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Abstract

- In both developing and transition economies, microfinance has increasingly been positioned as one of the most important poverty reduction and local economic and social development policies. Its appeal is based on the widespread assumption that simply 'reaching the poor' with microcredit will automatically establish a sustainable economic and social development trajectory animated by the poor themselves. We reject this view. We argue that while the microfinance model may well generate some positive short run outcomes for a lucky few of the 'entrepreneurial poor', the longer run aggregate development outcome very much remains moot. Microfinance may ultimately constitute a new and very powerful institutional barrier to sustainable local economic and social development, and thus also to sustainable poverty reduction. We suggest that the current drive to establish the central role of microfinance in development policy cannot be divorced from its supreme serviceability to the neoliberal/globalisation agenda.
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Microfinance and the Illusion of Development:
from Hubris to Nemesis in Thirty Years
Milford Bateman
1
and Ha-Joon Chang
2
Abstract
The contemporary model of microfinance has its roots in a small local
experiment in Bangladesh in the early 1970s undertaken by Dr
Muhammad Yunus, the US-educated Bangladeshi economist and future
2006 Nobel Peace Prize co-recipient. The immense feel-good appeal of
microfinance is essentially based on the widespread assumption that
simply ‘reaching the poor’ with a tiny microcredit will establish a
sustainable economic and social development trajectory, a trajectory
animated by the poor themselves acting as micro-entrepreneurs getting
involved in tiny income-generating activities. We reject this view,
however. We argue that any positive outcomes are very limited in number
and swamped by much wider longer run downsides and opportunity costs
at the community and national level. Our view is that microfinance
actually constitutes a powerful institutional and political barrier to
sustainable economic and social development, and to poverty reduction.
Finally, we suggest that continued support for microfinance cannot be
divorced from its supreme serviceability to the neoliberal/globalisation
agenda.
Key words: Microfinance, Microcredit, Neoliberalism, Impact, Poverty, Development.
1
Department of Economics and Tourism, Juraj Dobrila Pula University, Pula, Croatia.
2
Faculty of Economics, University of Cambridge, Cambridge. UK.
The authors declare no potential conflicts of interest with respect to the research, authorship, and/or
publication of this article. The authors received no financial support for the research, authorship, and/or
publication of this article. This article is a substantially revised and updated version of a 2009 mimeo
(Bateman and Chang, 2009). We would like to thank all those who commented on our article on the
World Economics Journal website, as well as those who in the past couple of years offered private
comments on our original mimeo. The usual disclaimer applies
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1. Introduction
As originally conceived, microfinance (more accurately, microcredit
3
) involves the
provision of a small loan, a microloan, that is used by a poor individual to support a tiny
income-generating activity, thereby generating an income sufficient to effect an exit
from poverty. Since the early 1980s, the microfinance-supported proliferation of
informal microenterprises and self-employment has been very widely promoted as the
solution to poverty and under-development. By the 1990s, microfinance was the
international development community’s highest-profile and most generously funded
poverty reduction policy (for example, see Balkenhol 2007; 213). The expectation began
to form that a historically unparalleled poverty reduction and ‘bottom-up’ economic and
social development episode was in the making.
This article challenges the view that the microfinance model has a positive association
with sustainable poverty reduction and local economic and social development. On the
contrary, we find the microfinance model is most likely to lock people and communities
in a ‘poverty trap’. Moreover, in a growing number of ‘microfinance-saturated’
countries, regions and localities, the outcome of the microfinance model has been
nothing short of catastrophic. Nonetheless, despite the growing evidence that it has failed
in its original mission to reduce poverty, a fact that even long-standing proponents now
concede, the microfinance model still largely retains its reputation and popularity within
the international development community. To help explain why there is such a
widespread misunderstanding of microfinance, we go on to argue that the microfinance
model remains attractive to the international development community because of its
huge political serviceability to the neoliberal worldview that centrally locates the main
driver of economic development to be individual entrepreneurship.
The article is structured as follows. Section 2 briefly charts the rapid rise of the
microfinance model after 1980 and its recent tribulations since mid-2007 that have
contributed to people waking up to a completely new understanding as to its long-term
impact. Section 3 then summarises the key areas where we feel the theory behind
microfinance as opposed to its mere (possibly inefficient) execution, has proved to be
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most problematic. Section 4 explores the intimate links between the neoliberal
globalisation project and the microfinance project. A brief conclusion summarises the
argument.
2. Background
Broadly defined, microfinance has a long history and encompasses a diverse range of
institutional formats, ranging from individual money-lenders through to more formal
institutions, such as village banks, credit unions, friendly societies, financial
cooperatives, building societies, state-owned banks for SMEs (Small and Medium-sized
Enterprises), social venture capital funds, and specialised SME funds. The majority of
these financial initiatives, especially those from the 18th and 19th century onwards, arose
from a desire to transform the lives of the poor and the new industrial working classes, as
they struggled to cope with the growing perils and exploitation associated with the rise of
industrial capitalism. Noteworthy examples include the many Friendly Societies that
were an outgrowth of the rapidly growing trade union movement (Thompson 1963) and
the financial institutions established by the burgeoning Europe-wide cooperative
movement that began in England and Scotland in the early 1800s (Birchall 1997). In
short, the objective was not so much to help the poor to passively accept their poverty
and exploitation under elite-dominated economic systems, but to challenge the emerging
capitalist model and to genuinely empower the poor by enlarging the space of economic
and social activity under their effective (and proto-democratic) ownership and control.
The recent explosion of interest in microfinance, and the foundation of a powerful
‘microfinance movement’, represents something quite different, however. At the
forefront of this new microfinance movement was Dr Muhammad Yunus, the
Bangladeshi-born and US-educated economist. Following a number of experiments in
the mid-1970s with the provision of microcredit in and around the village of Jobra near
Chittagong in Bangladesh, Yunus began to argue that the mere availability of a
microloan would greatly benefit the poor everywhere, and especially women in poverty.
The poor simply had to establish and operate an informal microenterprise in their local
3
The term ‘microfinance’ is the most commonly used term today, so we use this term. Microfinance is
actually the generic term covering all varieties of microfinancial interventions, such as microcredit,
microsavings, microinsurance, micro-franchising, and so on.
4
community and they would be well on the way to escaping their poverty. Yunus took to
claiming that microfinance would ‘eradicate poverty in a generation’ and he confidently
predicted that very soon our children would have to go to a ‘poverty museum’ to find out
what all the fuss was about (for example, see Yunus 1997).
The international donor community very much liked what Yunus was saying, and so
agreed to underwrite his bold ideas for promoting self-help and individual
entrepreneurship among Bangladesh’s poor. This goal was to be achieved through a
dedicated institution the Grameen Bank. The Grameen Bank was formed in 1983 and,
largely based on Yunus’s constant declarations that it was an enormous success, it was
soon being copied all over Bangladesh and then all over the world. Pretty soon, too,
Yunus began to attract a dedicated band of followers, especially in the USA, who all
agreed (though often without any real analysis or evidence see below) that
microfinance would make massive inroads into global poverty. An efficient, private
sector-led and market-driven model of poverty reduction and ‘bottom-up’ economic and
social development appeared to have been found.
However, although neoliberal policymakers greatly appreciated the emphasis upon self-
help and individual entrepreneurship, and thus also its implicit support for free market
capitalism, they still had major reservations about the financing of the Grameen Bank
microfinance model. This was because it soon became clear that Grameen Bank’s
operations, as with most microfinance institutions (hereafter MFIs) that had sprung up
around the world at that time, actually depended upon a continuous inflow of subsidized
capital. This funding was mostly provided by an MFIs own government and/or by the
international development community. The neoliberal policymaking community began
to feel increasingly awkward about using subsidies to keep the supposedly non-state,
market-driven microfinance sector going. Spearheaded by the main Washington DC
institutions USAID and the World Bank - decisive action was therefore initiated to
phase out the original Grameen Bank model of subsidised microfinance. The long-term
solution to the ‘problem’ of subsidies in the microfinance sector was found in the idea to
reconstitute microfinance as a privately-owned, profit-driven business model. Key
advocates of commercialisation, notably Maria Otero (see Otero and Rhyne 1994) and
Marguerite Robinson (Robinson 2001) saw this new commercialised model, and the
5
likely increase in the supply of microfinance, as being capable of generating huge
benefits for the poor.
