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22 Feb 2018Working Paper Summaries

Debt Traps? Market Vendors and Moneylender Debt in India and the Philippines

by Dean Karlan, Sendhil Mullainathan, and Benjamin N. Roth

Small-scale entrepreneurs throughout the developing world often rely on moneylenders for working capital but at exorbitant interest rates. Results of three experiments involving market vendors in India and the Philippines show the difficulty that small-scale entrepreneurs face in escaping usage of moneylender debt.

Author Abstract

A debt trap occurs when someone takes on a high-interest rate loan and is barely able to pay back the interest, thus being perpetually in debt (often by refinancing). Studying such practices is important for understanding financial decision-making of households in dire circumstances as well as for setting appropriate consumer protection policies. We conduct a simple experiment in three sites in which we paid off high-interest moneylender debt of individuals. Most borrowers returned to debt within six weeks. One to two years after intervention, treatment individuals were borrowing at the same rate as control households.