A matter of trust

In some coun­tries, poor bor­rowers repay loans to micro­credit lenders at rates of close to 100 per­cent while other coun­tries see repay­ment rates so low that it makes microlending unsus­tain­able — a dis­parity that econ­o­mists have been unable to fully understand.

“Tra­di­tional eco­nomic indi­ca­tors didn’t pre­dict any­thing, and the game theory analysis we have of it was sus­pect,” said Matt Jordan, AS ’11, who has been working with Bill Dickens, a pro­fessor of eco­nomics in the Col­lege of Social Sci­ences and Human­i­ties.

But now, the existing under­standing of the eco­nomics of microlending may be changing, thanks to work by Dickens and Jordan, who, as an under­grad­uate, con­ducted field research in the Dominican Republic, where microlending has helped bring many out of abject poverty.

“It was great that micro­fi­nance worked there, but it didn’t work right across the island in a place like Haiti,” Jordan said.

Back in Boston, Jordan col­lab­o­rated with Dickens, who taught a class that applied the math­e­matics of game theory to eco­nomics. Jordan has been working to apply the ulti­matum game — an indi­cator of trust and coop­er­a­tion that asks one par­tic­i­pant to split a sum of money between him­self and a partner, with the partner able to accept or veto the entire deal — to fields of microlending. Dickens and Jordan have iden­ti­fied a strong cor­re­la­tion between his­tor­ical out­comes of the game and the suc­cess of microlending in a spe­cific region, with cul­tures that are more trusting overall and more likely to repay debts.

The issue of trust is key to microlending, Jordan said, because loans are made to groups rather than indi­vid­uals. Loans default when the group is unable to repay its oblig­a­tions, which often occurs when mem­bers stop trusting one another after a dis­ap­pointing finan­cial outcome.

“What we think this model can do is estab­lish new prac­tices, even just have insti­tu­tions call for a break period after bad news is given,” Jordan said. “A cooling-​​off period may lead to a more rea­soned approach, not just one where someone thinks another person is cheating and then blows off the whole group,” leading to a default.

Dickens called Jordan’s appli­ca­tion of game theory to micro­fi­nance “a pro­found and coun­ter­in­tu­itive way” to look at the problem.

The work con­tributes to Northeastern’s focus on use-​​inspired research that addresses global chal­lenges in health, secu­rity and sustainability.

Still, much work is needed, like con­ducting field research to gather more infor­ma­tion about how res­i­dents of dif­ferent coun­tries play the ulti­matum game, data that is not uni­ver­sally avail­able. Dickens and Jordan, who is in the process of applying to grad­uate schools as he works on his research here at North­eastern, plan to pub­lish a paper on their findings.

– by Matt Collette