Think Again

Think Again: Microfinance



"Microcredit Is a Proven Weapon Against Poverty."

Alas, no. Microcredit, the strategy of lending sums as small as $100 to help poor people start tiny businesses, has won acclaim like few other recent concepts in economic development, winning plaudits from political leaders, titans of industry, and celebrities. Bill Clinton and Tony Blair love microcredit. So do Queen Rania and Natalie Portman. More than 100 million people in more than 100 countries have received microloans, thanks in no small part to billions of dollars from foreign aid agencies, philanthropists, and "social investors" looking to do well while doing good. In 2006, microcredit pioneer Muhammad Yunus and the Grameen Bank he founded in Bangladesh shared the Nobel Peace Prize. Microcredit has gained a global reputation for lifting people out of poverty and empowering women.

What has made so many so sure of microcredit? The ideas are powerful: a blend of self-reliance and liberation that appeals across the political spectrum. Microfinance promoters told compelling stories of individual men and women whose successes embodied those ideas, and papers in prestigious journals gave convincing evidence that the loans, especially when they went to women, made them less poor.

But the old studies are now discredited. Newer, better ones have found that microloans rarely make an impact on bottom-line indicators of poverty, such as how much a household spends each month and whether its children are in school.

The reversal of this academic verdict is a sign of a larger shift in development economics, toward randomizing in order to pin down cause and effect. If you observe that less-poor people are more likely to have taken microcredit, it is hard to know what caused what: Did the microcredit make them better off, or did being better off make them readier to borrow? If you instead flip a coin to decide who in a village will be offered microcredit and who will not -- randomizing -- and then observe that the fates of the two groups diverge over time, you can more accurately observe what effect the loans are having on those who receive them.

Recent randomized studies in India, Mongolia, Morocco, and the Philippines have found that access to microcredit does stimulate microbusiness start-ups -- raising chickens, say, or sewing saris. But across the 12-18 months over which progress was tracked, the loans did not reduce poverty. So today the best estimate of the impact of microcredit on poverty is zero. (In retrospect, reverse causation cannot be ruled out as the source of the more upbeat findings of earlier, nonrandomized studies.)

This finding clashes with the microcredit mythology. But it comports with common sense. If you're reading this article online, you probably belong to the global middle class, the billion or so people who earn steady wages and lead lives of material comfort. What in your family history lifted you to your enviable perch? It probably wasn't tiny loans to your indigent ancestors so they could raise goats. Then, as now, most poor people's best hope for escaping poverty lies in graduating from tenuous self-employment to steady employment -- to jobs, which are the fruit of industrialization.



"Microfinance Is Useless."

No. It would be wrong to overreact to the hype about microloans and dismiss the entire enterprise as a waste of money and effort. Twenty years ago, journalist Helen Todd spent a year following the lives of 62 women in two Bangladeshi villages served by Yunus's famous Grameen Bank. Of the 40 who took microcredit from Grameen, all stated business plans to get the loans: They would buy cows to fatten or rice to husk and resell. A few actually did those things, but most used the money to buy or lease land, repay other loans, stock up on rice for the family, or finance dowries and weddings.

That's probably just fine. As the book Portfolios of the Poor shows, the people said to live on $2 a day actually don't. They live on $3 one day, $1 the next, and $2.50 the day after. Or they are farmers who earn money once a season. But their children need to be fed every day, and husbands don't fall ill on convenient schedules. The need to match an unpredictable income to spending needs with different rhythms generates an intense demand among poor people for financial services that help them set aside money in good times, when they need it less, and draw it down in bad.

All financial services help meet this demand, however imperfectly: loans, savings accounts, insurance, money transfers. A mother can pay the doctor for treating her daughter by getting an emergency loan from a friend, depleting savings, persuading her brother in the city to send money, or even -- if she is very lucky -- using health insurance. That is why the microcredit movement became the microfinance movement and today supports other services along with loans.

Poor people have less money than the rich, but they aren't dumber; in fact they are generally more resourceful out of necessity. If a woman uses a microloan to buy rice or repair a roof instead of starting a business, I hesitate to second-guess her. People in wealthy countries see fit to buy everything from food to houses on credit. Should we expect the poor to differ?



"Muhammad Yunus Invented Microcredit."

Yes, just as Henry Ford invented the car. Where Ford had the assembly line, Yunus's breakthrough innovation was joint liability, the practice of making small groups of borrowers -- the women of a particular village, for instance -- collectively responsible for each other's loans. The vouching for peers substituted for collateral and produced astonishingly high repayment rates.

Joint liability was not new, however. Proverbs 11:15 warns, "A foolish man hands over his bounty which he pledges for his neighbor as security." A similar concept was also at the core of the credit cooperatives that sprouted across Germany starting in the 1850s, in which groups of poor people would band together, borrow from outside benefactors, and then divvy out the credit among themselves. Around 1900, seeking to quell unrest, the British introduced credit groups into colonial India, which included the territory of modern Bangladesh. In the late 1970s, these already functioning cooperatives inspired Yunus and his students as they built their own microcredit method by trial and error.

