Microcredit in a Nutshell

Hey folks – been on the road the past few weeks so haven’t had a chance to post. But, I did like this nugget from Tyler Cowen on one of the reasons Microcredit works

If you don’t pay up, your associate has to. The reality is that the person left holding the bag — who knows you well — will come seize your TV set or in some cases the process is a bit less pleasant. Part of the efficiency of microfinance is simply the separation of the lending and the “thug” functions.

I’m a Microcredit fan overall but like Cowen, instead of seeing it as a whole new way of doing business, I see it as an interesting alternative to traditional charity for a very underserved margin. However, even at this margin, many of the old rules of capitalism still apply. So I look forward to the day when Microcredit as well as its borrowers grow up, credit becomes more formal, and hopefully the “thug function” becomes the final reserve of the state.

26 thoughts on “Microcredit in a Nutshell

  1. Vinod — This is a really stupid post.

    The “thug” function here is repossesion, and in modern capitalist countries, its not the reserve of the state. Financial institutions can re-posses your car — but it’s not the government that takes the car away.

    Micrcredit — in this sense — is not charity. It is the use of peer pressure to replace courts or formal private arbitration in contract enforcement. Similar things happen at a larger scale among some merchant minorities, where poor legal infrastructure is sometimes replaced by in group peer pressure, which is effective because the group is tightly knit.

  2. The “thug” function here is repossesion, and in modern capitalist countries, its not the reserve of the state.

    Ikram – that’s a “really stupid comment.”

    ;-)

    (can we please keep things civil?)

    There are harsh limits to what the Repo Man can do and ultimately, even he resorts to the state / Sheriff’s dept to repo / forcibly evict / etc. whatever property belongs to a creditor. In a modern economy + state, force is a court controlled monopoly.

  3. vinod, whats with you and this fetish towards microcredit =P

    i understand that you are libertarian. so you need to be doing some posts on Mccain to counter all the obama ass-kissing posts that Abhi and ennis have bombarded us with. Frankly, I am starting to get turned off by sepia mutiny coz of this.

  4. 4 · soxfan said

    i understand that you are libertarian. so you need to be doing some posts on Mccain to counter all the obama ass-kissing posts that Abhi and ennis have bombarded us with. Frankly, I am starting to get turned off by sepia mutiny coz of this.

    Actually, Ron Paul would be your man if you are a libertarian. McCain is not even remotely libertarian.

  5. 5 · Rajesh said

    McCain is not even remotely libertarian.

    atleast, he is more libertarian than obama

  6. Well, not all groups practice group lending microcredit; many MFIs are now loaning to individuals.

    Also, it’s important to remember that the peer groups serve as sources of positive AND negative pressure, for support in times of crisis, advice for women with families, and for challenge in times of repayment.

    The microcredit industry at present is doing some soul-searching after the Comportamos IPO and many microfinance players profiting from promoting microcredit. Wasn’t it about human rights to being with? Isn’t that why Yunus accepted the Nobel Peace Prize, anyway?

  7. if you haven’t already, check out Nobel Peace Prize winner, Mohammad Yunus’s book on social capitalism and microcredit.
    http://www.amazon.com/Creating-World-Without-Poverty-Capitalism/dp/1586484931

    microcredit is not supposed to be charity. it is supposed to be a profitable, sustainable business with a double bottom-line that includes serving the poor with financial services otherwise unavailable to them. in my mind there is nothing wrong with making money while helping those in need especially when it enables the poor to get out of poverty.

  8. Sorry Vinod.

    True enough — the sanction of violence is a state monopoly. But I’m not sure that peer-lending works with violence. It can also use ostracism, verbal abuse, or gossipy aunties determining your children are bad marriage prospects because you don’t repay your loans. That’s not very nice, but its a lot better than a loan shark goonda breaking your legs.

    I’d also note that microcredit, as discussed in the article, isn’t so much charity as small, uncollateralized consumer debt. It’s the equivalent of an Capital One credit card or a payday loan facility for countries without sophisticated credit bureaus.

  9. Ikram, wouldn’t gossipy aunties make you want to pay back your loans? microcredit is also more than a cheap version of a Capitol One card. to obtain a loan you have to follow all sorts of rules for hygiene, school attendance, etc. I’m a big supporter of microcredit as well and I do think with some of the technological advances recently that banks have an opportunity to serve the poor unlike before.

  10. Vinod, I thought you were quasi-libertarian? But you’re advocating for the state playing the role of “thug”? Isn’t that a great set up for corruption? (and please do not argue that corruption does not exist in the “modern” state)

    As for violence, I think you’re taking a rather limited tack on it. There are plenty of forms of “lower level” violence that people exact on one another every day, yes, including in modern societies.

