James Suroweiki of “Wisdom of the Crowds” fame has a piece that tries to reality check the current enthusiasm for micro-loans.
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Mohammed Yunus. Good vibes. |
There’s no doubt that microfinance does a tremendous amount of good, yet there are also real limits to what it can accomplish. Microloans make poor borrowers better off. But, on their own, they often don’t do much to make poor countries richer.This isn’t because microloans don’t work; it’s because of how they work. The idealized view of microfinance is that budding entrepreneurs use the loans to start and grow businesses–expanding operations, boosting inventory, and so on. The reality is more complicated.
The core issues are 2 fold. First, Microloans generally don’t go into job-creating ventures. Second, the ventures that really do create jobs are often far outside of micro-loan territory and subject to many other local constraints (for ex., corruption, infra, etc.)….
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p>Suroweiki touches only a bit on a more subtle issue, however — the “meta-narrative” and lessons learned from microfinance on capitalism and charity. This last issue has sorta been nagging at me since I saw Muhammed Yunus speak in San Francisco back in January (its worth ipod-ing the MP3) and I’ve been reading up on microloans quite a bit since Yunus won his Nobel Prize.
But first, some empirical research on how loans are actually used –
…Microloans are often used to “smooth consumption”–tiding a borrower over in times of crisis. They’re also, as Karol Boudreaux and Tyler Cowen point out in a recent paper, often used for non-business expenses, such as a child’s education. It’s less common to find them used to fund major business expansions or to hire new employees. In part, this is because the loans can be very small–frequently as little as fifty or a hundred dollars–and generally come with very high interest rates, often above thirty or forty per cent. But it’s also because most microbusinesses aren’t looking to take on more workers. The vast majority have only one paid employee: the owner. As the economist Jonathan Morduch has put it, microfinance “rarely generates new jobs for others.”
Make no mistake, Children’s education is a Very Good Thing. And many of the “strings” that come with microloans (group loans, fostering initiative, female empowerment, etc.) almost certainly have important social capital impacts. But, as “consumption smoothing”, and to use a Western consumer analogy, the majority use case is more akin to “credit cards” rather than “small business loans”. In this regard, the critique that microloans are a bandaid probably mirrors much of the dev-econ brouhaha around remittances –
“Remittances: the New Development Mantra?” asked an article by Devesh Kapur of the University of Pennsylvania. He sees the money as a palliative that, while at times helpful in easing poverty symptoms, leaves underlying structures unchanged. “If I ask can you name a single country that has developed through remittances, the answer is no — there’s none,” he said.
Second, Suroweicki notes the types of ventures that create real jobs by the bushel are often far outside the purview of Microloans –
…Sustained economic growth requires companies that can make big investments–building a factory, say–and that can exploit the economies of scale that make workers more productive and, ultimately, richer...What poor countries need most, then, is not more microbusinesses. They need more small-to-medium-sized enterprises, the kind that are bigger than a fruit stand but smaller than a Fortune 1000 corporation. 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.
I’ve noted in the past that the size / scale of a single Chinese factory can regularly exceed the largest desi outsourcing shops. And Chinese manufacturing firms exist in the thousands thus employing 10s of millions. That’s the sort of scale that can really transform India…. – And those factory workers were far more likely to have been rescued from the cusp of poverty. Some Microfinance critics like Aneel Karnani, put it far more bluntly –
Despite the hoopla over microfinance, it doesn’t cure poverty. But stable jobs do. If societies are serious about helping the poorest of the poor, they should stop investing in microfinance and start supporting large, labor-intensive industries. At the same time, governments must hold up their end of the deal, for market-based solutions will never be enough
…To understand why creating jobs, not offering microcredit, is the better solution to alleviating poverty, consider these two alternative scenarios: (1) A microfinancier lends $200 to each of 500 women so that each can buy a sewing machine and set up her own sewing microenterprise, or (2) a traditional financier lends $100,000 to one savvy entrepreneur and helps her set up a garment manufacturing business that employs 500 people. In the first case, the women must make enough money to pay off their usually high-interest loans while competing with each other in exactly the same market niche. Meanwhile the garment manufacturing business can exploit economies of scale and use modern manufacturing processes and organizational techniques to enrich not only its owners, but also its workers.