Yet the comparison to the carmaker is apt. Truly, Yunus is the Henry Ford of microfinance. Over the course of 28 years, until Bangladesh's prime minster forced him out in 2011 in an act of political spite, Yunus built a bank with thousands of employees delivering useful services to millions of customers. He inspired competition within Bangladesh and imitation beyond, which led to a steady stream of new innovations in the name of serving the poor, including savings accounts and more flexible loans. He was the first leader of the modern microcredit movement to operate in a relatively businesslike way: to mass-produce and charge the poor enough interest to cover most operating costs so that the bank could expand to serve more people.



"Microcredit Empowers Women."

Not so much. The microcredit movement began in the 1970s. In sync with the global movement for gender equality that began at the same time, microcredit has focused mainly on women. Promoters have asserted that the loans "empower" female borrowers. Women who came home with loans, it was said, gained more leverage vis-à-vis their husbands in household decisions about whether to buy food or beer, to invest or consume. Meanwhile, women who had been traditionally confined by their culture to the domestic sphere, as in Bangladesh, found liberation in being able to conduct business in public at the weekly meetings where loan installments were paid. Some nonprofit microfinance programs include classes about such subjects as basic accounting and prenatal nutrition.

But though credit is a source of possibilities, it is also a bond -- potentially an oppressive one when enforced through peer pressure. Indeed, greater sensitivity to social pressure helps explain why microlenders have favored women: In many cases, they have paid back more reliably, putting up less argument than men.

Anthropological studies have found a mix of stories about the link between credit and empowerment. In some cases, women gain increments of liberation, just as hoped. After studying female microcredit users in Bangladesh in the mid-1990s, Syed Hashemi, Sidney Schuler, and Ann Riley concluded in the academic journal World Development that the Grameen Bank had empowered female borrowers on average. They wrote:

Several of the women … told the field investigators that through Grameen Bank they had "learned to talk," and now they were not afraid to talk to outsiders. In both programs some members have the opportunity to play leadership roles. One woman told the researchers, "I have been made the [borrowing group] Chief. Now all of the other women listen to me and give me their attention. Grameen Bank has made me important."

But there are also sad stories. Anthropologist Lamia Karim has documented how in Bangladesh, where most borrowers are female, women who defaulted have had their possessions -- in extreme cases, their houses -- carted off by their jointly liable peers to be sold to repay their loans.

From what I can tell from the fragmentary evidence, the most famous form of microcredit -- group-based credit as pioneered by Grameen -- is the least empowering and most fraught with risk, because of the way it marshals peer pressure to enforce loan repayment. Individual microloans, given one-on-one, without the burdens of weekly group meetings and peer pressure, appear to have less of a dark side. If microbank staff can't outsource loan decisions to the group, though, they must spend more time vetting customers, making the whole enterprise less profitable and less likely to focus on the neediest.



"Microcredit Is Immune to the Irrationalities of Mainstream Finance."

Absolutely not. The hype made it seem like more money for microcredit is always better. But microcredit is actually more prone than conventional credit to overheating and bubbles. It suffers from two vulnerabilities: a general lack of credit bureaus to track the indebtedness of low-income people, which leaves creditors flying blind; and the irrational exuberance about microcredit as a way to help the poor, which has unleashed a flood of capital from well-meaning people and institutions.

Most of this cross-border capital flow -- some $3 billion in 2010 -- has gone straight into microloans rather than business-building activities such as training and computer purchases. The stock of outstanding microdebt has grown 30 percent or more per year in many countries. The pace has proved faster than some lenders and borrowers could safely manage. In Nicaragua, after a nationwide debtor's revolt won backing from President Daniel Ortega, the tide of defaults destroyed one of the largest microcreditors, Banex. In the last five years, bubbles have also inflated and popped in Bosnia-Herzegovina, Morocco, and parts of Pakistan. In the short run, that has been good news for borrowers who took loans and then defaulted. (After all, if the lenders lost a lot of money, that money went somewhere!) But in the long view, damaging the industry reduces access to finance.

Then there is the Indian state of Andhra Pradesh, where, before the overheated market could implode on its own, the state government in 2010 essentially shut down the industry overnight. Visiting shortly afterward, I learned of villages where microcreditors were so plentiful that they were known by the day of the week on which their clients gathered to get loans and make payments. Some women had loans for every day of the week.

The bottom line: Microfinance is no silver bullet for poverty, but it does have things to offer. The strength of the movement is not in reducing poverty or empowering women, but in building dynamic institutions that deliver inherently useful services to millions of poor people. Imagine your life without financial services: no bank account, no insurance, no loans for a house or an education; just cash in your pocket or under your mattress. Poor people transact in smaller denominations, but they have to solve financial problems at least as tough as yours. They need and deserve such services too, just as they do clean water and electricity. The microfinance movement is about building businesses and business-like nonprofits that mass-produce financial services for the poor -- not just microcredit, but microsavings, microinsurance, and micro money transfers too.

The well-meaning flood of money into microcredit distorts the industry toward overreliance on this one, risky service. It is the greatest threat to the greatest strength of microfinance as a whole. That is why the hype about microcredit has been not merely misleading but destructive. And that is why less money should go into microcredit, not more.



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