Microfinance · Opinion · Social Business

Critiquing microfinance, Part I

It is healthy and expected for any growing trend or endeavor to receive critique and microfinance is no exception. I’ve decided to do a mini-round up of some recent critiques for those of you who might not have seen them.

The New Yorker Article

The New Yorker recently published an article by James Surowiecki called What Microloans Miss. In this article, Surowiecki argues that while microloans definitely have positive impact they are not what poor countries need most in order to get richer. He observes that the majority of people in developed countries are salaried workers, not entrepreneurs, hence we need more new small/medium businesses which hire people (he calls the “missing middle”.) He also states that microloans are often used for non-business activities including providing consumption credit during lower income periods. He calls for more focus on equity investments vs. loans to small businesses in addition to loans. In summary, he says “for some people the best route out of poverty will be a bank loan. But for most it’s going to be something much simpler: a regular paycheck.”

Microfinance network Pro Mujer CEO, Ben Moyer posted a response where he argues that “the goal [of microloans] is not to make “poor countries richer”; it is to bring desperately poor people out of poverty by helping them to become self-sufficient.” He goes on to note that “For now, the impoverished semiliterate and illiterate women receiving microloans won’t benefit from investments in the ‘missing middle.’ Microcredit will continue to offer the best return on investment, because it eradicates poverty one person at a time.”

I think that this isn’t an either/or type of issue, but an AND … that is, we need to encourage the continued growth of microfinance and new growing enterprises which create income for families in poor countries.

Microfinance appears to be the best tool available to quickly grow the income of desparately poor families to the point which they can get above the poverty line. That is, they can become relatively stable in being able to provide for their basic needs. Microfinance requires relatively small amounts of capital and infrastructure which means that it can reach and serve large numbers of families very quickly. And you can start to see income improvements in terms of weeks, not years. So, while I agree that we should not over-hype and over-promise on how microfinance can reduce extreme poverty, I also think we should not underestimate the continued positive impact it is having. More importantly, there are many countries and regions where microfinance is almost non-existent, so we need to continue to encourage increased investment to bring this baseline financial service to these families.

There is indeed a dirth of financing options available for new small business … even high-potential ones … in emerging economies. I wrote previously about this “funding gap“. Also, there is a good article by Vinay Ganti which dives further into this topic. The reality though is that this is a medium to long term contributor to emerging market income due to the nature of starting and growing these businesses. It doesn’t mean we should not start investing now!

Also, to get perspective on the reality of timelines for dramatically changing systems, I recommend Hernando Desoto’s groundbreaking book on the history, state and importance of adequate property rights described in his book, The Mystery of Capital. Desoto reviews the history and complexity of the development of property rights in the USA (and other countries) not to discourage more acceleration in property rights in other countries, but on the contrary to help articulate the lessons learned in order to accelerate property rights in emerging countries. We want to deconstruct (in order to understand) the accelerated success of new business starts in certain Asian countries over the past 50 years in order to better encourage similar growth in countries which have not yet participated in poverty reduction growth.

Read Part II

Please post your thoughts in comments.

6 thoughts on “Critiquing microfinance, Part I

  1. Microfinance does not eradicate poverty, even one at a time. If we are talking about really poorest of the poor, in the best case scenario, access to microcredit (combined with various training) smooths consumption, empowers women, makes people less vulnerable to the unexpected shocks. Majority of them stay in the survival paradigm – they just survive better. There is nothing wrong about it, let’s just reduce our expectations. The country which achieved the most impressive reduction in its poverty is China and microfinance did not seem to play a sifgnificant role in the process. With all my respect Bangladesh is hardly on anybody list of success stories so far.From my perspective, supplying poor people with credit on a commercial basis cannot be considered provision of social good any more than selling them any other products (such as alcohol). But I do believe in a power of microfinance as an empowerment tool when it is implemented as part of an integrated strategy, offers extensive training and makes an emphasis on savings rather than just credit (some information about our approach is available here: http://www.thp.org/awffi/index.html)Warmest regardsKT

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  2. KT, thanks for stating your opinion. I completely disagree with your statements: (a) that microfinance doesn’t lift any poor people out poverty (it does); and (b) your comparison of sustainable (commercial) provision of microfinance as equivalent in benefit to selling alcohol to the poor. Both of these statements are ridiculous with no basis in fact.I think that there are indeed different approaches to delivering microfinance which have merit. In some cases, delivering microfinance with other kinds of products/services makes a lot of sense and I’ve seen this work. I’ve also seen very passionate (and effective and pro-poor) social entrepreneurs argue that packaging bundled subsidized services is the wrong approach.I’m glad that your organization has found a model that seems to be working to reduce poverty in rural Africa. Keep up the good work as this is a greatly underserved market! Please though pause before striking out at others who are attempting (some failing/some succeeding) at other promising approaches.

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  3. Hi Dave, we might have different definitions what “lifting out of poverty” means. For me the person who is meeting his basic needs (three meals a day, ability to pay school fees and medical bills etc) is still poor. As I have mentioned, poor people can benefit from access to finance and survive better but access to capital on its own (without infrastructure, access to markets etc) is not enough for significant business growth.How would you explain that in developed world with much high availability of credit only 10% (UK) and 6%(US) are entrepreneurs? Isn’t it because only small percentage of us are naturally born entrepreneurs? In terms of alcohol, I came across this parallel in few other places. And I do believe that charging higher interest rates than return on investment of poor people business activities is indeed socially irresponsible.Can you please elaborate on why do you find this comparison ridiculous?

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  4. KT, here are my brief thoughts…Poverty is by nature a relative term/condition. I do think though that the highest global priority is seeing people step out of extreme or abject poverty. Again, probably lots of definitions, but common definition is providing a level of stability (water, food, shelter, clothing, medical help, education, etc.) combined with some level of hope for further advancement … if not for themselves, then at least for their children. I have personally seen how microfinance has helped many people in this way.On the “everyone’s not an entrepreneur” topic … I agree that there are certainly only a minority of people who are, let’s call it, super-entrepreneurs … capable of building a large scale/impact business. This hardly though takes away from the benefits that having some capital to combine with your own labor benefits almost everyone. While microfinance is by no means the all-in-one solution for poverty, it is a very strong contributor.On “access to markets, infrastructure, etc.”, I agree that ultimately these are important and I’ve written about this previously.On interest rates … frankly, I’ve seen people in places like Mexico more than happy to pay interest rates for microcredit loans at 80%+ APR. I struggled (and struggle) to feel like this is not unfair/exploitive (I’ve written about this in another post). Yet, it is not uncommon for these borrowers to earn 200%+ ROI on these loans with their businesses. In places like India, where borrowers are paying 25-30% interest, they are paying substantially below the 60%+ that the middleclass are paying on outstanding credit card balances. And most poor borrowers are earning 100-150%+ ROI in their microbusinesses.On alcohol … I have seen how it is so destructive to families in the slums of major Indian cities especially impacting children and women. While I have seen the occasional negative impact of someone taking a loan that they could not repay, well-managed microfinance cannot be compared to offering narcotics or alcohol to the poor.

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