By the early 1990s a thoroughly ‘neoliberalized’ for-profit model of microfinance was
being ushered in as the ‘best practice replacement for the original subsidized Grameen
Bank model. This ‘new wave’ model (formally known as the ‘financial systems’
approach - see Bateman, 2003) quickly became the dominant template for microfinance
programs. By the turn of the new millennium, the ‘new wave’ microfinance model was
at the peak of its power and influence. Even the iconic Grameen Bank felt it had no other
option but to finally agree to convert over to ‘new wave’ respectability, which it did in
2002 with the ‘Grameen II’ project. The UN declared 2005 to be the International Year
of Microcredit. Numerous prestigious awards were also forthcoming for those involved
in microfinance, famously including the 2006 Nobel Peace Prize jointly awarded to
Muhammad Yunus and the Grameen Bank. And thanks to all these activities, the list of
‘microfinance-saturated’ countries (defined in terms of borrowers per capita) soon began
to comprise not just the original pioneer Bangladesh, but also Bolivia, Bosnia, Mongolia,
Cambodia, Nicaragua, Sri Lanka, Peru, Colombia, Mexico and India (see Bateman
2011b, 4, Table 1.1). It seemed obvious to all involved that the world was undergoing an
historically unparalleled episode of poverty reduction. But then the carefully constructed
edifice of modern microfinance began to crumble.
Beginning in 2007, and in a most rapid, dramatic and unexpected fashion, hubris quickly
turned to nemesis. It is widely recognised that the first spark was provided by the 2007
Initial Public offering (IPO) of the Mexican MFI, Compartamos. Rather than revealing
commendable levels of poverty reduction among poor Mexican individuals there still
remains no evidence for this whatsoever - the IPO process revealed instead the Wall
Street-style levels of private enrichment enjoyed by Compartamos’s senior managers.
These vast rewards were effectively made possible by quietly charging 195% interest
rates on the microloans taken out by their poor mainly female clients.
4
The
Compartamos IPO led to much public outrage against Compartamos and its senior staff,
and then a tidal wave of criticism of the commercialised microfinance model in general.
Even long-standing supporters of microfinance began to openly express their concerns at
4
See http://blogs.cgdev.org/open_book/2011/01/compartamos-and-the-meaning-of-interest-rates.php
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the way the microfinance concept was being destroyed in the hands of neoliberals and
hard-nosed investors (notably Malcolm Harper see Harper 2011: see also Klas 2011;
Sinclair 2012).
Very soon the narrow criticism of the Compartamos IPO and commercialised
microfinance was joined by a much more comprehensive critique of microfinance as an
economic development model per se (see Dichter and Harper 2007; Bateman and Chang
2009; Bateman 2010a; Bateman 2011a). Other researchers using new and supposedly
more accurate Randomised Control Trial (RCT) methodologies found little to no impact
arising from individual microfinance programs (Banerjee et al, 2009: Karlan and Zinman
2009). Roodman and Morduch (2009) and Duvendack and Palmer-Jones (2011) mounted
a serious challenge to the single most important study routinely cited as the best evidence
that individual microfinance programs had a strong poverty reduction impact a study
undertaken in the 1990s by then World Bank economists Mark Pitt and Shahidur
Khandker (Pitt and Khandker 1998). Re-examining the original dataset used by Pitt and
Khandker, both sets of authors located serious mistakes in the original analysis and, as a
result, declared that Pitt and Khandkher’s work did not confirm a positive impact from
the microfinance programs studied.
5
Adding considerable impetus to the growing critique of the microfinance model were a
number of hugely destructive sub-prime-style microfinance meltdowns taking place
around the globe. The first ‘microfinance meltdown’ had actually taken place in Bolivia
in 1999-2000, but at the time microfinance supporters described it as a ‘one-off’
aberration caused by factors supposedly unrelated to the core of the microfinance model,
such as unfair competition from a large MFI coming to Bolivia from Chile (see Rhyne
2001). However, starting in 2008, a new round of even more destructive ‘microfinance
meltdowns’ began in Morocco, Nicaragua and Pakistan, marked out by huge client over-
indebtedness, rapidly growing client defaults, massive client withdrawal, and the key
MFIs plunging into loss or forced to close or merge. These episodes were then followed
in 2009 by the dramatic near-collapse of the hugely over-blown microfinance sector in
Bosnia (see Bateman, Sinković and Škare 2012).
5
Notably, as Roodman and Morduch discussed in their revised paper published in 2011, Pitt and
Khandker did not examine and rule out reverse causation, meaning that their reporting of a positive
7
By all accounts, the most devastating ‘microfinance meltdown’ to date started in late
2010 in the Indian state of Andhra Pradesh (Sriram, 2010; Arunachalam 2011). With the
poor increasingly taking out more and more microloans in order to repay earlier
microloans that they had all too easily accessed, it was clear that the microfinance model
in Andhra Pradesh had degenerated into nothing more than a vast Ponzi-like survival
strategy for a very large number of the poor.
6
In late 2010, thanks to a deluge of personal
over-indebtedness, defaults and MFI losses, Andhra Pradesh’s microfinance industry
effectively collapsed.
7
Further over-supply problems are also clearly emerging
elsewhere, notably in Mexico, Lebanon, Peru, Azerbaijan and Kyrgyzstan.
8
In 2011 came a further quite devastating blow to the microfinance industry. This was a
UK government-funded systematic review of virtually all of the impact evaluation
evidence long said to confirm that microfinance has had a positive impact on the well-
being of the poor (Duvendack et al. 2011). The review found that the previous impact
studies were almost all seriously biased, incomplete or else very poorly designed to the
point of being quite unusable.
9
The Duvendack review reached an explosive conclusion,
arguing that ‘(the) current enthusiasm (for microfinance) is built on (..) foundations of
sand’ (page 75). Importantly (especially in the context of our comments below), the very
association between microcredit and household spending may indicate as is the case in very many
countries - that richer families simply borrow more.
6
By late 2009 it was found that poor households in Andhra Pradesh were on average in possession of a
total of 9.3 microloans, compared to between 2 to 4 microloans per poor household in the next most
saturated states in India - Tamil Nadu, Orissa, Karnataka and West Bengal (see Srinivasan, 2010)
7
In mid-2010 the microfinance industry possessed a gross loan portfolio of nearly $3 billion (up from
just $230 million in 2006), but it is predicted that it will almost entirely cease to exist by mid 2012. For
example, with its once nearly £1 billion microloan portfolio in Andhra Pradesh almost entirely written
off by the end of 2011, the largest MFI in the state SKS - has announced it will move into new areas
of operation as of early 2012, including rural insurance, rural payments and small business lending. See
http://www.dnaindia.com/money/report_new-sks-head-talks-of-sea-change-in-business-
model_1617016
8
Private communications with MFI analysts: see also CGAP 2010
9
Most of these earlier studies were undertaken by, or contracted out by, the microfinance institutions
themselves, as well as by the rapidly expanding raft of microfinance advocacy bodies. Genuine
analysis of the microfinance model was overwhelmingly shunned in case it produced a negative result,
an outcome that would have scuppered the chances of the external funding (from donors, governments,
foundations, etc) that most MFIs and microfinance advocacy bodies desperately required. It is thus not
too hard to locate the source and rationale for almost all of the massively exaggerated, and often openly
false, claims relating to the power of microfinance. The parallels with the adverse role that the three
main ratings agencies played in creating the global financial breakdown starting in 2008 are obvious.
8
final comment (page 76) points to the case for microcredit having been made not so
much on the basis of the economics (of poverty reduction and development), but to the
politics, and the authors conclude that further research is required by political scientists
in order to understand ‘(why) inappropriate optimism towards microfinance became so
widespread’.
One far-reaching result of all this bad news is that the microfinance industry has begun
to drop the important claim to be facilitating poverty reduction, moving very quietly to
redefine a new goal for itself in terms of facilitating the far more nebulous concept of
‘financial inclusion’. However, in reality this new objective for microfinance appears to
have even less substance to it than the failed poverty reduction objective it is designed to
replace (Bateman 2012a).
We agree with the substance and direction of much of the growing criticism of
microfinance. However, our own scepticism on this issue is not just rooted in our
analysis of the faulty economic principles upon which the microfinance concept is based,
as we will outline in the next section, but also in the important counterfactual that
emerges from a careful examination of the economic history of the most successful
national, regional and local economies. For if one looks at the advanced economies
(USA, Japan, Western Europe), as well as of the East Asian ‘tiger’ economies that burst
on to the scene from the 1970s onwards (South Korea, Taiwan, Malaysia, China,
Thailand and, most recently, Vietnam), one finds evidence of a successful national
economic model that is almost the exact opposite of the market-driven microfinance
model. As is now widely accepted (see Amsden 2001, Amsden 2007; Chang 2002,
Chang 2006, Chang 2007, Chang 2011; Reinert 2007; Wade 1990), sustainable progress
was forthcoming in all these countries largely thanks to a range of pro-active
‘developmental state’ interventions. In addition, a pivotal element underpinning the
success achieved in many of these ‘developmental state’ countries also lies in what has
been termed the ‘local developmental state (LDS) model - pro-active local development
and growth strategies undertaken by local government level institutions (see Friedman
1988; Weiss 1988; Oi 1995; Lall 1996; Bateman 2000; Thun 2006). This successful LDS
model is very far removed indeed from the contemporary microfinance model, even
though it may have some superficial similarities to it (for examples, see Bateman 2010a,
Chapter 7).
