liability loans to the poorest of the poor – has been touted as a powerful approach for combatting global poverty, but sustainability varies dramatically across banks. Efforts to improve the sustainability of microcredit have assumed defaults are caused by free-riding. Here, we point out that the response of other group members to delinquent groupmates also plays an important role in defaults. Even in the absence of any free-rider problem, some people will be unable to make their payments due to bad luck. It is other group members’ unwillingness to pitch in extra – due to, among other things, not wanting to have less than other group members – that leads to default. To support this argument, we utilize the Ultimatum Game (UG), a standard paradigm from behavioral economics for measuring one's aversion to inequitable outcomes. First, we show that country-level variation in microloan default rates is strongly correlated (overall r = 0.81) with country-level UG rejection rates, but not free-riding measures. We then introduce a laboratory model ‘Microloan Game’ and present evidence that defaults arise from inequity-averse individuals refusing to make up the difference when others fail to pay their fair share. This perspective suggests a suite of new approaches for combatting defaults that leverage findings on reducing UG rejections.

Type
Article
Information
Behavioural Public Policy , Volume 6 , Issue 2 , April 2022 , pp. 303 - 324
Copyright
Copyright © Cambridge University Press 2019

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