Microcredit programs have expanded rapidly in recent decades in the developing world. They have reached more than 20 million borrowers in Bangladesh, about 60% of the country's poor rural households (World Bank 2006). The United Nations declared 2005 as the International Year of Microcredit, and urged multilateral donor agencies and developed countries to support the microfinance movement to achieve its Millennium Development Goal of halving poverty by 2015. The success and popularity of microcredit over the past decades are evidenced by the fact that there are more than 7,000 microfinance institutions (MFIs) today, serving millions of poor people, and that microcredit has proved to be an important instrument in helping "large population groups find ways in which to break out of poverty" (The Norwegian Nobel Committee's press release in awarding the Nobel Peace Prize for 2006 to Grameen Bank and its founder Muhammad Yunus).
If access to microcredit helps reduce poverty, then one might surmise that it could also improve investment in children's education. This is because underdeveloped credit markets coupled with low household income (Baland and Robinson 2000; Doepke and Zilibotti 2005; Ranjan 1999) or lack of access to credit are often considered major factors responsible for inadequate education for children in developing countries (Dehejia and Gatti 2005; Edmonds 2006, 2007; Jacoby and Skoufias 1997; Ranjan 2001). Access to credit can have a positive effect on children's education through a number of channels. First, to the extent that credit may increase the borrower's income, the income effect may positively affect the demand for children's schooling (Behrman and Knowles 1999). Second, the vulnerability of rural households to adverse exogenous shocks may force them to pull their children out of school in times of need, hampering sustained school enrollment for their children. Loans from microcredit organizations (MOs) can assist consumption smoothing, thereby reducing the likelihood that children are withdrawn from school in response to adverse shocks. Third, preferences toward schooling may also be influenced by mandatory adult training programs conducted by MOs. Although MOs in general do not have any direct declared objective of improving children's education, they do educate members about the potential benefits of sending children to school. For example, Grameen Bank members need to memorize 16 decisions, one of which is, "we shall educate our children."
On the other hand, microcredit may also have unintended consequences on children's education for several reasons. First, microcredit loans often require establishment of household enterprise that requires extra labor to work in it. For example, if a household uses microcredit loans to purchase livestock, it will require labor to take care of the animals, which can increase the demand for child labor. Second, the amount of loan is not large enough to hire external labor, which may compel the household to resort to child labor. (1) Third, the loan repayment period is short and interest rate is high, making the household myopic, which may induce parents to heavily discount the future return on their children's education. (2) To service the loan, it may be necessary to supplement household income, at least temporarily, with the proceeds from child labor. Therefore, the additional activities made possible by access to microcredit and the factors related to servicing the terms of microcredit loan may adversely affect children's education. (3) Children may need to be employed directly in the newly created or expanded household enterprises, or as caregiver for their siblings, or in farm and livestock duties, and other household chores.
There is conflicting evidence on the impact of microcredit on human capital formation. One strand of empirical studies suggests that access to credit can help reduce child labor and increase schooling in developing countries. …