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Alternative charity: get homey to apply for a microloan instead. |
My last point is a little more subtle. While I’m a huge fan of microloans in general, I fear that for many, the lesson drawn is that micro-loans somehow subvert “traditional” capitalism (whatever that may be). It’s a flame that Yunus certainly fans and that many, but clearly not all, boosters latch onto (esp. at the SF Commonwealth Club) ; for ex –
Grameen Bank succeeded by abandoning the traditional banking model* Traditional banks: the more you have, the more you get; Grameen: the less you have, the more you get
* Banks look at skills and experience in potential borrowers; Grameen looks at intent and ambition
* Banks are interested in your history; Grameen is interested in your future
…Without compassion, capitalism would consolidate all wealth into the hands of a few.
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p>While you could make “traditional banking” defenses to every one of those points (ever get an unsolicited credit card as a zero-collateral student? ever see a VC invest in an entrepreneur’s intent & ambition?, etc.), there’s a deeper, underlying thread in these arguments.
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p>I’d argue that instead of reenginering capitalism to help the poor, microloans are far more profoundly reengineering charity to help the poor help themselves. Why point out this seemingly semantic difference? It’s about identifying the long term goal and the moral high ground.
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p>Trade has always “expected” something back from the guy you give your $$$ to. Charity, however, is far more often the proverbial blank check given on the basis of need rather than “what can I expect of you?”. The second there is an up front commitment to downstream reciprocity (of any form), you’ve made a major conceptual leap between the 2 modes of exchange. And with microloans we’re encouraging the discipline of reciprocal behavior even if the “donor” didn’t really need the money in the first place.
Secondarily, once you’ve gotten over the short term consumption hump that microloans fix, what’s next? Microloans are ideally a new on-ramp helping these individuals participate in the virtues of Global Capitalism (and eventually graduate into traditional banking) rather than some sort of bypass.
Of course, with that frame, a 100,000 employee factory in China is arguably more virtuous than a Grameen bank – not quite the conclusion some folks are looking for… 
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I think this misses the whole point of microloans. Grameen Bank doesn’t operate like a charitable grant-making foundation that gives away money without any expectation of getting it back. All loans are expected to be repaid — in fact the loan default rate is extremely low. Can you name any foundations that expect to get their grant monies back? 🙂
This time, it’s an incorrect description of charity that bugs me. The returns on a charitable investment are almost always non-monetary — ideally, real, measurable social and economic outcomes. There are positive externalities involved. The recepient of charity (I’m expanding this to organizations, not just individuals) has to prove to the donor that they are capable of delivering social and economic returns — proving that there is a “need” is insufficient for most charities, unless you are looking at purely charitable donations in crisis situations, e.g. natural disasters.
Where’s Anna?
I think Surowiecki has given the real picture. We often tend to think Microcredit as the panacea to reduce poverty across the world. But actually poverty is mainly society’s problem and it is a bi-product of all the actions societies take or not take. Even the welfare nations have failed to remove poverty with their affluent resources.
It concerns to our sense of respect towards other beings, our care and passion towards them and treating them as an equal member of the society.
Since ages the notion of fighting poverty/helping others is also embedded in all the major religions. But in practice people do the opposite. For an example the religion Islam has theoretically the best protection against the poor neighbors (Jakaat etc.). But in practice we see the wealthy Arab Sheikhs ignoring the plights of their neighbors, workers from South Asia or say poor people in Muslim nation, instead they misinterpret a saying in religious scripts to fund for Jihad. I know blaming the Sheikhs is the popular way of doing it and I should rather say that most Muslims are guilty of not practicing the ethics the religion provides and try to get away from helping the poor. The same probably applies to other religions too.
Microcredit is an idea, its a revolutionary way of respecting the poor that they have the potential to do much better if they get a little push. The problem is not with the idea but in the process. Thousands and thousands of loan sharks are emerging to utilize their idea to make a living of some people. Microloan models are profitable, self sufficient and easier to sell. But in the process we forget the very reason the idea was born, the poor people. To get them out of poverty we need to raise awareness, change people, authority’s attitude towards them and grow them in a helpful climate.