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3. Why microfinance most often makes things worse, if not much worse
The above section has demonstrated that, after a seemingly auspicious beginning, in
recent years the microfinance model has clearly run into a brick wall. In this section we
identify the key factors that account for why it is that the microfinance model has had
such an adverse impact at both the local community level and national economy level.
(a) The microfinance model ignores the crucial role of scale economies
By definition, microfinance produces microenterprises that is, enterprises and
agricultural units that are very small and almost always operate below minimum efficient
scale. However, it is widely accepted that for all enterprise sectors there remains an
identifiable minimum efficient scale of production, and operating below this level makes
it virtually impossible for any enterprise to survive and prosper in a competitive business
environment.
In general, we may say that microfinance policymakers largely fail to register the crucial
importance of minimum efficient scale. What matters above all, so their argument runs,
is to construct a local financial system dominated by MFIs that can establish as many
microenterprises as possible in the short term. Going further, microfinance supporters
argue that a collection of the tiniest microenterprises is actually the ideal foundation for
sustainable development. As Dambisa Moyo (2009; 129) relates of her native Zambia,
‘Think of a woman selling tomatoes on a side street. (.) this group the real
entrepreneurs, the backbone of Zambia’s economic future need capital just as much as
the mining company’ (italics added). The argument here is essentially that scale does not
matter, and that many more of such tiny microenterprises will indeed provide the best
possible (neoclassical textbook) foundation for sustainable development. It is an
argument that has been extensively taken up by the microfinance industry as a whole: it
is the numbers of microenterprises established that appear to matter the most, rather than
their (initial) size. But is it an argument that holds water?
First of all, we can say that Moyo’s thesis holds no water in Africa. Africa already has
more micro-entrepreneurs per capita than anywhere else on earth (see African
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Development Bank and OECD 2005), and the rapidly expanding supply of microfinance
is actually increasing this number year by year. For example, the share of the informal
economy in GDP in Kenya is now as much as 72%, in Zambia around 58%, while even
in more industrialised South Africa informal employment as a proportion of non-
agricultural employment is likely to be above 70% (Rolfe et al. 2010). However, Africa
effectively remains trapped in its poverty precisely because the increasingly
microfinance-dominant financial structure in Africa is suitable only to evolve an
enterprise structure overwhelmingly composed of very tiny units operating way below
minimum efficient scale. For a number of reasons, a careful study of economic
development history (for example, see Chang 2011; 157-167) provides no evidence that
might lead us to think that in Africa, or indeed anywhere else, entirely avoiding to reap
economies of scale in productive activity will nevertheless still provide a suitable
foundation upon which sustainable economic and social development can be achieved
(see also below).
The situation in India is not dissimilar. Despite its rapid and well-publicised growth in
recent years, India still has many huge development and poverty-related problems. One
of the most pressing development problems is the need to fill the so-called ‘missing
middle’ that exists between, on the one hand, the small number of large internationally
well-known computing and manufacturing companies and, on the other hand, the
hundreds of millions of ‘survivalist’ informal microenterprises. Put simply, India has so
far failed to nurture an innovative and growth-oriented SME sector, one that would be
capable not just of providing millions of desperately sought-after formal sector jobs, but
also of acting as an efficient subcontracting and supplier base for the large firm sector.
Meanwhile, the microfinance sector in India has been growing very rapidly indeed,
especially in Andhra Pradesh state, as we noted above. As of 2006 microfinance
constituted 15% of all commercial bank lending in the whole of India, while, as
Arunachalam (2011) extensively documents, the non-bank microfinance sector has
experienced a significant boom this last decade thanks to the entry of private
entrepreneurs and other financial institutions and foreign investors. Crucially, the growth
of funding for microfinance has arrived thanks to the diversion of funds away from other
uses, particularly financial support for SMEs. Indeed, this substitution effect is one of the
main features of the Indian banking sector this last decade, and it is at least partly driven
forward by the Indian government’s firm belief in the virtues of microfinance
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(commercial banks in India are required by law to allocate a certain percentage of their
funds into the microfinance sector, usually via MFIs).
As Karnani (2007) points out, however, the growing focus on microfinance and the
subsequent growth of tiny informal microenterprises in India, and the concomitant
reduction in funding and support for SMEs, has quite dramatically undermined the
productivity and overall efficiency of India’s economy (see also Karnani 2011).
10
This is
because the SME sector has seen what little hope it had of obtaining financial support
recede even further into the distance. Providing finance to the SME sector is both risky
and low margin work for India’s banks, compared to investing in its large Indian and
foreign companies, which is a secure and stable investment, and to investing into the
country’s booming microfinance sector, which (until recently at least) demonstrated very
high returns. Moreover, India’s Self-Help Group (SHG) movement, a movement that
provides very poor women with a way of gradually accumulating a tiny amount of
savings, by design does not lend to small or medium projects undertaken by members.
Karnani’s (2007; 39) view is that the millions of tiny survivalist microenterprises that
have emerged in India in recent years do not provide anything approaching a solid
foundation for India’s growth and poverty reduction efforts. His conclusion is that it was
wrong for Indian policy-makers to ignore the crucial importance of economies of scale in
productive activity, because this has led to a seriously adverse economic structure where,
[t]he average firm size in India is less than one-tenth the size of comparable firms in
other emerging economies. The emphasis on microcredit and the creation of
microenterprises will only make this problem worse’.
In neighboring Bangladesh - the spiritual home of modern microfinance the situation in
this anti-development respect is probably even worse than in India. With a high and
growing share of the country’s savings and commercial funds being recycled into highly
profitable microloans, Bangladesh now has the highest microfinance penetration rate in
the world (25% of the population are borrowers from MFIs see Bateman 2011b, 4).
But the price that is being paid for this microcredit largesse is that Bangladesh’s SME
sector has effectively been displaced and starved of funding. Some of the international
development agencies are now beginning to wake up to the damage being caused in
10
See also ‘Microcredit: why India is failing’, Forbes, 10 November 2006.
12
Bangladesh as the far more productive SME sector is increasingly being left to wither on
the vine. For example, research by DFID (Department for International Development),
the UK government’s aid arm, summarized the situation in Bangladesh (see DFID 2008:
2-3), as one where,
[t]he financial system - including banks, capital markets and the micro-finance
sector - is inadequate to support long term investment financing for growth.
Smaller firms, responsible for the lion’s share of employment, have severely
limited access to financial resources. Rural areas, with the highest potential
for lifting low income groups out of poverty, are cut off from most financing
mechanisms. (Our italics)
If what the DFID study calls smaller firms (that is, small firms that are not
microenterprises) are finding it difficult to access financial support in the rural areas of
Bangladesh, areas where the country’s famed MFIs are increasingly in a desperate search
for new microenterprise clients in order to keep themselves alive, then the ‘smaller firm’
funding situation is clearly very bad indeed. Informal microenterprises and poor
individuals can very easily access - in fact, they are being pushed to access - far more
funding than they can repay, while ‘smaller firms’ are increasingly being left without any
finance to get established or to grow.
However, there is very little that the Bangladesh government appears capable of
doing to stop the hugely unproductive informal sector from absorbing a large and
growing part of the scarce funds available in that country (mainly savings and its vast
remittance inflow). It certainly does not help that the ‘big 4’ MFIs in Bangladesh
Grameen Bank, ASA, BRAC and Proshika are all very powerful political and
economic institutions, and they have all tended to resist suggestions by the Bangladesh
government and others that their lending programs should venture a little more into
much less profitable, but perhaps more developmental, business areas, such as SME
lending or housing mortgages.
11
In other words, just like in neighboring India, the
11
In 2011, a documentary by award-winning Danish filmmaker, Tom Heineman, famously exposed the
Grameen Bank’s reluctance to get involved in housing mortgages, even with donor grant funding
explicitly offered for this purpose. Using previously secret documents held in the Norwegian state
archives, Heinemann showed that in the mid-1990s Grameen Bank obtained a $100 million Norwegian
government grant to be used to develop low-cost housing mortgages in Bangladesh. However, this
grant was right away secretly transferred by Muhammad Yunus to a sister company (Grameen Kalyan)
only for Yunus to then instantly transfer it right back to Grameen Bank as a loan to be used for far
13
massive microfinance industry in Bangladesh has turned out to be a major obstacle in
terms of supporting the development of the enterprises operating at or above minimum
efficient scale that Bangladesh very urgently needs in order to sustainably develop and
reduce poverty.
The very same adverse dynamics have been identified as a major problem in Latin
America too. In Mexico, for example, the manifest shift of resources into the hugely
profitable microfinance sector has directly precipitated a booming sector of ‘changarros’
(informal microenterprises, or simply ‘mom and pop stores’), but at the same time
undermined the desperately required capitalization and expansion of the country’s
crucial SME sector. One result, as Levy (2007) argues, is that, ‘There are more resources
to subsidize informal employment than formal employmentand so Mexico is probably
saving less and investing in less efficient projects. Mexico’s biggest development
problem today has become one of Over-employment and over-investment in small
informal firms that under-exploit advantages of size, (and so) invest little in technology
adoption and worker training’. Crucially, one of the reasons for this misallocation of
capital scenario is the booming microfinance sector that has emerged in Mexico since the
mid-1980s, and which has resulted in a growing percentage of the country’s scarce
capital resources being diverted into informal microenterprises and away from
potentially higher value uses, such as formal SMEs.
