The impact of informal credit on household welfare: evidence from rural Ethiopia

ABSTRACT

This study focuses on a credit-related informal risk-sharing mechanism and analyzes the effect of informal credit on household welfare. We use two-stage least squares regression to avoid the endogeneity problem and the Heckman correction procedure to remove possible self-selection bias. We find that informal credit is positively associated with welfare; each thousand Ethiopian Birr (approximately US$ 28) received in the form of informal credit improves the welfare expenditure of a household by approximately 4.3%.

KEYWORDS:

• Informal credit
• household welfare
• rural Ethiopia
• instrumental variable
• Heckman correction procedure

JEL CLASSIFICATION:

• O16
• O17
• O18

Acknowledgments

The views expressed herein are the authors’ own and do not necessarily reflect those of of National Planning and Development Commission or KDI.

Disclosure statement

No potential conflict of interest was reported by the authors.

Notes

¹ ‘Idir is an association established among neighbours or workers to raise funds that will be used during emergencies, such as death within these groups and their families, while Equib is an association established by a small group of people in order to provide substantial rotating funding for members in order to improve their lives and living conditions.’ (‘Socio-Economic Traditions of the Ethiopians’ by Ayele Bekerie 2003).

² The result of the first-stage regression of informal credit is available upon request. The coefficient of the IV is −0.282 and statistically significant, indicating that households from a more competitive community have a lower credit share.

³ This result is similar to those of Schindler’s (2010) and Nguyen and van den Berg’s (2011).