Has the microfinance bubble really burst? Guest blog by Milford Bateman
Microfinance used to be untouchable – the developmental equivalent of motherhood, apple pie or Mother Teresa. Now it is increasingly coming under fire. Today guest blogger Milford Bateman lays out the case for the prosecution. Responses by Malcolm Harper and Thankom Arun to follow. Or you could just listen to this Guardian podcast with Ha-Joon Chang, David Roodman and Ajaz Khan.
“The development industry has recently been transfixed by the battle being fought by Dr Muhammad Yunus to remain in charge of the institution he founded in 1983, the Grameen Bank. Yunus was relieved of his position as head of Grameen Bank last month, though yet another appeal has been mooted. Given Yunus’s iconic status as Nobel Peace Prize-winning global anti-poverty campaigner, this story not surprisingly generated headlines around the world. But of far more long-term importance is the accompanying critical scrutiny of the previously unchallenged ‘success’ of microfinance itself.
This is something new. Mainstream media everywhere these past few years have begun asking awkward questions about microfinance (more accurately ‘microcredit’), among them: How come microfinance-dominated Bangladesh remains in deep poverty compared to the rest of rapidly growing East Asia? Why is it that Jobra village in Bangladesh, where Muhammad Yunus effectively started the entire microfinance movement more than thirty years ago, is not only still mired in deep poverty and deprivation, but also has a new social problem in the shape of serious individual over-indebtedness? With so many countries having achieved microfinance ‘saturation’ this last decade or so (notably Bolivia, Bosnia, Mexico, Peru, Cambodia and others), why is it that in none of these countries can we see obvious substantive poverty reduction and ‘bottom-up’ development gains? And, more recently, how could the microfinance industry in the Indian state of Andhra Pradesh precipitate such an explosively damaging wave of individual over-indebtedness, social distress and economic disruption?
The first place to start looking is among the very many impact evaluations undertaken by the microfinance industry and its supporters. Most of the early impact evaluations were undertaken or sponsored by the very same microfinance institutions and microfinance promotional institutions (notably the US-based Grameen Foundation, ACCION and Opportunity) that were trying to convince the world of the magic bullet virtues of microfinance. Since then, however, most independent and rigorous evaluations have been unable to show any concrete evidence that microfinance has had a meaningful positive impact. After decades of huge funding and policy attention, for economic policy-makers and poverty specialists everywhere this is naturally a very worrying outcome.
The first specific issue I raise in my Background Note is one that is typically over-looked, but which seriously undermines the original argument for microfinance, namely that it promotes poverty reduction and development through income-generating activities. In fact, major microfinance figures, notably FINCA’s John Hatch, have openly admitted that up to 90% of microfinance is actually used for consumption rather than income generation. If we then factor in the high interest rates that typically prevail in most microfinance programs (because of high transactions costs and, increasingly, because of profiteering by those owning and/or in control of a microfinance institution) it becomes clear why many now refer to microfinance as ‘loan sharking-lite’. In response, microfinance supporters have shifted their argument, stressing its ability to smooth consumption, (notably the authors of the book ‘Portfolios of the Poor’). But such arguments largely ignore the growing percentage of poor households’ weekly budget that is being allocated to a new budget category – ‘microloan interest payments’.
We find more bad news when we look at that small amount of microfinance that, as per the original Grameen Bank model, actually does go into supporting income-generating activities through microenterprise development. Previously identifiable positive impacts are, in fact, swamped by two largely ignored factors operating at the local level.
First, local economies in developing countries don’t just elastically expand in order to automatically accommodate the legions of new microfinance-induced arrivals and expansions. With no additional local demand, pre-existing microenterprises will suffer by losing their existing customers (and these individuals are often just as poor as those requiring microfinance). What we are seeing here is the ‘fallacy of composition’ – the microfinance industry is wrongly assuming that the marginal benefit registered by one supported unit (by one microenterprise making, say, baskets) will remain true for the whole community of microenterprises (everyone making baskets).
Second, negative impacts also arise from microenterprise failure. Just as in the developed economies, many microenterprises quickly fail after just a short period of operation. The importance of this event is not just that any possible poverty and development impetus is lost, but that it all too often plunges the poor clients into irretrievable poverty and deprivation through the loss of other assets. Importantly, as one book famously noted in its title ‘The Poor Always Pay Back’ (Dowla and Barua, 2006) – many poor clients feel honour-bound to repay their microloan, even though they now have no income flow with which to do so. That typically means that they have to liquidate a whole range of other assets, such as savings accounts, buildings and land, and divert remittance incomes flows into loan repayments. The microloan is eventually repaid, but the poor become poorer. As we have seen in Andhra Pradesh state in India, others simply continue taking out microloans from other microfinance institutions in order to repay their earlier microloans, leading to spiralling individual debts and an even greater personal/family crisis when they can repay no more.