12
Moreover, the IDB’s far-reaching conclusion in a recent high-profile publication (IDB
2010) is that Mexico’s adverse capital allocation and subsequent deindustrialisation
problems have essentially been the main story throughout all of Latin America this last
thirty years or so. As the IDB reports, Latin America has for too long remained trapped
in poverty and under-development because it has channelled far too much of its scarce
more profitable individual microloans. The exposure of this misappropriation of donor funds only came
to the notice of the Norwegian government two years later, which immediately demanded that the $100
million be returned, which most of it was. Not unexpectedly, both parties to the transaction quietly
agreed to keep the whole incident under wraps for fear of tarnishing the reputation of Yunus and the
Grameen Bank, and that of the Norwegian aid authorities, as well as the reputation of microfinance in
general. However, Heinemann’s exposure of this misappropriation, as well as the huge publicity that
ensued when his documentary went on to win a handful of major international documentary film-
making awards, directly led on in 2011 to Muhammad Yunus being removed from his position as head
of the Grameen Bank. See Sinclair, 2012.
12
For example, bank lending to formal enterprises (SMEs) fell in Mexico in the new millennium, going
from 60% of total lending to just over 48% in only six years - see Dos Santos, 2008:2.
14
financial resources into low-productivity informal microenterprises and self-
employment, and far too little into more productive formal small and medium
enterprises. In other words, the massive microfinance-induced proliferation of informal
microenterprises that has taken place in Latin America since the 1980s has not been its
economic and social saviour, as analysts like the Peruvian economist Hernando De Soto
have long propounded would be the case (De Soto 1989), but a factor that actually lies at
the very root of that continent’s recent economic and social malaise. As the IDB
summed up (2010, 6), the overwhelming presence of small companies and self-
employed workers is a sign of failure (in Latin America), not of success (our italics).
Without perhaps having this objective in mind, the IDB has quite clearly blown out of
the water the long-standing belief that the programmed expansion of microfinance in
Latin America has been a positive development.
An equally dangerous ‘primitivising’ aspect of microfinance here is in relation to the
agricultural sector, and against a background of food shortages and agricultural
commodity prices rises that are (re)introducing food insecurity problems in many
developing countries. It is well known that the microfinance sector has proved adept all
around the globe at moving into the subsistence farming sector. Yet there is a wealth of
evidence to show that tiny subsistence agricultural units are simply not the most
appropriate agricultural units if a developing country wants to achieve sustainable rural
jobs growth and local food security (for example, Sender and Johnston 2004). Inserting
microfinance into supporting the expansion of such units is therefore counter-productive
into the longer run in terms of rural sector development. Moreover, the proliferation of
microfinance in the agricultural sector is likely to have undesirable political
consequences in the form of a reduction in female empowerment, as micro-farms cannot
survive without an increase in the exploitation of what is euphemistically known as ‘non-
contractable labour’, that is, unpaid female labour (see Manji 2006, for further
discussion). But, at the other extreme, nor are the sort of large-scale plantation-style
farms advocated by commentators such as Collier (2008) any better for the poor. In the
main, such plantation farms employ few people on decent wages, may destroy the local
ecology, and the often large profits go up to a tiny elite, which is often not even resident
15
in the country concerned (and so valuable spending power is lost to the local
economy).
13
Instead, it is commercially viable, small (but not ‘micro’) family farms that are in many
circumstances the most valuable in terms of contributing to efficient, sustainable and
equitable agricultural sector development.
14
This is because family farms help to
maximize the potential to adopt technologies that create rural employment opportunities,
are big enough to make good use of irrigation schemes, raise agricultural productivity,
re-localize the consumption of food, address food security issues, and all without unduly
damaging nature’s goods and services (see Norberg-Hodge, Merrifield and Gorelick
2002; Pretty 2005). Notwithstanding, the microfinance sector today continues to recycle
a country’s valuable financial resources into the tiniest of subsistence farms, which are
the least efficient forms of farming, while ignoring the family farming units that are
likely to bring about most long-term benefits to the local community overall. It is
difficult to conceive of a more damaging local financial structure in terms of facilitating
the programmed long-term destruction of the agricultural sector.
An obvious illustration of the structural damage to agriculture brought about thanks to
microfinance is in the Indian state of Andhra Pradesh a global pioneer in increasing the
supply of microfinance, as noted above. By all accounts, from the 1990s onwards the
profit-driven channelling of large quantities of microfinance towards tiny subsistence
farming units has precipitated a human and economic disaster. With evidence of a
growing over-indebtedness to a new breed of commercial MFI, offering immediate
access to a microloan but all too often at a deceptively high rate of interest (for example,
thanks to a lot of hidden charges), the Andhra Pradesh rural economy began to implode.
In 2003 the state authorities commissioned a major report to look into the problems (see
13
Obvious examples here include the commercially successful large-scale vineyards and wineries in
parts of South Africa, which are also the location for the highest concentration of poverty in the
country (see Du Toit 2004), and Kenya’s horticultural export sector, which is very successful for its
mainly European owners, yet the local workforce receives poverty-level wages (see Pollin, Githinji and
Heintz, 2008). But see also the discussion in Cramer, Oya and Sender (2008), which shows some
plantations operating in a somewhat better light.
14
The definition of a ‘family farm’ is not an easy one to provide and it will vary from country to
country. However, we may say it lies somewhere in the space above the inefficient subsistence farm
variant described by Sender and Johnston, in that there is a significant marketable surplus, but well
16
Commission on Farmers Welfare 2004). The report centrally noted that ‘Agriculture in
Andhra Pradesh is in an advanced stage of crisis (.) The heavy burden of debt is perhaps
the most acute proximate cause of agrarian distress. The decline of the share of
institutional credit, and the lack of access to timely and adequate formal credit, in the
state have been a big blow to farmers, particularly small and marginal farmers.’(ibid: i).
Notwithstanding these findings, nothing was done to stop rural over-indebtedness to the
new highly commercial MFIs, which rose even more dramatically than before.
15
A
serious microcredit bubble was created, which in 2006 collapsed in the shape of the
‘Krishna Crisis’ (named after the Krishna District in which the over-indebtedness
problem first became apparent - see Arunachalam 2011).
The core problem here was that the least productive subsistence farms (generally less
than two hectares) were all too easily able to access a microloan, when it should have
been clear that they could really do almost nothing with it. Any marginal increase in
output was simply not enough to cover the high interest rate charges on the microloan
that gave rise to it. Of course, many subsistence farmers were desperate, and so it was
easy for the local MFIs to persuade those already in deep debt to accept more of virtually
any form of credit at any rate of interest in order to try vainly to resolve their long-
standing problems. But the result of the subsistence farming community accessing
microfinance in Andhra Pradesh was the gradual entrapment of several hundreds of
thousands of its tiniest and least productive subsistence farms in a vicious downward
cycle of dependency and growing microdebt (see the illuminating discussion in Taylor
2011). Just under 82% of farmers in Andhra Pradesh were in debt by the mid-2000s, the
highest figure in all of India (Patel 2007).
Crucially, precisely because of their very small size and low productivity, very little
additional agricultural output was actually secured by accessing so much microcredit: in
fact, most subsistence farms in serious debt ground to a virtual halt. One reason for this
was that high interest rate payments on microloans effectively pushed many of the tiniest
farms into financial loss-making territory. These farms then chose to slow down, or even
stop farming completely, rather than rack up even more losses trying to fund the next
below the plantation-type farm promoted by Collier, which is almost entirely geared up to producing
for often distant markets.
17
agricultural cycle (see Commission on Farmers Welfare 2004). Tragically, this reduction
of output also arose because of the rising number of rural suicides in Andhra Pradesh.
16
At any rate, thanks to so many tiny subsistence farms languishing and failing outright
under the burden of microdebt, while more commercially-oriented small family farms
were increasingly unable to access capital on affordable terms and maturities, rural
incomes fell by 20 per cent in Andhra Pradesh in the decade after 1993 (Ibid). Even
worse in retrospect, it was largely the commercial failures in the rural sector that
encouraged Andhra Pradesh’s MFIs subsequently to move into its urban areas in search
of a completely new raft of poor clients to service, to quite devastating effect, as we saw
above.
All told, the most obvious result of focusing upon expanding the numbers of the very
tiniest informal microenterprises and farming units is the de facto shift of resources away
from the far more productive above-minimum efficient scale enterprises and farms. This
has resulted in what one astute critic of the microfinance model has denoted as ‘the
microcredit paradox’: a situation where the poorest people can do little productive with
the credit, and the ones who can do the most with it are those who don't really need
microcredit, but larger amounts with different (often longer) credit terms.’ (see Dichter
2006, 4). More broadly, such a shift has led to the proliferation of ‘infantilizing’
development trajectories. Almost everywhere where the microfinance model has entered
into the enterprise and agricultural sectors we find little real sustainable progress, while
major opportunity costs are manifestly evident.
