The Causal Relationship of Microfinance and Economic Development: Evidence from Transnational Data

Abstract

The purpose of this study is to investigate the so far underexamined statistical causality of the relationship between microfinance and economic development. For a representative transnational dataset covering the period 1995 - 2012 we instrumentalize pairwise vector autoregressive (VAR) estimation models and the Granger approach. We utilize prevalent microfinance institutions’ (MFI) performance indicators as measures of microfinance as well as relevant economic development indicators that not only measure economic and capital growth but also poverty, income inequality and labor participation. We find bidirectional causal interactions between both MFIs’ social and financial performance and economic development. Based on our results important implications for microfinance theory, research and practice can be derived. Future empirical research should account for the statistical causality between microfinance and economic development. In practice, purposeful and progressive action that considers the directions of causality between microfinance and economic development verified within our study should be taken to promote economic growth and poverty alleviation.