This is part two of a two-part post on microfinance. Part one can be read here
In the last post, I gave a rundown of the mechanics of microfinance and explained the criticism of high interest rates. Another criticism came from development economists like Dean Karlan, founder of Innovations for Poverty Action and pioneer in the utilization of randomized controlled trials for determining the efficacy of development interventions, and Jonathan Morduch, who, in his seminal book, Portfolios of the Poor, found that microfinance had limited impact in increasing incomes for clients. They found that, contrary to conventional wisdom, microfinance was actually most beneficial in “smoothing consumption.” Most people living $2 a day do not actually earn $2 every day. Instead, they might earn $10 one day and nothing for the rest of the week. So the consistent capital offered by a microfinance loan actually allowed them to feed their families and pay school fees when no money was coming in.
My opinion on the effect of microfinance has largely remained unchanged. First, I understand and recognize the necessity of charging high interest rates. In order to maximize their impact, MFIs must be profitable to some degree and operated largely unsubsidized if they are to be sustainable. If this means charging higher interest rates, so be it.
Regarding the criticisms from the development economists, a randomized controlled trial conducted over a two-year time frame is hardly a sufficient time frame to determine whether microfinance is an effective tool of poverty alleviation. The effects are generational. If a microfinance loan allows someone to keep their child in school consistently and maybe even graduate high school when they otherwise would have pulled them out to work on the family business, the impact on the community will not be felt until that child is grown and is sending money back from his or her well-paying job in the city in the form of domestic remittances. This is a 20-year time frame, at the minimum. To my knowledge, no longitudinal study comparing communities served by microfinance with those that are not has yet to been done.
Secondly, there are some incredible success stories of clients bringing themselves out of poverty as a direct result of microfinance loans. I know because I met some of them – the ones who started with a loan to build a small stall to sell vegetables, and expanded to purchase a small restaurant, a piggery, and a motorcycle repair shop. These stories cannot be discounted and, even if they were all that microfinance had to show for its efforts, that to me is enough.
Thirdly, microfinance institutions offer benefits beyond simply credit. I have documented on this blog many times the different products offered by NWTF and other institutions. Mass weddings for those who could never afford it, life and health insurance for families who are constantly in danger of falling deeper into poverty with a single illness, and financial literacy trainings to help them better run their businesses. MFIs also act as a distribution channel for products that might never reach the base of the pyramid market. Clean cookstoves, solar products, and other products can be sold to the hundreds of thousands of microfinance clients who, at least once a week, convene with a potential salesperson.
Lastly, and most importantly, I believe in the free market and the right for people to choose what they think is best for them. Most recently, I worked for a company whose mission – to provide an affordable, low-cost alternative to public education – is fundamentally libertarian (namely, school choice is a good thing). Criticizing microfinance institutions for misleading clients and offering a service that is flawed is, to my mind, patronizing to the clients who subscribe to the model. If the women taking loans from microfinance institutions felt they were being exploited, they would cease to take them, just as parents would pull their kids from Bridge schools if they felt their child was not being educated.
People in the development world too often underestimate the ability of the people they purport to serve to make rational decisions. I don’t, and, if I did, I might have the same criticisms. But I do, and have stated my reasons for doing so many times on this blog.
To try to document all of the benefits I see to microfinance would take far more time than I would like to allot in this segment of my re-cap of the last three years. In future posts, I will elaborate on other issues in microfinance. But I am comfortable saying that, to this day, I feel the same way about microfinance as I did two years ago, when I extolled its praises all over this blog.
In my next few posts, I will talk about my thoughts on agriculture development.
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