    Finally, I really wish you would stop with the “microcredit = a kind of charity” meme; it is an inaccurate and dishonest characterization, as has been discussed in each of the previous posts you’ve provided on the topic. I don’t think you’re a typically dishonest guy, and your claim is not bold and provocative unless you’re going to argue that microcredit should be subject to the same economic models as charity/altruism (which you have, and which others responded to).

  11. 12· Camille said

    Vinod, I thought you were quasi-libertarian? But you’re advocating for the state playing the role of “thug”? Isn’t that a great set up for corruption? (and please do not argue that corruption does not exist in the “modern” state)

    By nearly every modern definition, a monopoly on internal force in the form of Cops + Courts is the exclusive domain of the state. In fact, it’s the basic diff b/t the “State” and any other form of collective action (e.g. the PTA isn’t allowed to “lay its hands on you” while the school board can ask the courts/cops to do it in a far more direct manner.)

    Libertarians, recognizing that FORCE is the central thing that makes the state diff from any other group (for ex., the Welfare dept vs. the Salvation Army) also recognize the degree to which physical force corrupts… and thus, put harsh limits on what the state is able to use that force for.

    As for violence, I think you’re taking a rather limited tack on it. There are plenty of forms of “lower level” violence that people exact on one another every day, yes, including in modern societies.

    Which… is a central insight that Microcredit’s collective lending practices take advantage of… As Cowen points out, even though the State officially owns violence, Microcredit’s “thug function” recognizes very low level forms of coercion / influence that your neighbors are able to perform under the radar. Clearly, not all MFIs rely on collective lending practices, but it is one of the most common features of MF.

    Finally, I really wish you would stop with the “microcredit = a kind of charity” meme; it is an inaccurate and dishonest characterization, as has been discussed in each of the previous posts you’ve provided on the topic. I don’t think you’re a typically dishonest guy, and your claim is not bold and provocative unless you’re going to argue that microcredit should be subject to the same economic models as charity/altruism (which you have, and which others responded to).

    Finally, I really wish your comment was less preachy and personally condescending

    ;-)

    Mohammed Yunus bascally accuses MFI compartamos of being too capitalistic. So clearly, there are still widespread questions & disagreements even from the high priest himself about where on the continuum from Capitalism to Charity microcredit lives. The existence of the “thug” function is perhaps one aspect of capitalism (contract enFORCEment) that many who view it as “charity” probably assume doesn’t exist in happy/shiny/MFI-land. Cowen, in a nice, simple formulation, shows where it’s been displaced.

  12. Two points:

    First, to repeat myself — the “thug”, or enforcement function, need not involve violence. (which is why the term “thug” is inappropriate. Not to mention anti-Hindu.) It can involve social pressure, ostracism, gossip, etc. This has never been the function of the state. Peer-lending is a real innovation in financial services.

    Second, you don’t necessarily need an enforcement function. A lender must repay the first small loan in order to get a second slightly larger loan. The desire for continued access to consumer finance is the enforcement function itself.

    That’s the same reason people pay off their credit card bills in a timely fashion. If you don’t pay your bills, the credit card company will screw your credit rating, preventing you from getting additional credit.

  13. Although people don’t pay their credit card bills on time, most people will only pay the minimum payments. Credit Card debt is the largest component of non performing assets for bank and involves significant write offs and by some accounts securities backed by CC debt may be the next to blow up like subprime mortgages.

  14. 15 · Ikram said

    (which is why the term “thug” is inappropriate. Not to mention anti-Hindu.)

    How is it anti-Hindu?

  15. I don’t think you’re a typically dishonest guy,

    oh boy – case of the pot calling the kettle black.

    Does pawnbroking fall under micro-credit ? I guess it is true around the world that pawnbrokers (corporates or individuals) abound in poorer areas. In Madras a pawnbroker is called a ‘setu kada’ – meaning shop of the ‘seth’ – normally a marwari. Setus give you a loan for anything including school notebooks.

  16. melbourne desi, are you saying I’m being dishonest, or that I am dishonest? But to answer your question, pawnbroking would not qualify as microcredit (although it may be a form of microfinance or lending, albeit a pernicious one), as has been discussed in previous threads on this topic and in the relevant economic literature.

    Vinod, I apologize if my comment was quick — it wasn’t meant as a backhanded compliment, nor was it intended to be preachy/condescending. I’ll put it in the affirmative — you strike me as a relatively honest guy. It’s just that you have cited the SAME microcredit = charity argument over the past two years, with little deviation or additional analysis:

    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.[October 2006]
    “To its backers, on the other hand, the success of Compartamos, despite the recent lacklustre performance of its shares, symbolises how the profit motive can help lift many more people out of poverty than charity alone could ever do.” [quoted in May 2008]

    Perhaps the perceived “condescension” is merely a manifestation of my frustration, as articulated in forum-level commentary :) There are much more logical economic models and explanations for what’s happening than a simple “microcredit == charity.” In trying to draw a distinction between microfinance/lending and microcredit, I think presenting one as capitalistic and the other as charitable fundamentally misrepresents both. Hence frustration.

