15 responses to “Does microfinance work?”

  1. milford bateman

    This article is to be commended for highlighting a number of the most pressing issues concerning microfinance today, especially since it is produced by a staff member of one of the international development agencies (UN-DESA) with a major interest in local economic development. With honourable exceptions, the main international development agencies seek to hugely underplay the very significant damage inflicted upon developing and transition economies thanks to microfinance, preferring instead to follow the lead set by the World Bank (especially the Consultative Group to Assist the Poor, CGAP), the IMF and USAID. However, a number of important omissions that generally lead to an over-statement of the importance and impact of microfinance. Permit me to comment at some length.

    First, the counterfactual issue. The true counterfactual to microfinance is actually what a similar intervention or program, using the same resources and targeted at the same people, would have achieved in the local community. For example, if we cared to look, we might find that Conditional Cash Transfers (CCTs) or SME programs help the poor in a local community much better over the longer term compared to microfinance programs that increasingly do no more ‘good’ than simply putting the poor into more microdebt than ever. ‘The poor always pay back’ as the authors of a Muhammad Yunus hagiography famously said. But what they felt quite unable to say was that the poor increasingly repay their microloans by simply taking out more and more microloans to repay the earlier ones! This is why southern India and also Bangladesh too, are becoming dangerously over-supplied with microfinance, and it is why the Grameen Bank itself is, by all accounts, getting into some serious problems.

    Second, we really do have to accept that almost all microfinance impact evaluations to date are seriously flawed, and probably deliberately so, in order to egregiously inflate the impact arising from microfinance. The conventional impact evaluations do this by deliberately ignoring two hugely important downside factors. The first one is ‘job displacement’, which is when a new or expanded microenterprise simply takes business from another microenterprise, which closes or sheds its own staff. This effect generally means little NET additional economic activity in most poor regions is registered thanks to establishing or expanding microenterprises in the very simplest of business areas (trade, petty services, etc). Anyone who, like me, gets annoyed whenever they hear Wal-Mart claiming to have created 400 jobs in a locality when it opens up a new retail store, knowing also that what they very conveniently leave out is the fact that many of the local retailers close down and/or shed jobs as a result of Wal-Mart’s entry, will understand what I’m getting at here. Simply replacing one street vendor or mobile phone time seller or fast food stand with another one operating in the same street or neighbourhood, is a process that creates few jobs or additional income. Moreover, microfinance-induced entry and expansion helps to depress the price of these local non-tradable goods and services. This is not so good if you are one of the non-clients of the microfinance institution. Job displacement, it should be quickly pointed out, also has little economic merit from a Schumpeterian-style ‘transformational’ angle. There is generally little ‘transformational’ about simple job churn involving very simple microenterprises.

    The other key issue of concern here is client failure, which is when a microfinance client fails, which statistics tell us most do after a few years. This is especially the case if they are of the ‘poverty push’ variety, which is what we are talking about when we talk about microfinance, and not the ‘opportunity-pull’ variety, which is the type of entrepreneurship that is more productive. The main impact here is that those desperately seeking an exit from poverty through a simple microenterprise project very often end up in even deeper and irretrievable poverty later on if – or we should say, when – it all goes wrong. To repay their microloan after the business venture fails the poor typically have to sell off personal assets (including land), savings have to be drawn down, relatives are tapped for their support, and other income flows (notably remittances) are diverted into microloan repayment. The poor thus very often end up much worse off than before they accessed their microloans.

    Importantly, the faddish ‘randomised control trials’ (RCT) methodology largely fails to factor in these two huge problems, with the result that they always produce a more positive evaluation of microfinance than is merited by the situation on the ground.

