Tuesday, June 28, 2011

Microfinance Harms the Poor

When Professor Yunus won his Nobel Prize in 2006 he set the international community alight. Here was a man advocating the international community’s gospel. At last! One can help the poor help themselves, and possibly turn a profit. Only a fool would turn this down.

 The UN proclaimed 2005 to be the year of microcredit. Micro loans were swiftly disbursed throughout the developing world at huge cost. The poorest people - lacking sufficient collateral to obtain commercial loans - would individually or through groups borrow money at high interest rates to set up a stall or buy a cow and turn a profit. Ingenious.

 What started in Bangladesh soon travelled across Eastern Europe, Africa and South America. The world over people gushed and cooed, the romantic idea of a poor villager earning an income and supporting his family spread like wildfire, sites like Kiva personalized the romance enabling ordinary people, like you and I, to make a donation too.

 A leading proponent of microfinance and co-author of a leading textbook on the subject once said that: “While economic theory suggests microfinance has benefits, rigorous evidence that shows it happening just doesn’t exist… The evidence is pretty dicey”. Why then have billions of dollars been spent on an initiative lacking any substantial evidence of its merits? Bosnia’s sector reached levels of saturation and over-indebtedness when it turned out many “clients” were taking out numerous loans to service already existing loans, plunging them further into debt and further into poverty. And, before you ask, yes a regulatory body existed, but loan officers’ bonuses were linked to the number of loans disbursed. A similar scenario is recorded to have happened in India and Bangladesh where many resorted to suicide out of desperation and fear of loan recovery mechanisms.

Brutal, for what is purported to be charitable. Many now recognize this scheme to be little more than glorified loan sharking, many too, trust and believe in it still. Microcredit is big business, and many will be reluctant to relinquish their portfolios. The industry stretches far and wide, and has quickly developed into the number one feel good job. What concerns me is the vast amount of valuable and, not to mention scarce resources available for sustainable development, spent on harming the poorest, a rather expensive and reckless opportunity cost?  

 If I had a burst pipe, and feared flooding, would I stick a band aid on and hope for the best? The band aid is microfinance. Sure, a small sum may cause some relief though a World Bank Study has shown that half of the businesses fail within a year, micro-firms often operate within the informal sector and therefore have no legal protection, Governments also, are unable to levy taxes to service basic infrastructures and institutions. Stuck in subsitence farming, these goods are far too inefficient to compete on global markets – Agri-processors often triple their costs on transport moving from one micro-farm to the next, for respectable volumes of goods to be sold.

 Over-lending leading to over-indebtedness plunges families deeper into poverty and exacerbates an already desperate situation. To some the idea of “pulling oneself from their bootstraps” is not only romantic but ideologically driven. To others, a glitterati endorsement and the growing demand for “impact-investments” makes the idea a dream job. A gentle reminder though, that one reason for the Soviet Economy collapse is the lack of technology intensive small enterprises, countries like South Korea and Japan developed not thanks to microfinance but rather because of an abundance of the technologically intensive SMEs.

 References for all points can be made available; just ask!