    Re: force, I’d like to tease this out further, if you don’t mind. Clearly Tyler Cowen and I are on the same page re: “thuggishness, or perhaps “gunda-ness” (although I, with my bleeding heart, would probably give it some postmodern term instead). You mentioned, as a libertarian, valuing sanctions for a state based on the mis-use of force. What would be an example of this? How should such sanctions be structured in order to disincentivize corruption? I think it is fair to say, that in the same modern states that hold absolute force via cops + courts, corruption still exists — albeit with slightly different terms than we assign to the same kind of activity in developing countries — throughout all levels of government.

    Also, are you arguing that enforcement is intrinsically at odds with a not-for-profit, or not explicitly profit-maximizing (what you term “charitable” and “capitalistic”) systems? Doesn’t one, in theory, nest within the other? Does that imply there is no violence or force within non-profit-maximizing arrangements?

  17. camille -

    I’ll put it in the affirmative — you strike me as a relatively honest guy. It’s just that you have cited the SAME microcredit = charity argument over the past two years, with little deviation or additional analysis:

    sigh… if that’s your take away, then I’ve failed to make my point. My argument is quite different (if you want to reduce it to a few bullet points)

    • microcredit is NOT charity
    • microcredit is a FORM OF capitalism
    • what’s unique is that it is being used to DISPLACE more traditional methods of charity

    When Yunus et. al. rail against Compartamos, what they SPECIFICALLY dislike is how uncharitable (e.g. capitalistic) it is. And that’s where I disagree w/ Yunus – a figure who likely represents the consensus opinion within the Microfinance community.

    The “additional analysis” in this post is Tyler Cowen (eloquently / succinctly) pointing out the central role of the “thug function” in microcredit. Contract enforcement is a central aspect of capitalism (b/c of the expectation of reciprocal action) but it is NOT a natural part of most charity.

  18. melbourne desi, are you saying I’m being dishonest, or that I am dishonest?

    I am saying that the same charge that you hurled at Vinod is applicable to you.
    Your explanation articulates your frustration much better.

    How should such sanctions be structured in order to disincentivize corruption?

    Very interesting question. One that I have grappled with for many years. Can sanctions be enforced in a feudal society. And how does one define corruption – is it shukhrana / nazrana / mehatana or jabrana ? Items 1-2 are common nay even the norm in the developed world, it is dominance of 3/4 in under developed world that is the trouble. Folks go around saying that the govt must do this / police must do that. But the govt and police are from the same stock.

  19. sigh… if that’s your take away, then I’ve failed to make my point. My argument is quite different (if you want to reduce it to a few bullet points) - microcredit is NOT charity - microcredit is a FORM OF capitalism - .. that is being used to DISPLACE more traditional methods of charity

    Thank you, this is much more clear to me, and now I understand how I have been misinterpreting your point. :)

  20. The “thug function” is not limited to microcredit. I remember that mainstream financial institutions (Citibank et al) used to use thugs to repossess cars not too long ago..

  21. Also, are you arguing that enforcement is intrinsically at odds with a not-for-profit, or not explicitly profit-maximizing (what you term “charitable” and “capitalistic”) systems? Doesn’t one, in theory, nest within the other? Does that imply there is no violence or force within non-profit-maximizing arrangements?

    w.r.t. the use of Force, I’d bucket the world into 3 (simplified) categories

    • Involuntary transaction + Preemptive threat of force = government (e.g. “you’d better pay your taxes, or the cops throw you in the slammer; I don’t care if you disagree with how the tax $$$ are being spent” )

    • Voluntary transaction + After the fact use of force as the last option if reciprocal obligation isn’t met = capitalism (e.g. if you sign for a loan and don’t pay, the court / your contract can allow the Repo man to come get your car; more likely, however, the “after the fact sanction” is refusal to do biz with you in the future, impact your credit score, etc.)

    • Voluntary transaction + no reciprocal obligation = charity (e.g. “hey bro, here’s some $$$…”)

  22. Inspite of all this talk about how successful it has been in Bangladesh, less than 10% of the population have access to micro-finance. This is after 25 years? Micro-finance is going to help only a fraction of all people- Education and family planning will help everybody……….

  23. I think microcredit can be a powerful tool and I understand why loan rates need to be high when the source of loan capital is commercial. But my questions would be: a) How big is the pool that can benefit? I would exclude the poorest of the poor, I think they require grants or will just end up eating the loan b) Can this amount of loan capital come from large non-commercial sources (e.g. govts, World Bank, socially responsible funds that are not just judged on IRR)?

  24. Clearly Tyler Cowen and I are on the same page re: “thuggishness, or perhaps “gunda-ness”

    ‘Thug’ is already a word from India. It comes from the Hindi verb ‘thug’.