The intellectual battlefield of development is littered with magic bullets. New ideas or technologies such as the internet or mobile phones are picked up, promoted as panaceas that will end poverty and transform societies, and then rapidly cut down to size by scrutiny and research. That process seems to be well under way on microfinance.
As it happens, I’m in Bangladesh at the moment, where microfinance, spearheaded by the Grameen Bank , began its meteoric rise. It has been picked up and supported by the World Bank, the UN and increasingly, the private sector and reaching over 100m borrowers by 2004. Microfinance’s rise culminated with the award of the Nobel Peace Prize to Grameen’s founder, Muhammad Yunus, in 2006.
Cue backlash. The critique has come from several angles. Firstly the evidence. The ‘success’ of MF has largely been judged on the success of the business model (i.e. do people repay their loans?), but does it actually reduce poverty? Two recent papers raise serious doubts, using ‘randomized control trials’ (RCTs) (themselves rapidly becoming a methodological magic bullet). These try and get round some thorny problems neatly summarized by the Economist:
‘Measuring the impact of microcredit is complicated by the fact that the counterfactual—what would have happened to a person who borrowed from a microlender if he had not done so—cannot easily be tested. Many early studies compared borrowers with non-borrowers. But if borrowers are in any case more entrepreneurial than those who do not borrow, such comparisons are likely to overstate hugely the effect of microcredit.’
RCTs, as the name implies, get over this by comparing a randomly selected sample of communities that do receive MF with another group that do not – if the randomisation is robust, any differences between them should be down to the presence (or absence of microfinance).
The results are striking. At least over the initial 18 months, two large RCTs in India and the Philippines found that MF did not reduce poverty.
‘Half of 104 slums in Hyderabad, India were randomly selected for opening of an MFI branch while the remainder were not. We show that the intervention increased total MFI borrowing, and study the effects on the creation and the profitability of small businesses, investment, and consumption. 15 to 18 months after the program, there was no effect of access to microcredit on average monthly expenditure per capita, but durable expenditure did increase…. We find no impact on health, education, or women’s decision-making.’
MF did have some impact though: pre-existing businesses used it to invest; would be entrepreneurs invested it and then cut back on ‘temptation goods’ like alcohol in order to keep up repayments. Others simply spent their windfalls on food and other consumption goods.
The study concludes: ‘at least in the short-term (within 15-18 months), microcredit does not appear to be a recipe for changing education, health, or women’s decision-making. Microcredit therefore may not be the ‘miracle’ that is sometimes claimed on its behalf, but it does allow households to borrow, invest, and create and expand businesses.’
All this confirms the arguments in a much more comprehensive attack in ‘The Microfinance Illusion’, a draft paper by Milford Bateman and Ha-Joon Chang. The paper starts off by pointing out that no successful national development stories to date have included a role for microfinance – I think it’s a pretty good rule of thumb that if what you are proposing has never worked at a national scale, you should step up your scepticism levels.
Bateman and Chang also make the point that MF is not ideologically neutral. In fact, MF is rather like the promotion of private individual property rights by Hernando de Soto and others – ‘by emphasising individual entrepreneurship over all other forms (state, cooperative, etc), the microfinance concept has strong political/ideological serviceability to the prevailing neoliberal/globalisation model.’
So much for the broad brush. Among Bateman and Chang’s more detailed criticisms are:
1. Microfinance ignores the crucial role of scale economies. It is ‘crucially important to invest in small enterprise units (including in agriculture) that can rapidly achieve a minimum efficient scale of operations.’ Instead, MF produces ‘an over-supply of inefficient microenterprises that undermines the development of more efficient small and medium enterprises (SMEs)’. This is a key point – economic dynamism often springs from supporting SME that can grow – MF diverts credit and support from these to much smaller businesses, often in retail rather than manufacturing, which merely flood the cities with tailors and streetsellers.
2. Microfinance ignores the ‘fallacy of composition’. Supporting one streetseller to buy larger quantities of stock at lower prices may make sense for that individual, but if everyone does it, the market becomes saturated and retail prices (and incomes) are driven down. La Paz, Bolivia, where I once calculated that there was one street seller for every 3 families in the city, does not need more vendors.
3. The entry of more commercial MF providers has driven up interest rates – at some point, as in George Orwell’s Animal Farm, the MF providers and the loan sharks start to look indistinguishable. Moreover, commercial providers are often keener to encourage borrowing than saving, even though poor people often want a safe and accessible place to save small amounts, rather than get into debt through microcredit. MF risks encouraging a debt rather than a savings culture.
What do Bateman and Chang suggest as alternatives? Well, how about financial and credit cooperatives, community and state development banks or subsidised SME loan and credit programmes. They’ve all worked in the past, but have fallen into disfavour in recent years. Hopefully they can be rehabilitated, now that the market fundamentalism of recent decades is looking so threadbare.
It’s all pretty healthy, really. Development is a messy business. On closer inspection simple solutions are often neither simple, nor a complete solution. Time to work out what MF can and can’t deliver and add it to the repertoire.
And the scepticism has even spread to Bangladesh. Yesterday I met the President of the Bangladesh Economic Association, QK Ahmad, whose own survey of 2,500 borrowers (99% of them women) concluded that microfinance had been grossly oversold. ‘They take out credit, and give it back. That’s all they do’ he said. His book, snappily titled ‘Socio-Economic and Indebtedness-Related Impact of Micro-Credit in Bangladesh’ criticised the ‘severe limitations of such a simplistic approach to poverty alleviation’ which ignored crucial issues such as ‘existing power relations in society.’ Couldn’t agree more.