What Yunus inspires us is telling that every one of us is an entrepreneur and can create something worthwhile (if felt that I am adding no value to myself in serving others) for the society. And the poor are like Bonsai trees, with more potential but deprived of juice. If we recognize the problem, it becomes easy to act accordingly. But many of us are happy to luckies with our uneducated maids, slums around the corner.
So why do we cry for loan models, when we can be part of the process of eradicating poverty? What if we try to select and sponsor education a little boy in a rural village and lets see if he can grow beside us? What if I buy my vegetables from a poor vendor, instead of the super stores. If we can be aware of the poor people besides us we can be able to do something about them, collectively. Otherwise the loan sharks will eat this revolutionary idea that people are not born poor and they have a potential to do anything like us who are not so poor.
i was talking to a fund involved in mircoloans the other day (Calvert Social Investment Fund) and they said they had invested in china and tibet (i think) and the way they look at it is as a double bottom line. In other words, I think they ended up making a tiny profit that certainly underperformed the market but they went back to their investors and sold them on all the good they did, and that was enough to keep them in the fund.
KM –
I think you’re in Violent Agreement with the central point. 😉 Grameen bank (et. al.), by demanding downstream reciprocal behavior is decidedly NOT behaving like an old skool charity. And for that we laud it.
Charity doesn’t demand reciprocity back to the giver. It certainly generate other benefits, for sure.
I happened to start reading Yunus’ new book on what he calls Social Business a few days back. I have not got very far due to a lack of time but the basic idea is that business should be started but not with the aim of maximizing monetary capital (which I would say is a direct reflection on your addition to an economy and thus is not so bad, as long as the addition to the economy is real and desirable as opposed to say an addition made by sweatshops on exploitation – but I digress) but a different kind of business with an aim of maximizing social benefits. So far so good – this can be a new model of charity along the lines of microfinance. However, I find his approach restrictive in the sense that he too comes from the frame of mind that profit is evil. Now, irrespective of whether you consider profit as evil or not, the fact is that it is still neccessary, a neccessary evil for the cynics. Thus, he is opposed to the idea of investments made with an aim for a monetary return, for example loans with an interest clause, etc. I think this is a problem.
Instead what you mentioned regarding Google.org makes complete sense. If organizations like the Gates foundation and Google.org in fact got more into the business of making loans for socially beneficial capitalism i.e. job creating industries and at the same time provided a kind of a consulting service in making such business ventures successful, these organizations can achieve a lot more. They can give loans maybe at an inflation rate of interest and thus can continue to be successful sans charity and still achieve their goals. Or if they want to be even more adventurous, they can start businesses and maintain ownership of these businesses while pumping the revenue generated after reinvestments, into more of the same kind of work they do. Sustainability and self driven growth are the key, even in the social sphere.
This may be true of Microcredit’s original intent, and that of thousands of microcredit institutions today, but it certainly isn’t true of what Microcredit indeed is. In essense, it is a business innovation that came along to serve a very particular market need. Poor people need small sums of money but have little collateral. Microcredit successfully capitalizes on the poor’s social networks to ensure repayment and low defaults. As a result, it is a remarkably good business. That said, using social networks to positively enforce repayment is a very difficult balancing act to pull off, and Grameen deserves credit for developing a fantastic business model. Charity has little to do with how microcredit really works.
Isn’t there an inherent contradiction in expecting job creation from a lending scheme that has almost 100% repayment rates? Doesn’t the social enforcement system effectively dampen risk taking? At the end of the day, isn’t it risk that creates factories and jobs?