(b) The microfinance model ignores the ‘fallacy of composition’.
As the late Alice Amsden (2010) argued, it has been a major mistake when dealing with
poverty in developing countries to assume that there is no local demand constraint, and
that every local economy therefore has the elastic ability to productively absorb an
unlimited number of the unemployed through the expansion of the local enterprise
sector. Amsden noted that this form of Says Law ‘supply creates its own demand’ – is
15
See ‘The Makings of a Debt Trap in Andhra Pradesh’. The Hindu Times, April 20th, 2006.
16
The cause and actual numbers of rural suicides, including those directly and indirectly caused by
over-indebtedness to local microcredit institutions, remains a matter of hot dispute. See ‘Death by
microcredit’, Times of India, 16 September 2006.
18
a seductive lure for policy-makers seeking to help the unemployed through supply-side
measures (such as enterprise development and training) but, as she demonstrated (see
also Galbraith 2008; 151-163), it has no basis in reality.
Other things being equal, new and expanded microfinance-induced microenterprises do
not raise the total volume of business/demand so much as redistribute or subdivide
amongst market participants the prevailing volume of business/demand (on this
important point, see also Davis 2006). This point is, of course, the ‘fallacy of
composition’ and it has quite serious implications for the presumed efficacy of
microfinance. This fallacy is most vividly manifested in the statement by Muhammad
Yunus that ‘[a] Grameen-type credit program opens up the door for limitless self-
employment, and it can effectively do it in a pocket of poverty amidst prosperity, or in a
massive poverty situation’ (Yunus 1989, 156).
The reality in virtually all developing countries is that local economies have been
saturated with simple informal microenterprises for many years: indeed, an informal
microenterprise has long been the default activity for those without any type of formal
employment or income the vast majority in some countries (see ILO 1972; Breman
2003). The scale and scope of the local informal sector was and is mainly determined by
local demand. With the arrival of microfinance in the 1980s, however, an artificial
supply-side MFI-driven increase in the numbers of informal microenterprises was
stimulated without any compensating intervention on the demand side. This inevitably
created hyper-competition at the local level, which in turn precipitated reduced turnover
in existing individual microenterprise units and downward pressure on local prices and
incomes in general (thus negatively affecting both new and incumbent microenterprises).
As a result, we find, not surprisingly, that from the 1990s onwards, incomes, wages,
profits and work-life conditions for those struggling in the informal microenterprise
sector began to deteriorate quite markedly across the globe.
17
Two negative but largely unregistered outcomes are uppermost as a result of
microfinance programs in this specific context: first, significant job and income
17
For example, see ILO, 2009.
19
displacement effects across the community and, second, significantly higher levels of
exit by incumbent producers.
Consider first the issue of displacement. In Mexico, the typical local economy has for
some time been bursting at the seams with informal microenterprises. Few market gaps
remain. The result of new entry and expansion thanks to microfinance is that prices on
most of the very simple products and services have been falling. In addition, lower
turnover in individual microenterprises, as local market demand is shared out among a
growing population of microenterprises, has been precipitating lower margins and
incomes. In many sectors and in many regions of Mexico, poor individuals are hugely
angry at the declining margins and wages, as well as longer working hours, brought
about by the unremitting inflow of ‘poverty-push’ microenterprises supported with
microfinance.
18
Noticeably in the wake of NAFTA
19
in 1994, which quickly closed many industries in
Mexico, and so stimulated an extensive wave of new informal microenterprises
composed mainly of the newly redundant, the end results were quite adverse. Popli
(2008) reported that poverty levels in the (newly enlarged) informal microenterprise
sector very rapidly increased after NAFTA. Even as some economic growth reappeared
in the Mexican economy in the mid-1990s, poverty levels in the informal sector
continued to rise. The simple dynamic here involved existing local market demand (and
in many areas, declining demand, because very many small farmers after NAFTA lost
their local market and incomes due to cheaper imported US corn) being shared out
within the now enlarged informal microenterprise sector. Very little, if any, net
employment or additional income was actually generated through the recession-driven
surge in new microenterprise entry.
Thus seen, the proliferation of MFI-financed microenterprises simply redistributes
poverty within the poorest communities, if indeed it does not exacerbate it: it certainly
does not resolve it. More importantly, the poor do not always meekly accept to pay this
social cost on behalf of society. Violent reaction against their fellow micro-entrepreneurs
18
See International Press Service (IPS), Mexico City, 2nd September, 2003.
19
North American Free Trade Agreement.
20
and local government officials (who mistakenly think that stimulating new entry is
always and everywhere a good thing) has all too often emerged as incumbent wages and
working conditions have declined, as was the case a few years ago in Mexico’s several
million strong community of mobile street vendors.
20
Turning to the related issue of an MFI’s clients failing, we find, first of all, that such
failure is even more pronounced in relation to informal microenterprises than in formal
small enterprises, because the former are generally much more likely to be established on
the basis of ‘poverty-push’ factors rather than ‘opportunity/profit pull’ factors. Failure
rates of informal microenterprises are often very high indeed in developing countries (for
an example from India, see George 2006). The core problem with client failure,
however, is that this event very often plunges the hapless individual into much deeper,
and possibly irreversible, poverty. This is because a failed microenterprise often means
the poor lose not just their already minimal income flow, but also any additional assets,
savings and land they might have invested into their microenterprise, or else are forced
to sell off (often at ‘fire-sale prices’) in order to repay the microloan. Social networks
and reputational capital are also lost.
An all too real illustration of what we mean here is to be found in Bosnia. As elsewhere,
Bosnia’s microenterprise sector is defined by its high failure rate, with up to 50% of
microenterprises failing within just one year of their establishment (Demirgüç-Kunt,
Klapper and Panos 2007). Behind this dry statistic, however, lies the fact that a very
significant number of Bosnia’s poor individuals failing in their microenterprise project
have ended up in much deeper poverty, vulnerability and insecurity.
Bateman, Sinković and Škare (2012) find that here are several reasons for this adverse
outcome. First, those failing in a microenterprise but who chose (or were effectively
forced) to continue to repay their microloan ended up drawing down family assets
(especially family savings) and selling off other family assets - family land, housing,
private vehicles, machinery, and so on. Second, many in Bosnia were forced to divert
other important family income flows into microloan repayment, such as remittance
income and pensions. Third, very many individuals in Bosnia got hooked into taking out
20
International Press Service (IPS), September 2nd, 2003, Mexico City.
21
multiple microloans, using each new microloan to repay existing microloans, but in the
process building up a mountain of personal debt that at some point needed to be repaid.
As a result, the interest payments required to service these individual debt mountains
constituted a growing proportion of household income, thus reducing the amount of
income available for other important household items. Fourth, even those quite
unconnected to a failing microenterprise, such as the estimated 100,000 individuals who
guaranteed a microloan for friends and family, as is the common procedure in Bosnia,
ended up severely disadvantaged by being forced to repay a microloan on someone
else’s behalf.
All told, there is no shortage of evidence from the field that routine displacement and
client exit factors have often completely frustrated the poverty reduction goals of
microfinance. However, partly because of the familiar neoliberal position that the
‘opportunity’ and ‘freedom’ to establish a new enterprise is all that really counts, and not
other conditions, such as the capabilities of the entrepreneurs involved or if there is real
demand for their simple outputs, these adverse features of the microfinance model have
long been completely ignored. Today, the view that displacement and client failure are
important factors is coming to be accepted by many individual analysts and institutions,
though certainly not by all.
21
One example of this new realism is the ILO’s recent
response to the global financial crisis and rising unemployment, which was to argue
against further stimulation of the informal microenterprise sector, since [a]s was the
case in previous crises, this could generate substantial downward pressure on informal-
economy wages, which before the current crisis were already declining’ (ILO 2009, 8).
(c) The microfinance model helps to de-industrialise and infantilise the local economy
21
In 2010 the EU launched the European Progress Microfinance Facility, a major €100 million
program designed to support the unemployed in recession-hit Western Europe. It was built on an
implicit assumption that there is sufficient local demand to un-problematically underpin a new wave of
microenterprises set up by the unemployed. However, the evidence the EU has used to underpin this
assumption is derived from evaluations of microenterprise growth and survival undertaken in the early
2000s, which showed that there was no shortage of local demand for microenterprises. That today’s
local demand situation is so radically different to the pre-global financial crash period appears to have
been ignored. See ‘Creating Jobs in recession-hit Communities in Europe: Why Microcredit will not
help’, Social Europe Journal Blog, 15th May, 2012. Go to: http://www.social-
europe.eu/2012/05/creating-jobs-in-recession-hit-communities-in-europe-why-microcredit-will-not-
help/
22
Entrepreneurship theory and studies in institutional economics show that it is new,
creative, technically innovative ideas and institutions that are the key engine in economic
development (Schumpeter 1987([1942]; North 1990; Baumol et al. 2007). To develop in
a sustainable fashion, and thus to reduce poverty, developing countries need to master
key technologies, better understand ‘state of the art’ industrial products and processes,
develop at least some innovative capabilities in domestic enterprises, and establish a
tissue of pro-active development-focused institutions and organizations (see UNCTAD
2003; Amsden 2007; Chang 2007).