    The section in the article on interest rates is also interesting, but I think it really needed to reflect upon two other important things as well. First, yes, providing a microloan is an expensive business, requiring lots of paperwork, officers on the ground and other things to do with running a program with so many clients. But raising interest rates to cover the full cost of this is not the answer because this directly hurts the poor. As elsewhere, this ‘full cost recovery’ mantra has been thoroughly discredited because it has brought down huge damage upon the poor denied access to health services and education. It needs to be completely demolished here too. But one problem that should have been raised is that, just like any other business (just ask the commercial banks seeking to recover from their antics up to 2008), the poor need low interest rates in order to have a reasonable chance of being successful. With high interest rates you simply cannot realise a little surplus, which you would otherwise hope to reinvest in your microenterprise, or else use to provide a few better things for your family. Yet commercialised microfinance makes a point of demanding that the poor pay the FULL cost of their microloan through high (market-based) interest rates, since profits are needed to provide more microfinance (outreach) to others equally poor. But a very strange moral imperative is at work here: it is essentially asking one very poor stratum of society today to cover the cost of helping out another equally poor stratum tomorrow, or somewhere else. To my mind, such a novel form of horizontal solidarity among the very poorest can hardly be called fair or just, and it certainly does not promote equality within the community: it is actually tantamount to the distribution of poverty among the poor, not its resolution.

    Second, it has long been the case that far too many microfinance institutions get away with claiming that high interest rates are necessary to keep their operation in surplus, when in fact the high interest rates are actually all about underpinning the high salaries and bonuses the senior managers deem they simply must receive be paid. Perhaps the most spectacular case of this what can only be called a scam, is that of Banco Compartamos in Mexico. This institution currently charges around 80% on its microloans (or nearly 129% according to the calculations made by Chuck Waterfield of Microfinance Transparency – see The Challenge of Understanding Pricing of Micro-loans, 15 May 2010). Digging deeper it was found out that over the 1990s the senior managers were quietly paying themselves Wall Street-style salaries and bonuses, plus from 2004 onwards raking off large dividends on their shareholdings too. Then they went for the ‘big one’ – an IPO – which brought absolutely nothing whatsoever for its poor female clients, but, as presumably intended, huge financial windfalls for the senior managers. This tells us everything we need to know about the future of commercialised microfinance and what it is all about. Unfortunately, the Banco Compartamos example now looks like being topped in terms of its sheer greed and naked self-interest by the example of SKS, the largest microfinance institution in India. SKS is also now going through an IPO process, one that has already rewarded the founder, ex-McKinsey consultant Mr Vikram Akula, with more than $12million for 25% of the shares he generously allotted to himself, and a likely further $50 million for the remaining 75%. It is hugely insulting to the poor to claim that these dynamics are ‘all about helping the poor’, and that managers like Mr Akula are getting stratospherically rich purely coincidentally or by accident almost. In fact, this new dynamic represent a new form of what might be called ‘compassionate exploitation’, a process favoured by up-and-coming elites – or ‘accumulation by dispossession’ as social theorist David Harvey has notably called the process.

    Another wider and longer-term problem with microfinance that the article should really have flagged up much more than it did, especially since this is a key concern of UNIDO and some other UN agencies (UNCTAD in particular), is that microfinance clearly helps facilitate the further deindustrialisation and infantilisation of the typical local economy in developing and transition countries. This occurs precisely because microfinance institutions overwhelmingly support only the very tiniest and very simplest of microenterprises – that is, street vending, cross-border shuttle trading, petty services, and some simple production-based activities that add value very quickly. So, to the extent that local savings and remittance income are increasingly channelled into such simple activities via the rapid growth of microfinance institutions, and so channelled away from more sophisticated and scaled-up activities associated with small and medium enterprises, the more the economic structure of that country, region or locality is inevitably going to be undermined and destroyed. This is in fact an ‘Iron Law of Microfinance’, a Law that many international development agencies are now, finally, coming around to accepting exists. For example, just look at the IADB’s flagship publication for 2010, ‘The Age of Productivity, a report that centrally highlights the enormous economic and social damage has been done right across Latin America thanks to the programmed channelling of financial support towards the most unproductive microenterprises and the self-employed. Mexico and Bolivia are given specific mention in this context, both of which, of course, are countries universally noted for being ‘saturated’ with microfinance. Latin America’s poverty and under-development is directly traceable to this adverse financial sector dynamic, the IADB says, and not to a shortfall of foreign investment, privatisation or liberalisation as was hitherto flagged up by the World Bank, IMF and US government.

