By the mid 2000s, the popularity of microfinance reached fever pitch. The year 2005 was designated the International Year of Microcredit by the United Nations, with endorsements from royalty, like Queen Rania of Jordan, and celebrities, like the actresses Natalie Portman and Aishwarya Rai. The ascendancy of microfinance reached its peak in 2006, when the Nobel Peace Prize was awarded jointly to Professor Yunus and his Grameen Bank.
Unfortunately, the hype about microfinance is, well, just that – hype. There are growing criticisms of microfinance, even by some of its early ‘priests’. For example, in a recent paper with David Roodman, Jonathan Morduch, a long-time advocate of microfinance, confesses that ‘[s]trikingly, 30 years into the microfinance movement we have little solid evidence that it improves the lives of clients in measurable ways’.[2] The problems are too numerous even to list here; anyone who is interested can read the fascinating recent book by Milford Bateman, Why Doesn’t Microfinance Work?[3] But those most relevant to our discussion are as follows.
The microfinance industry has always boasted that its operations remain profitable without government subsidies or contributions from international donors, except perhaps in the initial teething phase. Some have used this as evidence that the poor are as good at playing the market as anyone else, if you will just let them. However, it turns out that, without subsidies from governments or international donors, microfinance institutions have to charge, and have been charging, near-usurious rates. It has been revealed that the Grameen Bank could initially charge reasonable interest rates only because of the (hushed-up) subsidies it was getting from the Bangladeshi government and international donors. If they are not subsidized, microfinance institutions have to charge interest rates of typically 40–50 per cent for their loans, with rates as high as 80–100 per cent in countries such as Mexico. When, in the late 1990s, it came under pressure to give up the subsidies, the Grameen Bank had to relaunch itself (in 2001) and start charging interest rates of 40–50 per cent.
With interest rates running up to 100 per cent, few businesses can make the necessary profits to repay the loans, so most of the loans made by microfinance institutions (in some cases as high as 90 per cent) have been used for the purpose of ‘consumption smoothing’ – people taking out loans to pay for their daughter’s wedding or to make up for a temporary fall in income due to the illness of a working family member. In other words, the vast bulk of microcredit is notused to fuel entrepreneurship by the poor, the alleged goal of the exercise, but to finance consumption.
More importantly, even the small portion of microcredit that goes into business activities is not pulling people out of poverty. At first, this sounds inexplicable. Those poor people who take out microcredit know what they are doing. Unlike their counterparts in rich countries, most of them have run businesses of one kind or another. Their business wits are sharpened to the limit by their desperation to survive and sheer desire to get out of poverty. They have to generate very high profits because they have to pay the market rate of interest. So what is going wrong? Why are all these people – highly motivated, in possession of relevant skills and strongly pressured by the market – making huge efforts with their business ventures, producing such meagre results?
When a microfinance institution first starts its operation in a locality, the first posse of its clients may see their income rising – sometimes quite dramatically. For example, when in 1997 the Grameen Bank teamed up with Telenor, the Norwegian phone company, and gave out microloans to women to buy a mobile phone and rent it out to their villagers, these ‘telephone ladies’ made handsome profits – $750–$1,200 in a country whose annual average per capita income was around $300. However, over time, the businesses financed by microcredit become crowded and their earnings fall. To go back to the Grameen phone case, by 2005 there were so many telephone ladies that their income was estimated to be around only $70 per year, even though the national average income had gone up to over $450. This problem is known as the ‘fallacy of composition’ – the fact that some people can succeed with a particular business does not mean that everyone can succeed with it.
Of course, this problem would not exist if new business lines could be constantly developed – if one line of activity becomes unprofitable due to overcrowding, you simply open up another. So, for example, if phone renting becomes less profitable, you could maintain your level of income by manufacturing mobile phones or writing the software for mobile phone games. You will obviously have noticed the absurdity of these suggestions – the telephone ladies of Bangladesh simply do not have the wherewithal to move into phone manufacturing or software design. The problem is that there is only a limited range of (simple) businesses that the poor in developing countries can take on, given their limited skills, the narrow range of technologies available, and the limited amount of finance that they can mobilize through microfinance. So, you, a Croatian farmer who bought one more milk cow with a microcredit, stick to selling milk even as you watch the bottom falling out of your local milk market thanks to the 300 other farmers like you selling more milk, because turning yourself into an exporter of butter to Germany or cheese to Britain simply isn’t possible with the technologies, the organizational skills and the capital you have.
Our discussion so far shows that what makes the poor countries poor is not the lack of raw individual entrepreneurial energy, which they in fact have in abundance. The point is that what really makes the rich countries rich is their ability to channel the individual entrepreneurial energy into collective entrepreneurship.
Very much influenced by capitalist folklore, with characters such as Thomas Edison and Bill Gates, and by the pioneering work of Joseph Schumpeter, the Austrian-born Harvard economics professor, our view of entrepreneurship is too much tinged by the individualistic perspective – entrepreneurship is what those heroic individuals with exceptional vision and determination do. By extension, we believe that any individual, if they try hard enough, can become successful in business. However, if it ever was true, this individualistic view of entrepreneurship is becoming increasingly obsolete. In the course of capitalist development, entrepreneurship has become an increasingly collective endeavour.
To begin with, even exceptional individuals like Edison and Gates have become what they have only because they were supported by a whole host of collective institutions (see Thing 3): the whole scientific infrastructure that enabled them to acquire their knowledge and also experiment with it; the company law and other commercial laws that made it possible for them subsequently to build companies with large and complex organizations; the educational system that supplied highly trained scientists, engineers, managers and workers that manned those companies; the financial system that enabled them to raise a huge amount of capital when they wanted to expand; the patent and copyright laws that protected their inventions; the easily accessible market for their products; and so on.
Furthermore, in the rich countries, enterprises cooperate with each other a lot more than do their counterparts in poor countries, even if they operate in similar industries. For example, the dairy sectors in countries such as Denmark, the Netherlands and Germany have become what they are today only because their farmers organized themselves, with state help, into cooperatives and jointly invested in processing facilities (e.g., creaming machines) and overseas marketing. In contrast, the dairy sectors in the Balkan countries have failed to develop despite quite a large amount of microcredit channelled into them, because all their dairy farmers tried to make it on their own. For another example, many small firms in Italy and Germany jointly invest in R&D and export marketing, which are beyond their individual means, through industry associations (helped by government subsidies), whereas typical developing country firms do not invest in these areas because they do not have such a collective mechanism.
2
D. Roodman and J. Morduch, ‘The impact of microcredit on the poor in Bangladesh: Revisiting the evidence’, 2009, working paper, no. 174, Center for Global Development, Washington, DC.