However, given the high interest rates and short maturities demanded by most MFIs, it is
generally only the most simple and unsophisticated microenterprises that can service a
microloan. Typically, these microenterprises are very simple trading, retail and service
operations, with perhaps some very small production-based operations that can add value
very quickly (such as food preparation). We also know that very few growth-oriented
microenterprises or SMEs using more sophisticated technologies can effectively get
started or expand with the assistance of microfinance, as their returns are of longer term-
nature. Within the ‘new wave’ microfinance paradigm, moreover, there is an in-built bias
against longer term projects which are likely to be of much more value to the local
community, but which would struggle to repay high interest rates in their initial period of
operations. Nor does it help that many high-profile commercial banks are increasingly
‘downscaling’ out of traditional SME lending into higher profit microfinance.
Overall, then, to the extent that the financial sector shifts in favour of microfinance as
we are indeed seeing right around the globe - the more an economy’s scarce financial
resources are effectively directed towards the very simplest ‘no-tech/no-capital’ mainly
petty-trade-based microenterprise projects, and so channelled away from more
sophisticated and technology/innovation-based projects that offer far more to the
economy and society in the medium to longer term. As Baumol (1990) among others
have shown, we find many developing countries have, thanks to microfinance, evolved
an enterprise structure that is structurally (in addition to the scale economies problem
noted earlier) incapable of giving rise to sustainable productivity growth, and so also
poverty reduction.
23
Consider once more the case of Sub-Saharan Africa (see also Chang 2011; 157-167).
With the microfinance sector rapidly expanding this last decade, local savings and
remittance incomes are increasingly being recycled (and very profitably so) into the very
simplest of trade-based operations and inefficient subsistence farms. This is helping to
expand Africa’s already giant informal microenterprise sector. At the same time,
however, this emphasis upon microfinance has effectively reduced the financial backing
required for the ‘bottom-up’ industrial transformation of Africa, particularly through
reducing support for innovative and growth-oriented SMEs. In short, with the help of
microfinance Sub-Saharan Africa’s economic structure is increasingly becoming
characterised by the ‘missing middle’ phenomenon – it is a continent of hundreds of
millions of simple traders coexisting uneasily with a handful of large companies (e.g., oil
companies and copper and diamond mines), but very little else. Even in those countries
where a natural resource bounty has made the availability of finance much less of a
problem than elsewhere, such as in oil-rich Nigeria, the informal microfinance sector has
ignored the obvious oil-sector related opportunities (subcontracting, servicing, etc) and
demonstrated the usual overwhelming predilection to work with only the very simplest
microenterprises - nearly 80% of microfinance in Nigeria (and the sector is growing
rapidly at the expense of more traditional uses [i.e., SMEs]), is channelled into simple
cross-border petty trade-based microenterprises (see Anyanwu 2004).
Africa’s escape from poverty and under-development simply will not be facilitated upon
the microfinance-induced entry of more of the simplest ‘buy cheap, sell dear’ trade-
based microenterprises. Africa’s growth requires instead the gradual construction of a
robust light industrial and agro-processing foundation that will enable its entry into at
least some mainstream production and manufacturing-based enterprises capable of
productivity-growth. This in turn means that Africa urgently requires not even more
microfinance than at present, but a raft of robust and far-sighted private and public
financial institutions willing to socialise risk, carefully build productive capabilities
where appropriate, and hold steady to a longer-term development and industrialisation
vision. This need is not being addressed, however. In fact, (no) thanks to Dambisa
Moyo’s internationally well-received book setting out her own solutions to the continued
poverty and underdevelopment in her native Africa especially her belief that very
much more microfinance is needed (see Moyo 2009; Chapter 8) we would argue that
the real solution to Africa’s problems has become more elusive than ever.
24
In short, microfinance greatly reduces the ability of developing countries to promote
their industrial upgrading as one of the keys to eventual economic success and poverty
reduction. This is not only because the microfinance sector misdirects scarce resources
into the wrong type of enterprise (i.e., mainly into simple trade-based microenterprises),
but also because it draws scarce development funds away from financial institutions that
are perhaps up to the required task (e.g., Korean/Brazilian-style development banks,
SME technology funds). Meanwhile, in the formerly industrially sophisticated and
institutionally quite rich countries of Eastern Europe, an obvious and valuable industrial
inheritance - an inheritance that most developing countries are desperately wishing to
possess - has been largely abandoned despite being the potential starting point for a new
generation of relatively technology-intensive enterprises.
(d) Microfinance fails to connect with the rest of the enterprise sector
Another important factor that we now know lies behind successful local economic and
enterprise development is ‘connectability’ between enterprises of all sizes. It is now very
well understood that the tissue of horizontal (clustering, networks) and vertical
(subcontracting) connections within the local enterprise sector is a crucial determinant of
a local economy’s ultimate sustainability through industrial development (Pyke 1992).
Indeed, as Weiss (1988; 210) concludes in reflecting on the successes of both the Italian
and Japanese microenterprise and SME sectors since 1945, ‘the core of modern micro-
capitalism is not competitive individualism but collective endeavour’.
Wherever the microfinance model has been in the ascendancy, however, such beneficial
grassroots dynamics have largely been undermined. While succeeding in terms of
producing some new (albeit largely temporary) informal sector microenterprises, the
overwhelming majority of these new entrants have no need, wish or ability to
meaningfully cooperate in order to begin to forge the required productivity-enhancing
horizontal (‘proto-industrial districts’) and vertical (sub-contracting) connections. The
result in many developing and transition countries has been little movement towards a
more ‘connected’ local economy. This gives rise to some significant handicaps. For
example, large firms are unable to expand their operations by tapping into a local
structure of quality suppliers, but must import instead. A lack of potential sub-
25
contracting partners also typically dissuades investments in large-scale operations,
especially ‘greenfield’ FDI. Important cluster building programmes simply cannot
function when there are few, if any, local enterprises that can meet the technology,
market and scale requirements to benefit from cooperating with their counterparts.
In short, the microfinance model pays no heed to the important requirement that
enterprises be of the right type (size, quality, use of technology, innovative products and
processes, etc) that might both facilitate and benefit from local ‘connectability’. The
microfinance model therefore operates like a football academy that exists solely in order
to turn out players with individual skills, but all of whom have no ability to engage in the
vital organisational cooperation the teamwork - required to actually win the match.
(e) The microfinance model is pre-programmed to precipitate a sub-prime-style over-
supply of microfinance
Hyman Minsky (1986) predicted that neoliberal policies were likely to be especially
destructive when played out through the financial sector, with an inevitable tendency
towards Ponzi-style booms and busts in the supply of finance. It has become increasingly
apparent through a series of financial crises, culminating in the 2008 global financial
crisis, that Minsky was correct. Minsky’s predictions also very much pertain to the local
financial sector. For example, Black (2005) extensively documents a Minskyian-style
adverse trajectory in the shape of the boom and then spectacular bust of the US Savings
and Loans (S&Ls) institutions in the 1980s.
As the growing number of ‘microfinance meltdowns’ indicates, the microfinance sector
has proved very receptive to Minskyian dynamics. In fact, the massive sub-prime-style
over-supply of microfinance and various Ponzi-style dynamics are now intrinsic features
of the microfinance model.
Two important sub-prime-style drivers are important here. First, as in any private
business, pushing out a continuously increasing volume of microcredit is the most
important way that an MFI can both justify and physically provide the financial space
that allow for the generous salaries, bonuses and other perks that are increasingly the
norm in the microfinance sector. All that matters is that, somehow, an MFI’s clients are
26
able to absorb whatever output of microcredit is forthcoming, even if only to repay
microloans already taken out (as very much in Andhra Pradesh state in India). Second,
the larger an MFI becomes, the more likely it is that its senior managers will be able to
benefit when the time comes for the expected transition to publicly owned company
status via the IPO route. The primary mechanism that can provide for this private
enrichment is found in the fact that an MFI’s senior managers typically accumulate
shares in their own MFI, almost always using interest free loans from their own MFI to
do so. These shares are then offloaded at the time of the IPO. In the two most notorious
microfinance IPOs to date Compartamos in Mexico, and SKS in India senior
managers were able to garner several tens of millions of dollars of personal gain from the
sale of shareholdings they had built up over previous years using the interest free loan
route.
22
In a very real sense, then, the microfinance model contains the seeds of its own
destruction as a development intervention. Microfinance today is about making large
sums of money for the providers of microfinance, and not about resolving the poverty
situation of the poor recipients of microfinance (see Klas 2011: Sinclair 2012). MFIs
become super-charged into selling as much microfinance as they can, and, unlike in
other product markets (furniture, food, clothes, etc), it is not difficult to convince the
poor that there is no upper limit to how much microcredit they can ‘consume’. Both
providers and recipients within microfinance are thus automatically stimulated into
excessive supply and demand respectively, thereby providing the fuel for the inevitable
‘microfinance bubble’.