    One other aspect of microfinance beloved of its supporters and touched upon in this article is the empowerment of women angle. The author of this article goes along with this understanding. But this angle is far more bluff than reality. Most independent researchers report the reverse: women are actually disempowered as they get sucked more and more into the (under)world of microfinance and microdebt peonage. In fact, what microfinance advocates are aiming at is actually to get poor women to accept that the market is the sole avenue for improving their position; just forget the state, trade unions, collective organisations, pressure groups and so on coming to your assistance like in the past. Today, as intended, a women in poverty is increasingly permitted only one avenue to escape poverty – try to make a go of a microenterprise. In other words, and this is hugely important in helping explain microfinance, it is markets that are being empowered here, not women.

    Finally, I disagree with one other aspect of the article regarding the benefits of microfinance. Even where positive improvements are said to exist thanks to microfinance, such as in terms of consumption smoothing, the article should really have pointed out that almost ANY intervention will produce some positive aspects to it. So we can’t use this simple fact to justify microfinance, especially if we don’t point out the downsides too. There is no doubt, for example, that central planning had many positive sides to it for very many poor people, especially in the remote Eastern regions that were all but ignored for many years. But it was nevertheless very widely accepted – both in the former Soviet Union and in the western countries – that central planning was hugely inefficient as a whole, and so needed replacing with a much more dynamic economic structure with more entrepreneurship and private activity. The important point is the cost and benefits, not whether you can detect a small benefit from microfinance. And remember, above all, that a microdebt must still be repaid: it is not a grant. So consumption today must still be matched by decreased consumption or investment later. There is also the high interest rate aspect to take on board: with high interest rates, the poor end up repaying a lot of their meagre incomes out as interest payments on their growing bundles of microloans. This is for sure not the way to poverty reduction, but to microdebt peonage. Unfortunately, shifting the goalposts like this is becoming increasingly common – financial inclusion is the new goal of microfinance, not poverty reduction – but this ‘goal rotation’ should not be accepted by those concerned with wanting to find real solutions to poverty, rather than imagined ones.

    In the light of no real economic or social justification for microfinance, it is good to see, finally, that this article correctly flags up that there is a political/ideological justification for microfinance. It cannot be stressed too much how the political and ideological imperatives of the neoliberal-oriented development institutions, principally USAID, the World Bank and the IMF, have stood four-square behind the global push for microfinance. Now that, in the wake of the collapse of Lehmann Brothers in late 2008, neoliberal policies are effectively dead, we await to see if the political/ideological impetus to continue with microfinance will also die. So far, there is considerable evidence to show that as more of the problems precipitated by microfinance are exposed, microfinance as an anti- poverty tool is rapidly declining in value within the eyes of the main international development agencies (e.g., in the IADB). But whether microfinance goes very soon to the graveyard of failed neoliberal policies, or remains in operation zombie-like for a few more years, still remains to be seen.

    Milford Bateman
    Author of ‘Why Doesn’t Microfinance Work? The Destructive Rise of Local Neoliberalism’

  2. Anis Chowdhury

    I take most of the comments on my article as complementary. Some of the concerns raised in the comments are in fact mentioned in the longer version of the article, published as a DESA working paper (no. 89). Where we differ is on some likely positive impacts. While Bateman is totally dismissive, I am willing to accept that there might be some positives, and one of them is learning by doing.

    I have no disagreement about problems of counter-factuals and randomised control trials. However, despite limitations, as most other methodologies, most of the studies using the technique came out with sceptical conclusions. I agree with the possibility of a debt trap, i.e. micro borrowers paying one loan with another – it’s like having multiple credit cards.

    Second, the concern about job displacement and client failure is also quite valid and I also raised this, especially in the context of a stagnant or slow growing economy. I did emphasise that overall macroeconomic condition must be robust for microenterprises to succeed. Otherwise, there is a real possibility of falling into a debt trap.

