Wednesday, March 19, 2008

Is microcredit really all that it's cracked up to be?

I’ll start with a caveat. Isn’t it hard to quantify and qualify the benefits of a practice that is spread throughout the world and working under so many different guises? It would seem that something whose practices are as disparate and widespread as microcredit would fall into this category.

Karol Boudreaux and Tyler Cowen have generally ignored this problem in a piece for the Wilson Quarterly regarding the benefits and failures of microcredit around the world.

It’s important to remember that 7 out of 10 borrowers are Asian – so maybe it isn’t as widespread a phenomenon as a thought. Women make up a large majority of those receiving loans, mostly because banks have always discriminated against them although they prove to be good credit risks, managing family budgets and all.

More interesting tidbits about microcredit:

  • While loan sizes are variable, they are often in proportion to a country’s income level;
  • Microlenders charge between 50 and 100 percent interest, which is not as much as local money lenders charge;
  • Many microlenders refuse to lend money to start businesses, which seems counter intuitive;
  • Micro loans are often used for things outside of commerce: school fees, doctors fees, house improvements;
  • Microlenders also loan to people in the informal sector, which banks do not.

The report also focused on the works of local money lenders, who often borrow from rich relatives and then loan it to villagers in need. In more than one sense, it is these lenders that truly work on the micro level: they demand no paperwork and no waiting period; they deal strictly on a cash basis; they are often the last chance for credit to the very poor; they do, however, demand quick repayment.

One interesting aspect of the paper is the differing ideas of savings. While those in the West tend to keep their savings in cash or gold, people across the developing world often transform it into other forms of liquidity: perhaps animals, like cows or goats. Neither of these can be stolen like money, they won’t necessarily be borrowed from friends and relatives; and they have alternative benefits: they produce milk or fertilizer from dung or companionship.

After all that, the authors come up with some seemingly well deserved uncertainties about the new panacea that is microcredit:

Microcredit is making people’s lives better around the world. But for the most part, it is not pulling them out of poverty. It is hard to find entrepreneurs who start with these tiny loans and graduate to run commercial empires. Bang­la­desh, where Gram­een Bank was born, is still a desperately poor country. The more modest truth is that microcredit may help some people, perhaps earning $2 a day, to earn something like $2.50 a day. That may not sound dramatic, but when you are earning $2 a day it is a big step forward. And progress is not the natural state of humankind; microcredit is important even when it does nothing more than stave off ­decline.

With microcredit, life becomes more bearable and easier to manage. The improvements may not show up as an explicit return on investment, but the benefits are very real. If a poor family is able to keep a child in school, send someone to a clinic, or build up more secure savings, its ­well-­being improves, if only marginally. This is a big part of the reason why poor people are demanding greater access to microcredit loans. And microcredit, unlike many charitable services, is capable of paying for ­itself—­which explains why the private sector is increasingly involved. The future of microcredit lies in the commercial sector, not in unsustainable aid programs. Count this as another ­benefit.

If this portrait sounds a little underwhelming, don’t blame microcredit. The real issue is that we so often underestimate the severity and inertia of global poverty. Natalie Portman may not be right when she says that an end to poverty is “just a mouse click away,” but she’s right to be supportive of a tool that helps soften some of poverty’s worst blows for many millions of desperate ­people.

This paper has sparked a lot of debate, in both the popular press and in the more economic-centric journals. What the study proved to economics-reporter James Surowiecki of the New Yorker is that people in poor countries need to start thinking bigger, not just making more small groceries (that sell the same thing as the small grocery down the street), but investing in small and medium-sized businesses.

In high-income countries, these companies create more than sixty per cent of all jobs, but in the developing world they’re relatively rare, thanks to a lack of institutions able to provide them with the capital they need. It’s easy for really big companies in poor countries to tap the markets for funding, and now, because of microfinance, it’s possible for really small enterprises to get money, too. But the companies in between find it hard. It’s a phenomenon that has been dubbed the “missing middle.”

The question remains, of course, where to get the backers for such firms. He reports that some foundations have belatedly begun filling in that inefficiency in the market. For interested entrepreneurs, you've got homework to do: read his piece and then this piece; this does not constitute a paid advertisement or an endorsement.


Anonymous said...

Your analysis and critique of microfinance in light of the article published in the Wilson Quaterly is well done...from an outsider's perspective.

But tell me something...if the impact of microfinance is to help poor people earn an incremental 50 cents or a dollar a day as even that is an improvement over the past, why are the rich not willing to offer that opportunity to the poor without earning an absurd profit on the transaction? Does it sound right that we are hoping to earn a profit and better our own lives by making the life of the poor just a bit more bearable on a daily basis? Even you you tend to agree with that, the problem really is that this approach would make the poor dependent on the service while maintaining them in poverty.

Africa Flak said...

Thanks for the comment. To tell you the truth, I am a little more optimistic on microcredit than those in the Wilson Quarterly article. As I tried to point out, investigating something like microcredit is nearly impossible at a global level; practices differ by geography. I think most of their criticisms were regarding the more Asian model. For example, interest rates seem to be higher in Asia. And yes, you make another good point: if the interest rates are so onerous, why charge them?

However, there are a few implications the come along with microcredit. The first is African banks don’t work. They don’t deal with poor people; they don’t deal with anyone in the informal sector. They charge outrageous interest rates. It costs a fortune to open an account. And remember, most of the banks working in this part of the world come from Africa.

Who has responsibility for reforming the banking sector? Western donors or the World Bank? No. Ultimately that responsibility falls on Africans. So, let’s put the reform in the hands of political leaders who are supposed to regulate businesses and insure their citizens are being treated fairly.

For all the talk in Africa about Western countries messing up the continent through their development schemes, I generally agree. However, there comes a time when African leaders need to clean up their own house. Opening up the banking system so regular people can use it is a perfect start.