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Microcredit: The Dead End Debate Continues
Robert Katz, 8 Mar 07

An interesting debate about the efficacy of microfinance has been going on lately, pitting development experts and economists against one another as they seek to understand the impact of microfinance on economic growth and well-being.

The whole thing started with an op-ed in the Wall Street Journal. In it, Amar Bhide and Carl Schramm argue that microenterprise, fueled by microfinance, is less good than a "transformative entrepreneurship" enabled by policy reform. Their basic point is that everyone is not cut out to be an entrepreneur, and that simple access to finance is not enough - people need jobs, and to create jobs countries need better business environments.

(My opinion on this argument is mixed. To be sure, not everyone is cut out to be an entrepreneur; many microenterprises are economic decisions of last resort. By last resort, I mean that there are no jobs or economic alternatives to selling vegetables by the side of the road, for example, even if it is a highly competitive local market with low margins and little prospect for growth. On the other hand, "policy reforms" are easier said than done, and even with the "right" policies in place, who is to say that the economy will magically transform? You still need a bottom-up, SME-driven economic development to create the kind of employment than Bhide and Schramm envision. And for SMEs to develop, you need finance...often starting with microfinance.)

Here's where the debate gets more interesting. Following on the WSJ op-ed, Thomas Dichter (of Despite Good Intentions fame and previously featured here on WorldChanging) recently published a new essay through the Cato Institute. A Second Look at Microfinance argues that the democratization of credit will not affect economic growth or drive business development. Based on a mix of economic history and field experience, Dichter argues that development creates jobs, "which in turn makes the working poor an attractive target for financial services." Indeed, he seems to think that financial services are used by the poor almost exclusively for consumption smoothing and not for business investment; the poor would rather turn to informal networks to fund their enterprises.

Reaction to Dichter's piece has been muted, but one very credible critic has posted a response: Gil Crawford, CEO of MicroVest. Gil is an economic historian and development expert in his own right; he also founded and runs a for-profit microfinance investment fund based in Bethesda, Maryland. His response is posted to the MicroVest site; in it, he accuses Dichter of focusing too closely on donor-driven microcredit and not talking about the growing world of for-profit microfinance. Crawford systematically deconstructs Dichter's arguments over the course of a 1-page letter - worth a read.

Where do I fall in this debate? I'd say somewhere in the middle. Clearly, not enough small- and medium-sized enterprises are being created, and there is a definite lack of financing mechanisms to enable those stuck in the "missing middle" or "mesofinance gap" between microfinance and formal finance. Investments between $10,000 and $1,000,000 are needed, but MFIs have not shown much willingness to make them (as yet) and commercial financiers can't make the kind of returns they need to justify the risk and diligence costs. That's why the Acumen Fund and New Ventures and Endeavor and Technoserve and Aavishkaar are around - to try and fill the gap.

But why not enable MFIs to do it themselves? If, as Crawford argues, MFIs are making profitable small business loans as part of their portfolios, why aren't there more good jobs being created? Going back to the original WSJ article, where is the creative destruction? It could be too early - microfinance is just now making the transition away from donor-funded models to commercially-financed work, which gives MFIs better incentives to seek out, mentor, and invest in promising entrepreneurs from within their own portfolios. It's still not happening...and until it does, the debate will go on.

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nice article rob

Posted by: Chaz Littlejohn on 8 Mar 07

here's an openly available copy of the wsj article.

i'm shocked that this article doesn't mention public finance or public sector development at all. it's almost like all human life exists to entertain bankers. the way the wsj article talks about vietnam you'd never guess they were socialist. (or that the answer to illiteracy isn't "lower import tariffs," as they imply. or maybe it is! what do i know!)

is this why the debate "goes on"? whole economic factors are just being discarded, and big and small lenders are fighting over who gets credit for the now-miraculous results of publicly-controlled investment?

i see where it looks like microloans and credit cards are too close to tell apart. i don't think anyone can sensibly argue that a large group of people can lift itself without solid social, political, economic, and legal infrastructure. certain costs have to be shared in order to make many beneficial activities cost-effective. but it's more interesting to me whether it is the money that's important or the group support structure the lending process creates. whether you can weave a democratic finance model from a series of family-sized pieces of cloth.

Posted by: hibiscus on 8 Mar 07

- Everybody is a banker? (let’s have a break!), Alternative Finance, October 2003
- Microfinance in Africa: re--thinking the role of the actors, Microfinance Gateway, January 2007
Is microfinance the right tool to unlock the potential of the poor in Africa?

This paper presents the trends in African Microfinance movement and the future course of action. The paper recommends:
• Classifying MFIs by objectives to understand the trends.
• Offering more diversified services and addressing diverse segments.
• Realigning the roles of major actors to achieve the task of moving from a focus on “outreach? to “sustainability?.

Based on the new orientations aiming at enhancing access to the financial services, the author streamlines interventions at three levels - macro, meso and micro, and recommends the following interventions at various levels:

Macro level:
• Development of regulatory and supervision framework,
• Credit policies for more conducive environment and lesser government involvement,
• Integration of microfinance into mainstream financial market,
• Land reforms and property rights,
• Markets liberalization and sector’s analysis.

Meso level:
• Partnership between banks and MFIs,
• Capacity building and institutional strengthening,
• Guarantee schemes,
• Credit bureaux,
• Capacity building and institutional strengthening.

Micro level:
• Management best practice for increasing productivity,
• Information technology,
• Guarantee schemes to back up micro borrowing,
• Strategic management, business planning and capital restructuring,
• Product innovations,
• Reporting and auditing for transparency.

Posted by: Ascanio Graziosi on 9 Mar 07


Thanks for offering the free article URL. In your comment, you wonder whether the money or the group support structure is more important. I would argue that it's a little of both (maybe it's a cop-out for me to take the middle road, but bear with me).

First of all, microfinance is evolving rapidly. The self-help group model and social collateral still exist, but many microfinance institutions have become more like "real" banks, and operate with minimal group models. What I think microfinance institutions add to the mix is access to ever-broader types of services (savings, loans, insurance, mortgages, etc) as well as larger loans to growing businesses.

As microfinance clients return to their institutions repeatedly for larger and larger loans, the MFI continues to make money. And it starts to understand how profitable that piece of its portfolio can be - 1 client taking out a $5,000 loan at 35% is pretty lucrative versus 100 clients taking out $50 loans at 40% (lower overhead). In the process, the client learns more about how to run a business (if he/she doesn't, they default.) That's what I would call a win-win, and a middle ground.

Posted by: Rob on 9 Mar 07

Very good article and a very interesting debate.
I've blogged about it on our website:

Prof. Muhammad Yunus, Winner of Nobel Peace Prize 2006 and founder of Grameen Bank, Bangladesch is an outrider of microfinance.
He is one of the speakers of this years
Trend Day "Karma Capitalism", 06/05 Hamburg

Posted by: Philip Brandecker on 9 Mar 07



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