I don’t understand what this post is arguing for (or against). I don’t think any sane person claims that microloans are a silver bullet that should be pursued exclusive to all other development goals, or that it is a cure-all (of course, microcredit does not obviate the need for governmental initiatives, or make entrepreneurship as a model for development moot!). But it does seem to be the case that they have an important social function, and this is a model that works not just in one village or a small set, but generalizes to a large section of the developing world. The real benefits of microloans are in how they address a segment of the population that have not really been reached by the standard development initiatives (the extremely poor), the system that provides recipients with the support they need to start up their own businesses (yes, self-employed), and the local nature that forces people into making good decisions through a combination of incentives, penalties, and social peer pressure. This is very different from what the traditional entrepreneurship model does.
Also, do you have a citation for your statement that factories rescue people from the cusp of poverty – do you mean the people hovering around the poverty line, or the extremely poor, which is where microfinance is believed to really shine? Arguably, people set up factories in places that have good enough infrastructure, like electricity, water, transportation etc., not in the most impoverished areas. In that context, it is really another statement in the Aneel Karnani article that is very interesting to me:
Now if this is actually a legitimate conclusion that does generalize, that is really powerful and argues against one of the most crucial selling points of microcredit. I tried looking this book up, and an abstract I found actually seems to contradict the above statement, though:
The other serious issue is the total amount of capital required to fund microcredit for all of the world’s desperately poor. Here there is a real debate between the not-for-profit advocates like Yunus, and the for-profit advocates like Omidyar et. al. I think the jury is still out on whether for-profit microfinance can preserve its social development goals without gouging the recipients, as has been the case in a few places already, or if the non-profit model really scales.
Rahul, Where’s your SOH when you(we?) need it most?
Sorry, Neale. I’ve recently been functioning with humor credit (naturally, a microloan) from Manju.
10 · Rahul said
Don’t worry, as i said, microloans are all about double bottoms.
Since you’re talking about semantic differences, it might be better to say that Chinese factories have higher returns on investment rather than attribute virtue [virtuous (according to a dictionary) = conforming to moral and ethical principles; morally excellent; upright: Lead a virtuous life] to them.
I think there is a valuation problem here. I do agree that microloans may get used as consumption, but when they do get used in income-generating activities, they allow poor people to choose a vocation. The account above ignores that particular advantage that microloans extend to some poor people. Wealthier persons have the wherewithal to choose their careers, and poor people don’t. Microloans correct the disparity in opportunity, and simply putting a factory in a poor rural area does not do the same thing for poor people. True, working in an SEZ making shoes brings home the bacon, but it is not a choice many people would make if they had access to education as children or access to capital markets as adults.
Second, calling all sorts of microloans as charity is disingenuous. Yes, microloans where people do not expect repayment are charity, but there are several for-profit microloan organizations that disburse loans only to the working poor, where they expect consistent payments and profits. For a large financial organization, microloans might be good bet in terms of risk (I don’t know this from empirical work, but it is quite plausible): we are talking about small sums of money given to people who will be reliable debtors engaged in relatively low risk ventures. Microloans may not create jobs in the developing world, but they may actually turn out to be very good business for financial organizations looking for alternate revenue streams, and millions of potential customers who could slowly graduate to mainstream banking services(through small savings accounts and basic checking accounts).
5 · vinod said
Indeed, it is not intended to function as a charity. Calling it charity 2.0 is an insult – maybe they’d prefer compassionate capitalism. Yunus (and people like him) want a self-sustaining organization that allows the poor to integrate in the market structure that has so far excluded them. If you (like countless glib thinkers) believe that capitalism and democracy go together (glaring exceptions: China, and many developing nations that are essentially kleptocracies internally), and that democracy implies equality of opportunity, then microcredit organizations are basically correcting a market failure. Most of them (especially the prominent) are not charities and explicitly reject that characterization.
well, the theory is that the rising bourgeoisie will inevitably demand political power to go along with the economic, as well as the theory that an efficient market demands freedom of information, a freedom that can only be guaranteed within a democracy. China is, of course, the exception, but its probably too soon to tell, and in all likelihood the current state of things will prove to be a midwife between communism and democracy, not unlike the role capitalism was supposed to play within the Marxist system, ironically.
or to put it more glibly, freedom is indivisable.