(f) The microfinance model ignores the crucial importance of solidarity and local
community ownership and control
It has long been recognised that community solidarity, trust, volunteerism, equality,
cooperation and goodwill are intimately and positively linked to the wider issue of
‘community liveability’ (for example, see Zamagni and Zamagni 2010). But as many
have argued (for example, Leys 2001), whenever community development and poverty
22
For example, see SKS and Compartamos Catalysts for Catastrophe’, India Microfinance, October
19th, 2011. Go to: see http://indiamicrofinance.com/sks-compartamos-milford-bateman.html
27
reduction activities are constituted as commercial operations, this quite dramatically
increases the likelihood that such important outcomes for society are undermined.
In many ways the microfinance model undermines these important ‘community
liveability’-building processes. Perhaps most important of all, the local hyper-
competition that follows in the wake of microfinance is a patently unsuitable foundation
upon which to build ‘community liveability’. As Davis (2006) reports, it is precisely the
unrelenting growth of informal microenterprises that accounts for the destruction of the
sense of local community and solidarity in many developing countries. As Davis argues,
[t]hose engaged in informal sector competition under conditions of infinite
labour supply usually stop short of a total war of all against all: conflict, instead,
is usually transmuted into ethnoreligious or racial violence … the informal sector,
in the absence of enforced labour rights, is a semi-feudal realm of kickbacks,
bribes, tribal loyalties, and ethnic exclusion the rise of the unprotected
informal sector has too frequently gone hand in hand with exacerbated
ethnoreligious differentiation and sectarian violence (page 185).
Put very simply, the informal microenterprise sector simply does not possess the sort of
‘transformational power’ and solidarity-building capability widely claimed for it by the
microfinance industry and its ideological supporters. On the contrary, the inevitable local
hyper-competition and the resulting brutalization of poor individuals and intensification
of their day-to-day workload and suffering are an unlikely precursor to ‘community
liveability, or for any other desirable economic and social development outcomes. Local
solidarity is inevitably destroyed as the distorted business ethics and morals that
inevitably emerge under such Hobbesian conditions gradually percolate into other
enterprise structures (i.e., SMEs), other institutions (i.e., government) and across all
levels of society.
3. Microfinance is used as a vehicle for neoliberalism
One of the major assumptions about microfinance is that it is ideology-free and simply
about ‘helping the poor’. However, microfinance in its commercialised form is actually
almost perfectly in tune with the core doctrines of neoliberalism, the reigning ideology of
28
our time: that is, the need to vector all economic activity through private individual
initiative; the need to avoid any aspect of planning or conscious guidance of the market
mechanism; the need for all MFIs to attempt to ‘earn their keep on the market’; and, the
need to ensure that all economic organizations are also as much as possible owned and
controlled by the private sector (see also Harvey 2006). So might one of the reasons for
the almost unlimited well of support for microfinance be related to the political economy
of neoliberalism? After all, at least since the time of Marx, and more recently re-
emphasised by the conservative institutional theorist Douglass North (see North 1990),
‘bad’ organisations are allowed to survive, and may even be encouraged to flourish,
simply because it is in the interests of the powerful for this to happen. In this section, we
briefly adumbrate the intimate association that clearly exists between microfinance and
neoliberalism.
(a) Microfinance provides a model for poverty alleviation that is politically acceptable to
the neoliberal establishment
A pervasive and continuing fear among neoliberals is that the poor will opt to use the
democratic process or popular pressure to demand the establishment or strengthening of
state and collective institutions capable of remedying their plight. As Bromley (1978)
pointed out, neoliberals were very quick to see the informal sector in general, and, we
would argue here, the microfinance sector in particular, as a way to pre-empt more
radical alternatives that might upset the prevailing economic system and distribution of
power and wealth.
Microfinance offers to neoliberals the hope that informal sector activities backed up by
microfinance will become universally embedded as the only legitimate exit route out of
poverty for both the individual and the community, thereby also removing from the
political and policy agenda a wide range of progressive policies. These include demands
for constructive state intervention, robust social welfare programmes, quality public
services accessible to all, income and wealth redistribution (including land reform), and
all forms of state, collective and cooperative ownership. The microfinance narrative
helps to legitimise not only the entrepreneurial process as the core foundation of any
society, but also the vastly unequal rewards (wealth and power) that inevitably arise in
the process. After all, an opportunity to be successful in entrepreneurship in Dhaka,
29
Abuja or Quito (thanks to obtaining a microcredit), or else as an entrepreneur in London,
New York or Paris, essentially requires all parties to adhere to the same rules, regulations
and processes: only the final rewards are different. And because such rewards
(supposedly) depend on the amount of individual talent and effort put into the venture,
there should also be no complaint as to any unequal outcome.
In this context, microfinance can thus be deployed to delegitimize and dismantle all
possible ‘bottom-up’ attempts to propose alternative development policies which might
primarily and directly benefit the majority but which would circumscribe the power and
freedom of established elites. Put simply, microfinance offers to neoliberals a highly
visible way of being seen to be addressing the issue of poverty, but in a way that offers
no real challenge to the existing structures of wealth and power. Those who fail to put in
sufficient effort to establish a successful microenterprise, or, worse, do not even attempt
to establish a microenterprise, can very effectively now be blamed for their own poverty
situation.
(b) Microfinance can be used to undermine the concept of basic state service provision
and to support privatisation and private sector provision
In a very real sense, microfinance has been consciously positioned as the substitute for
social welfare spending (and international donor support). Once the poor can be made to
accept that they are now in control of their individual and family destiny by using
microfinance, it becomes much easier for the government to fully absolve itself of
continued responsibility towards them. Governments can also, if they so wish, even
begin to dismantle social welfare systems constructed after years of social mobilization
and collective struggle.
For example, microfinance has been deployed as part of the goal to promote private local
service provision, rather than collective service provision through the state or local
community. This has been a long-time goal of neoliberal policymakers everywhere. A
major aspect of neoliberal Structural Adjustment Programs (SAPs) has involved the
dismantling of important public services and utilities serving the common good, and
their gradual replacement with private provision based upon user fees. However, not
surprisingly, almost all of these programs meet determined resistance from the poor, and
30
this is where microfinance comes in. Because it can spread the cost of access to private
provision over a longer period of time, microfinance can dampen down the initial anger
inevitably felt when important services are privatised and put on a ‘full cost recovery’
basis. Shiva (2002) reports that microfinance programmes have been successfully used to
ensure a less precipitous, and thus less politically damaging, decline in water demand
after privatisation.
Once the negative effects of the introduction of user fees are softened by the provision of
microfinance, it is hoped that the poor will begin to accept that they must permanently
pay for service provision, and so begin to see microfinance as the only way to find the
larger sums of cash required to gain regular access to private provision. Even though
collective provision of social services by the local state is usually the most efficient,
including when directly compared to microfinance (for example, see Mader 2011), in
this way it might still be possible to encourage the poor to begin to rely upon much less
efficient private sector provision. In some cases, unconcerned government officials and
politicians hope that the poor can be fobbed off with microfinance rather than state
activity. In India, for example, Harper (2007: 258) reports that government officials are
increasingly deflecting community demands to support better basic education and health
services on the grounds that poor people now have microfinance’ and should
individually seek to purchase such services (albeit at high prices) from the private sector
rather than through taxpayer-funded public provision.
(c) Microfinance underpins the drive towards financial sector liberalisation and
commercialisation
Microfinance has played an important role in the promotion of global financial
liberalisation and commercialisation. As Weber (2002) shows, MFIs that have achieved
financial self-sufficiency provide working examples to developing country governments
of ‘efficient’, subsidy-free, financial institutions. It is thus expected that all other
financial institutions will have to follow suit. If a financial institution serving the poorest
people can be profitable, the reasoning goes, all other financial institutions with a better
clientele profile should aim for profitability as well.
31
Most recently, commercial funding of microfinance programmes, including the outright
purchase of established MFIs by the commercial banking industry, has increasingly
separated the microfinance industry from its roots in the NGO sector. As increasingly a
part of the global financial complex, microfinance can be portrayed as a good example of
how Wall Street and the global financial sector in general ‘cares’ and how it directly
addresses core societal problems. At least until the global financial crash of 2008, it was
hoped by many in the international development community that this ‘public service
function’ provided by MFIs, and very publicly supported by many of the largest banks
on Wall Street (e.g., CitiGroup), would contribute to obtaining continued government
and public support for the ongoing liberalisation of the financial sector in general.