Finally, the microfinance industry makes a fatal mistake in believing that sustainable poverty reduction and ‘bottom-up’ development actually lies within the gift of the informal microenterprise sector in the first place. Much of the impetus for this thinking has come from Peruvian economist Hernando de Soto (The Other Path; The Mystery of Capital), and more recently from the late CK Prahalad (The Fortune at the Bottom of the Pyramid). However, as with the earlier ideas promoted by Yunus, both de Soto and Prahalad appear to have misunderstood the nature of the growth and poverty reduction processes in the typical local economy. In Latin America, for instance, rising poverty and the expansion of the informal sector pretty much went hand in hand from the 1970s through to the early 2000s, a juxtaposition that clearly undermined De Soto’s very well received predictions made in the late 1980s that if microenterprises could massively proliferate (say, through liberalisation and getting rid of rules and regulations), then poverty would soon become a thing of the past. As Mike Davis notes, the displacement issue raised above meant that in Latin America average incomes in poor communities typically fell as more and more informal microenterprises were encouraged into competition with each other.
The Inter-American Development Bank (IDB) provided high-level confirmation of this seriously debilitating trend in its 2010 flagship report ‘The Age of Productivity’, arguing that Latin America’s high levels of poverty arose because far too much of its scarce financial resources were channelled into microenterprises and self-employment, and so not into small and medium businesses that are far more productive. De Soto’s ideas on microenterprises would now appear to be dead in the water. Similarly, Karnani found that hardly any of Prahalad’s signature ideas (actually, case studies) held up in practise.
Dambisa Moyo’s best-selling book ‘Dead Aid’ provides possibly the most vivid example of flawed logic linking microfinance, microenterprises and sustainable development. Referring to her native Zambia, Moyo argues (page 129) that the flow of microfinance in Zambia urgently needs to be increased in order to help out what she calls ‘the real entrepreneurs, the backbone of Zambia’s economic future’. What she actually means by this ‘backbone of Zambia’s economic future’, however, is made clear when she says you need to ’Think of a women selling tomatoes on a side street’. Her argument, in a nutshell, is that rapidly increasing the supply of female tomato sellers and similar petty activities will somehow underpin a sustainable development and poverty reduction trajectory. This is a staggering misunderstanding of what lies behind development and growth.
Ha-Joon Chang in his most recent book ’23 Things they don’t tell you about Capitalism’, argues that the problem in developing countries is not a shortage of micro-entrepreneurs at all: Africa, for example, has proportionally far more entrepreneurs than the developed countries. The development problem here is actually that the vast majority of existing entrepreneurs are forced to operate outside of the institutional and organizational structures required to raise the productivity of their efforts and upgrade their businesses. The western economies in their past climb to economic power, as well as the East Asian ‘miracle’ economies more recently, were able to build collective structures and sophisticated organisational options (large business and industrial organisations, local supply chains, subcontracting networks, industrial clusters, etc). Without these mainly state interventions, including a ‘developmental state’ operating at all levels (national, regional, local/village), the massive proliferation of individual entrepreneurship in developing countries actually becomes part of the problem, according to Chang, and not the solution.
In short, then, a carefully balanced reading of the evidence shows the microfinance model to be a much less positive intervention than has been widely claimed. It might even constitute a new form of ‘poverty trap’. Recently, a number of alternative interventions using the same resources and targeted at the same people have quietly begun to take the place of microfinance. Indeed, the recent proliferation of these alternatives – from cash grants to micro-savings to public employment programs and to a renewed interest in the ‘missing middle’ of SMEs which must now be filled more pro-actively – indicates that the international development community has finally begun to appreciate the serious problems surrounding the microfinance model.
Milford Bateman is a Research Fellow at the Overseas Development Institute and, since 2005, Visiting Professor of Economics at the University of Juraj Dobrila Pula, Croatia. He is the author of ‘Why Doesn’t Microfinance Work? The Destructive Rise of Local Neoliberalism’
And here’s Al Jazeera’s take on the Andhra Pradesh story