I don’t know enough about economics to comment intelligently about this, but I’ll try. 1) Sure, businesses that take microloans don’t create new jobs, but don’t they increase the country’s economic activity? 2) “If I ask can you name a single country that has developed through remittances, the answer is no — there’s none†A cheeky SM response would be – Britain. If money from remittances is used effectively, i.e. used for generating value, then it can have similar positive effects on the economy. 3) It’s also a matter of what kind of transformation you think is best for the country. I think that 100 one-person businesses is better than 20 executives, and 80 wage-slaves, which is what choosing one savvy big-loan–getter would do.
I agree that “microloans are ideally a new on-ramp helping these individuals participate in the virtues of Global Capitalism (and eventually graduate into traditional banking) rather than some sort of bypass”. Sure, microloans might not be enough to create companies that hire other people, but they help in creating companies that, given time, could achieve a size that it could borrow from traditional means and hire people.
I think what’s lacking in Suroweicki’s argument is a sense of time and of incremental change. I think I’ll go with the crowd on this one.
I think the argument being made is that in the same capital that’s needed for 100 one person businesses, 200 wage-jobs will be created (economies of scale). Plus whats the issue if your wage slaves have enough wages to live comfortably and unexploited.
Hi all – regarding job creation, most MFIs are not only providing small-scale loans to clients but also providing training for ‘the poor’ (eeps!) to gain transferable, technical skills.
The Grameen model is based on human rights theories – ie every individual should be treated with respect and can make a difference – while many job creation programs are still solely focus on economic development. Like it or not, emotional support is a large part of progressing out of poverty, and models like Grameen provide the peer support networks necessary unlike large-scale economic development interventions.
I do agree about the role of SMEs, but the biggest challenge they face is securing funding. There’s a movement within the microfinance community to provide loans to SMEs as well with a caveat of job creation for the poor.
Vinod, how does your idea re: microloans subverting capitalism jive with groups like Compartamos? Are you only counting “job creation” as those endeavors that lead to the creation of a physical plant with a manager/employee structure (e.g., a factory)? Economies of scale aren’t ideal in all industries, and I’m surprised that this discussion has not brought up a lot of discussion on port’s point — freedom of movement and of employment among workers. Perhaps there’s an alternate definition of “virtuous” you’re alluding to, but I can’t understand how gross human rights violations and slave wage economies (which may subvert also very low paying but subsistence economies or non-extractive/abusive alternate industries) are inherently more virtuous or preferred because of their purported scale. Why wouldn’t self-employment count as job creation? How would this later apply to post-industrial countries? If you’re not reliably measuring sole proprietorships in a country’s GDP (or in its HDI, for that matter), then how can you say whether it does or does not benefit the overall “wealth” of a nation?
It’s true that folks sometimes use loans to fund school fees, or to build a home, or to create assets in other ways. The biggest critique I often hear of microcredit/microlending is that it does not generate new wealth, but rather creates a system of indebtedness among the very poor. The other critique I hear is that it operates on an unrealistic vision of the “entrepreneurial” poor, and that specifically Grameen’s training to loan-recipients is paternalistic/patriarchal. All that said, it is building human and capital wealth in underserved and underbanked communities, specifically from a human rights perspective (which helps temper some of the nasty/predatory lending we see from other entities). I do think there is an element of self-sufficiency and dignity that microcredit affords communities that traditional development aid models do not. It’s also very notable that Grameen is “home-grown” — i.e., does not come from the typical development policy experts in Washington. It has consistently disproven naysayers.
I think there’s also a huge conflation here between the role of foundations, charitable organizations, and double or triple bottom-line companies/corporations. While they may all work for the social good, they are markedly different in their roles, responsibilities, and accountability structures. Just because a bank (and Grameen is a bank, even if it doesn’t seem like Chase) is doing something unique and not necessarily profit-driven does not make it a charity. This definition demeans the work being done both by charitable organizations and by socially responsible corporate entities.
Microcredit/lending is certainly not a panacea for poverty, although it’s often framed that way. On the other hand, there are very few thoughtful and robust programs geared towards slow but steady asset and wealth creation among very poor communities. It’s certainly a start.
