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Microlending: Panacea or Patchwork?

Chris Kaiser | Monday October 19th, 2009 | 5 Comments

 

Microlending has been hailed as the panacea of poverty.  They theory is simple:  lend the poor a small amount of money so they can start/grow their business, charge tiny interest rates (microcredit), then once business starts booming, the borrowers can easily pay the loan.  Woosh! Just like that, poverty disappears.  Or does it?

The Boston Globe recently had a story on microlending and two new research papers soon-to-be published by economists affiliated with MIT’s Jameel Poverty Action lab reveal that microcredit really doesn’t do all that much to provide a path out of poverty.  Is microlending a patchwork solution that just temporarily solves the ills of the poor?  Could it be that while microcredit can be an effective medicine against poverty, that it may just be treating the symptoms and not the disease?

Gasp!

The papers find that microcredit does indeed help a few of the more entrepreneurial poor grow their businesses, but that many microcredit customers spend their money on household items rather than on their fledgling business.  The papers also studied the impacts of microloans on empowering women, but they found that if there is any gender that benefits most from microcredit, it is male entrepreneurs with existing businesses.

From the article:

Neither household income nor spending rose for those who got microloans. And borrowers who did put the money into their businesses – instead of using it, as many did, for household expenses – actually shrank rather than grew their businesses. Karlan and Zinman suggest that this might be because the business owners were taking advantage of the loan to fire unproductive workers to whom they owed financial favors, and those firings seemed to explain the very small gains in profit Karlan and Zinman found. In addition, the gains accrued only to male entrepreneurs, not the women usually targeted by microcredit programs.

In regards to some of the findings the two papers uncover, Esther Duflo, an economics professor at MIT had the following to say:

I don’t see this as a negative finding,” she says. When asked why she thinks microcredit didn’t boost health and education outcomes, she says, “I would really ask the question, ‘Why did we expect all these things to happen?’ If you give people access to a financial instrument, it’s like any other instrument. It’s useful, but it’s not like the miracle drug to end poverty.

Is it possible that the rush by financial institutions, NGOs, and others into financing the climb up from poverty may end up in a bursting bubble?  And if there is indeed a bubble, and microloans end up going unpaid, can those of us in the developed world – who have just lived through two bubbles in the last 10 years – honestly say that we are surprised?

Are are we really surprised that those who lack access to a basic education and lack business fundamentals may not be able to pay back loans?  Apparently our “geniuses” who work on Wall Street can even figure out how to do that!

What is most surprising to me in the talk of microcredit is not what a wonderful idea it is in helping the poor, but how it only attempts to scratch the surface.  What microlending doesn’t do is ask the question: Why are all these people poor to begin with? Is it because they just haven’t had some banker approach them with low interest rates?  Or could it be that they lack access to a solid education, the basic life necessities (food, clean water, energy) needed to focus on their dreams, and the freedom to achieve those dreams.

While I’m not attacking the concept of microlending, because at its core it is a wonderful tool that can be utilized to help the poor, but it is only that:  a tool.  It is only a component that needs to be present in the machine – and it might be a major component – but a machine needs many components in order to work.

Instead of just analyzing if microcredit works, why don’t we also ask how we can we make it work better.  Why don’t we look at the quality of education in the places where microcredit is heavily utilized? And how freely are people in those areas able to pursue their businesses? Do they have access to food, water, healthcare?  Just focusing on easy money is like simply giving a hungry man a fish.

The Western world did not become wealthy due to low interest rates.  We did it through scientific innovation, a society that gives us the freedom seek out new ideas, and leaders willing to bridge the gaps.  We did it through our education system that turned out engineers who knew how to solve problems and business people who knew how to write an actual business plan.  We did it on the backs of industrial giants who created businesses and hired thousands of employees.  And we did it in a society that protected intellectual property and encouraged innovation.

When Greg Mortenson, co-author of “Three Cups of Tea” and co-founder of Central Asia Institute, first decided to make an impact in one of the poorest places on earth in northern Pakistan, he didn’t go to villages with a backpack full of cash and begin making loans.  He decided to build schools.

Microlending is a great resource for the world’s impoverished.  But in order to make a just and lasting change, the world’s poor will also need education, freedom, and men and women who are visionaries and leaders.  At some point those interested in helping have to stop asking, “How can we give more money to the poor?” And start asking: “How can we ensure the poor will have the tools they need to grow their money once they receive it?”


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  • Meggan

    Good point. I think that people maybe just wanted to say “we’re giving money to poor entrepreneurs –great, we’ve solved it!” and leave it at that. And the funny thing is that most people didn’t think of the whole “machine” aspect. I wonder how many lenders even thought about sending a business aid over to serve as a guide or anything like that. It’ll be interesting to see if lending actually continues after this or if these findings will be used as a scapegoat to abandon the project or if they (hopefully) make some needed changes.

  • Bill S.

    Ahhh, the ever elusive search for THE silver bullet. Did people really think that microcredit would solve all of the worlds problems? It’s a great tool for a specific purpose – help an entrepreneur start or expand a business. But that’s about all.

    I’ve been an active lender on Kiva for a few years now and limit my loans to entrepreneurs (There are also people looking for personal loans). Meggan’s idea of having business aides also is an excellent idea. Some of the Kiva field agents can serve that function, but I don’t think it’s in their formal function.

  • Taj

    The Boston Globe story essentially says Microlending is more hype than help. In many ways, Chris’s reaction piece accepts the premise and re-asserts the always welcome, but somewhat tired trinity of providing education, health care, and freedom. An alternative perspective might be to simply view microfinance as a financial resource for underserved populations, populations that traditional commercial banks avoid. It is a resource that we take so much for granted here in the developed world, that we can ask questions like “is microfinance The Silver Bullet?” Instead ask yourself: does my credit card keep me healthy? Does my savings account make me more educated? Will my business loan lift me out of my current socio-economic class? I answer no to all of these questions. However, access to credit, savings, and loans is part of what defines me as a middle class American. Microfinance is nothing more, nothing less, than a financial resource that addresses a market failure that currently leaves billions of people unbanked.

    For anyone interested, I highly recommend The Economics of Microfinance by Beatriz Armendariz and Jonathan Morduch.

    p.s. small nit-pick for Chris – mircofinance does not necessarily offer lower interest rates. Check out FAQ #6 at Kiva.org – Why are microcredit interest rates so high?

  • Fred

    Since learning about microlending practices, it always seemed to me that websites that endorse such activities hype it as more than it truly is. Kudos to the author for an informative article on this practice.

  • JessieB

    I used to live in Kenya, and I did a research project on microfinance in a rural town there that came to essentially the same conclusions as MIT (without being statistically valid, of course). Among 12 female entrepreneurs in various sectors, none of them used their microloans from a local MFI for their business. Immediate needs were just too great: school fees (in a country where school is supposedly free), food, health care, you name it. This is not to say that microfinance can’t work, but as others have pointed out, it’s not a one-size-fits-all solution.

    But there’s more. Kaiser makes some excellent points, but like almost everyone else talking about the issue, he implicitly casts “the poor” as helpless individuals who need developed countries to “help ensure they have tools” to get out of poverty. Actually, what we need to do is stop imposing our own view of what works on societies totally unlike our own. Yes, individual freedom is important; yes, meeting basic needs is important. But we shouldn’t determine how countries achieve those ends for their citizens any more than we should give handouts. We can *partner* with countries, organizations, and peoples, but the aid model we have right now is too much like condescending “charity” to be successful long-term.