    The comment on interest rates and full cost recovery is quite extended. The longer version of my paper relates to exploitation of labour surplus. Obviously, the surplus is captured by the CEOs and other employees in the form of high salaries and other benefits. The examples cited in the commentary strengthens my argument.

    The issue of de-industrialisation is interesting, and was not captured fully in my article. However, the discussion on the problems of microenterprises and on the importance of developmental-oriented macro and industrial policies does cover the issue to some extent.

    I agree that micro credit is an inefficient way of providing social security. In the absence of a comprehensive universal social security system, micro credit is a second best solution for consumption smoothing, and it has some beneficial effects if consumption smoothing means keeping the children at school or seeking medical help at time of economic distress.

  3. Paul Hesp, Vienna

    I cannot claim to have any expertise in the matter of micro-finance apart from receiving pocket money (grants, not loans) from my dad many decades ago. But the discussion above did make me think a bit. To me, the key elements of the discussion were:

    – Micro credit can help to create a better social environment for development, though it may result in the same debt trap as informal lending
    – It is of doubtful value in making the leap from self-supporting to (technologically) innovative, dynamic enterprise
    – To make the best of it, you need an overall social and political environment that is conducive to broad-based development
    – Micro-credit bankers are not necessarily morally superior to other bankers

    The latter would bring me to the need to give policy its rightful place again; the free-for-all ideology of the past decades has predictably done a lot of socio-economic and environmental damage. But here I’d like to concentrate on # 3, which I think is a key point. The savings and “farmers loan” banks that emerged in Western Europe in the 19th century catered for people whose position in society was often not much better than that of the poor in many developing countries. These banks came to play a very important role in the economy, and for the less well-off in particular. As most countries were properly governed and the feudal system had received a death blow, some major barriers to participation in development for those at the lower end of society had disappeared (even though it would be some time before everyone accepted that farmers’ and workers’ associations were not a threat to society). Quite rightly, UN projects now insist that the social and gender aspects of development are taken seriously – but it’ll be some time before everyone understands that…A very difficult issue that very often remains, however, is good governance, which must ensure that those who have been given a ‘leg up’ by a development project will find no other obstacles to their progress in society.

  4. Michele Clara

    On a related issue, I would suggest a look at the (admittedly partisan) post by Milford Bateman on ODI’s blog (http://blogs.odi.org.uk/blogs/main/archive/2010/08/17/microfinance_SKS.aspx) entitled “Commercialised microfinance: a Wall Street-style calamity for the poor?”

    It reminded me of earlier work I did on the link between SME cluster development and micro-finance where I first stumbled across the notion of micro-debit as the “dark side” of microfinance: is it so absurd to imagine future debates on micro-subprimes? Admittedly the interest rates charged are likely to offer more room for security. Having worked in close proximity to several MFI in Asia, I often wondered how safe their entire portfolio could be, in view of very aggressive marketing , especially in rural villages where the scope for productive investment was fairly low

  5. Will

    Poverty ends thanks to education. Dollars don’t reduce poverty.

  6. dan lundmark

    It’s great to see the discussion here. My input is straightforward: I’ve seen microfinance first-hand in Mexico, Ecuador, Chile, and Bolivia and I have observed the savings as microfinance itself was a ‘counterfactual’ to the status-quo higher-interest moneylenders. Should the poor have some level access to credit as the middle-class and affluent do? Of course! This access allows people to achieve more than they could with their own resources: credit is a social service. And just as the middle-class and affluent should not be burdened by debts/mortgage foreclosures/credit card traps, the poor also should not be burdened by microdebt. Access to financial services (for the affluent and the poor) must be paired with financial responsibility and fair/ethical lending practices.

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  9. Charles
  10. Charles

    Does Microfinance Reduce Poverty? An Analysis of India’s Crisis

    Arvind Panagariya, Nonresident Senior Fellow, Global Economy and Development, The Brookings Institution

  11. Charles Arthur
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