Why dont these people just open up a computer chip company and compete with celeron and pentium? Maybe these poor people could manage hedge funds? Maybe start REX investing? Either way this guy proves the micro-finance guy has a micro brain and is an idiot.
Dont you think that it might be harder now for poor countries to make it? This world is so connected that as soon as a rich guy from the west hears about a new way to make money in some poor country then he is the one that ends up making all of the money and not the poor people. Are the folks that make Nike shows painting the town red were they live? Are the kids that make the shirt I am wearing now buying fancy cars and partying with the finest strippers?
Surely any economy will benefit from having the correct ‘mix’ of large-scale industry and small scale industry. But the correctness of the ‘mix’ should only be determined by the marketplace. i.e. if Indians are going to benefit from large-scale ‘labor-intensive’ industry the market will ‘on its own’ create conditions to favor such industries. It is imperative that ‘society’ in any way shape or form, other than private enterprise, does NOT start ‘start supporting large, labor-intensive industries.’ In fact this is exactly the sort of backwards economic thinking that got India started of on the wrong foot.
Regarding microcredit; as long as only private charities and profit-minded entities pursue micro-credit we can be sure it is a net positive for Indian people. Since that is the way it is now, I am sure that micro-credit is a good thing…it is organic. But the danger lies that the government will get involved. Either in terms of regulation, or even worse offering microcredit from its own funds.
Well-said, Camille (post #18). The criticism of micro-credit is based on a classic strawman argument, if there was ever one. Micro-credit was never meant to be a panacea for poverty-alleviation. Its original intent (at least in Bangladesh) was to make rural women more self-sufficient. And in this measure, Grameen Bank succeeded spectacularly.
I met Mohammed Yunus a few years ago when he visited my business school, before he won the Nobel. I specifically asked him if he thought micro-credit would work in India. He said that what India needs is not micro-credit, but micro-finance, a much larger suite of financial services that encompasses the former.
Roger23 (post #21): Good point. I am hopeful that the GoI will react in the same way it did with the IT boom, which is to take a passive support role, and let the private sector work its magic.
why so much confusion ?
see, sepiamutiny = 1 blog employing 10 bloggers. now, do i want to click on 10 individual blogs or go to 1 blog ?
similarly, factory = 1 workplace employing 1000 employees whereas microfinance = 1000 housewives with 1000 sewing machines do i want to buy from 1 factory or go door to door checking out 1000 housewives & their wares, especially when their husbands aren’t home ?
18 · Camille said
err… I’m not saying that microloans subvert capitalism. In fact, I’m arguing the opposite, they work so well because they reengineer charity by adding capitalist principles to it.
I’m a fan of them.
I’m citing the evidence from several sources that, in all developed economies, most people – particularly those above the poverty line – are employees of a larger organization rather than sole proprieter entrepreneurs.
The world needs both for sure but the evidence is that it needs more of the former to bring a country out of poverty.
This is the segment Microloans “miss”.
because 1) not all companies commit “gross human rights violations” and pay “slave wages” (reportage aside, in the grand scheme of things as long as the cost of starting a firm is small, and employment is at-will, it’s a woefully small % of companies that truly engage in those shenanigans…. )
2) as the evidence notes above, economies that have firms (particular mid-size) emerge out of poverty. And getting out of poverty is incredibly virtuous.
20 roger23 said
The problem is whether the Government of India prevents the market from creating the optimal mix. They could inhibit this directly (e.g. corruption & demanding bribes) or indirectly ( lack of infra, licensing, etc. that increase the cost of firm creation).
Both of these create a bias towards the very large firms (who can afford full time staff to deal with bribes, etc.) and VERY small firms (who stay under the govt radar & don’t require as much support infra like roads, electricity, etc.)
If I give a $200 microloan, the person receiving the money may not hire another person but he or she will buy something with that money. That purchase will increase demand. Demand requires someone to supply that good or service and hence a job is created.
Poor country’s need to think about getting money in! One way is Export! Factory has a bigger chance do develop this “ties” to the outside, then a lonely entrep.
If society had been honest, the way up would’nt be so hard!
Good submit, adding this to my own blog now, thanks.