(d) Microfinance acts as an important ‘safety valve’ within the globalisation project
Perhaps the most important factor of all, however, is the ‘containment’ role that
microfinance has been allocated within the neoliberal globalisation project. It is widely
argued by neoliberals that globalisation has the potential to provide a major reduction in
poverty. Yet it is hardly a coincidence that globalisation has been determinedly driven by
a handful of the wealthiest of the developed countries by the US most of all (Gowan
1999) which (or rather whose elites) are expected to be, and have by far been, its major
beneficiaries (Stiglitz 2002; Chang 2007). But as globalisation increasingly concentrates
wealth and power into the hands of a small number of countries, regions and corporate
elites, the flipside, as Faux and Mishel (2000) explain, is a growing worldwide
population of the unemployed, powerless, marginalised, hyper-exploited and insecure.
And the rub here is that these ‘losers’ are beginning to reject both the outcome assigned
to them and, most dangerous of all for neoliberals, the globalisation process itself.
Symptomatic of this rejection is the rising social unrest, increased social and gang
violence, explosion in substance abuse, increasing crime and illegal business activity,
huge rise in pseudo-religions and cults, collapsing levels of social capital in the
community, and associated violent conflict (see Davis 2006).
In the potentially explosive situation emerging in many developing and transition
countries today, dramatically made worse by the Wall Street-precipitated global financial
crisis, and particularly acute in the growing number of ‘mega-cities’, microfinance
provides a crucial ‘safety valve’. The logic is well known. Universal social welfare
32
systems are being dismantled under the guidance of the main International Financial
Institutions, secure public employment opportunities are rapidly disappearing, and
formal sector employment are an increasing rarity too. Nevertheless, the hope (not
always a realistic one
23
) is that the microenterprise sector can engage the most articulate
and vocal of the poor, who might otherwise be thinking about resisting, or proposing
realistic alternatives to, neoliberalism and the globalisation project.
4. Conclusion
This article has raised issues of serious concern relating to the contemporary
microfinance model. While accepting that there are some minor and largely temporary
short-run benefits for a small minority of ‘winners’, just as in any casino a few lucky
punters will end up on a winning streak, we argue that the microfinance model has very
serious limitations as development policy. In many respects, in fact, microfinance
constitutes a very powerful ‘poverty trap’. We outlined the main flaws in the
microfinance model. We then provided at least part of the answer as to why the
international development community continues to lavishly support the microfinance
model in spite of these fatal, and now increasingly well-publicised and accepted, flaws.
The microfinance concept is linked to neoliberalism and the globalisation project. It is
therefore supported so strongly and uncritically because it is in agreement with the
international development community’s preferred economic and societal model based on
self-help and individual entrepreneurship.
Finally, a word on what might be better local and national alternatives. We very much
believe that there are better financial institution alternatives, such as financial cooperatives,
credit unions, building societies and local and national development banks. Fully
adumbrating the advantages of these generally community-owned and controlled alternatives
would, of course, require another article (however, see Bateman 2010b, Bateman 2012b:
Chang 2007).
23
The young and well qualified people who led the recent Arab Spring uprisings were not just risking
their lives to bring down dictators, but also very centrally arguing against being stuck in petty retail and
service jobs (i.e., in informal microenterprises).
33
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Thesis
Financial inclusion as part of the development process has gained considerable attention from policymakers worldwide. The numbers remain quite stark as 1.7 billion people worldwide remain without access to basic financial services. This PhD thesis aims to empirically disentangle some of the many interrelationships between financial inclusion, entrepreneurship and gender. It consists of four chapters and relies on the use of longitudinal data at the individual level. The first chapter studies the effect of geographical access to microfinance on entrepreneurship and examines if having this access enables individuals to move up the economic ladder in Pakistan. The second chapter examines if financial inclusion promotes women autonomy by generating women entrepreneurship. This chapter also constructs a comprehensive financial inclusion index to measure the state of financial inclusion in Mexico after taking into account access as well as the usage of different financial products. The third chapter explores the main drivers of financial exclusion in Pakistan after taking into consideration the need for credit and voluntary financial exclusion. Finally, the fourth chapter proposes a novel methodological approach of measuring household financial vulnerability by relying on unsupervised machine learning algorithms in the case of U.S. All these chapters use nationally representative survey data and rely on several methodologies to tackle endogeneity issues and concerns pertaining to selection bias. The results indicate that financial inclusion, entrepreneurship and gender are intimately related with each other. Microfinance seems to play an effective role in promoting entrepreneurship and enabling individuals to move up the economic ladder, whereas financial inclusion also seems to encourage women autonomy by fostering women entrepreneurship. The empirical results also uncover the main drivers of involuntary financial exclusion: financial illiteracy, poverty, and gender. Moreover, this thesis considers new methodological approaches to analyze household financial vulnerability and involuntary financial exclusion as an alternative to the standard line of research on these topics.
... Predatory lending, resulting from the strong competition among Mfis in an increasingly saturated market, has pushed many borrowers in a condition of over-indebtedness with some tragic consequences (Priyadarshee and Ghalib 2011). Furthermore, from a purely economic point of view, serious doubts have been raised about the true effectiveness of micro-credit (Bateman and Chang 2009;Sinclair 2012). Impact evaluation studies have undermined the initial euphoria surrounding microfinance, reporting an insignificant or even negative impact on poverty reduction and business creation (Straus 2010). ...
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Financial inclusion has been broadly recognized as critical in alleviating poverty and achieving inclusive economic growth. The capability of borrowers to repay their microcredit loans is a critical concern and is the first risk of Microfinance institutions sustainability. Exploring the determinants of credit risk is an issue of substantial importance in microfinance. The purpose of this research was to identify the savings group members’ characteristics that have impact on default risk. We have used a multivariate regression model to identify the factors that affect default behaviour among microcredit borrowers from savings groups. We have analysed a sample of more than different 400 Savings Groups and 7251 active users of the “Saving and Learning” program in Ecuador. Empirical results demonstrated that factors such as seniority, accumulated savings and the number of members in the savings groups are determinant variables of default risk. The significant positive sign on variable “Gender” is consistent with the previous authors that indicate that the probability of having problems in loan repayment is higher for males than for females. The generalizability of our findings should, of course, be interpreted with caution, as they may be idiosyncratic of the sample, period or region. To contrast and contextualize these results, we had in-depth discussions with the Savinco managers and their field agent in Ecuador. There are many contributions. For practitioners, relevant factors that can affect savings groups default rates have been identified. For academics, the rich information provided by the Savinco mobile App could be a starting point for further quantitative research.
... According to Maclsaac (1997), microcredit may be less effective, or even counter-productive, in helping the poorest of the poor to raise their living standards because the worse-off borrowers use the loans only for consumption or invest in less riskier (and generally less remunerative) activities compared to the better-off borrowers who tend to invest in riskier and more productive ventures including technological improvements, which provides opportunities of generating greater income to improve their living standards. In the same vein Bateman & Chang (2009) more recently, argue that microfinance works against technology adoption by creating an environment that helps perpetuate primitive technology. Maclsaac (1997) suggests that microcredit can be more effective when combined with other financial interventions such as savings and insurance. ...
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Microfinance has been widely discussed as one of the rural development initiatives to distribute credit and financial services to the rural poor in Thailand since the mid-1970s. In 2013, approximately 67.2% of the country’s 7.3 million poor resided in the rural areas and nearly half of them lived in north-east region. Most of the poor are smallholder farmers who experience poverty and live below the basic standard of living. Thus, they require to access credit to invest in their farming businesses and for household consumption. The demand for short-term credit plays an important role in the rural households’ borrowing that is predominantly supplied by the informal lenders. However, during the past few decades, the proportion of credit from formal financial institutions have grown dramatically to substitute the informal credit in the rural areas. This chapter presents an overview of microfinance in Thailand including the types and characteristics.
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Examines the impact of microcredit of Medellin. In particular, it highlights how the issue of much surplus capacity in existing informal microenterprises suggests that the creation of new microenterprises with the help of microcredit actually undermines the fight against poverty and creates social tensions.
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The most-noted studies on the impact of microcredit on households are based on a survey fielded in Bangladesh in the 1990s. Contradictions among them have produced lasting controversy and confusion. Pitt and Khandker (PK, 1998) apply a quasi-experimental design to 1991–92 data; they conclude that microcredit raises household consumption, especially when lent to women. Khandker (2005) applies panel methods using a 1999 resurvey; he concurs and extrapolates to conclude that microcredit helps the extremely poor even more than the moderately poor. But using simpler estimators than PK, Morduch (1999) finds no impact on the level of consumption in the 1991–92 data, even as he questions PK’s identifying assumptions. He does find evidence that microcredit reduces consumption volatility. Partly because of the sophistication of PK’s Maximum Likelihood estimator, the conflicting results were never directly confronted and reconciled. We end the impasse. A replication exercise shows that all these studies’ evidence for impact is weak. As for PK’s headline results, we obtain opposite signs. But we do not conclude that lending to women does harm. Rather, all three studies appear to fail in expunging endogeneity. We conclude that for non-experimental methods to retain a place in the program evaluator’s portfolio, the quality of the claimed natural experiments must be high and demonstrated.