The Complexities of Poverty and Development Strategies

A recurring theme in this journal is the amount of self-criticism within the development community.  There is no shortage of critics of an academic mind to point out the flaws in an approach to development without offering a reasonable alternative.  One common criticism is that microfinance doesn’t really offer a sustainable long-term economic solution to the problem of poverty.  It is too focused on the individual and not enough on the big picture – what is good for the population as a whole.  Most micro-businesses will never grow to a meaningful size because the capital provided by microfinance is not enough to bring them to scale.  So, the reasoning goes, poor people are destined to amble along without actually making their financial situation any better, while the small and medium enterprises (SMEs) that actually create the jobs needed to move the needle on macroeconomic development and poverty alleviation are neglected.

This critique is too simplistic.  For one thing, the argument that microfinance institutions operate at the expense of SME financing is a straw man.  It is true that there are a limited number of aid dollars in the world and allocation is a zero-sum game, but that is irrelevant here since the largest microfinance institutions are financially sustainable, raising money through unsubsidized loans at commercial rates, public equity, and their own operations. The World Bank, the IMF, and NGOs around the world do provide a lot of money for research, seed capital for smaller MFIs, and pilot programs for non-financial services.  But, for the most part, there is not much diversion of aid funding as a result of microfinance.  This is more of a gripe with how some critics frame their arguments.  The more important point is that there is a tendency among critics on both sides of the debate to ignore the complexities of the issues and create false tradeoffs in order to simplify the debate.  It is easier to argue in black and white than deal with shades of gray.

Microfinance Insights, an industry rag, posted an interview with Milford Bateman, author of the ambiguously-titled Why Microfinance Doesn’t Work.  Bateman illustrates this point well.  To Bateman, Muhammad Yunus is the Ron Popeil of development, and microfinance is the Showtime Rotisserie Cooker (“All you spend for this fabulous machine – a $400 value – is four easy payments of $39.95!”).  Here he discusses his beef with the notorious snake-oil salesman and his dubious wares:

Microfinance Insights (Insights): Where do you think microfinance has gone wrong?

Milford Bateman (Bateman): Microfinance’s initial idea of serving the poor might have been a good one but it misunderstood basic economic fundamentals—by believing that supporting the tiniest of enterprises is a long-term solution. There is no historical evidence that this is a workable development model, not least because very few tiny businesses actually grow into small and medium enterprises (SMEs). Microfinance misunderstood the basic growth processes of a market economy.

This is a broad-stroke critique that dismisses microfinance as a development model because it doesn’t produce the macroeconomic results that bring the masses out of poverty. Instead, we should be making larger investments in businesses with potential for growth that can be competitive on a higher level, employ people, and improve the local economy.  This is a neat explanation, but the reality is much more complex than that.  It is true that there is a “missing middle” of businesses that are too big for a microloan but too small for commercial bank.  But even if these potential businesses received the capital they needed, and began employing more people, there would still be the unemployed poor running a business out of their home.  And those would still benefit from a microfinance loan, though maybe not to grow their business.  Maybe they need it because they sell fish two days a week, but need to eat seven days a week.  So on the other five days, they can use the money from the loan to buy food until they get paid.  Bateman is right that most of these businesses won’t ever employ more than one person (though some will), but wrong in using this fact to dismiss microfinance.

These arguments also downplay or outright dismiss the value of incremental growth and marginal improvements in the lives of poor people.  Microfinance is part of a long-term solution, but not a “magic bullet” for poverty alleviation.  Just like any industry, there are fads in development that usually have an appealing narrative that fuels its popularity.  Some in the microfinance community have picked up the narrative and run with it, since, on balance, publicity generates interest, and interest brings money.  Here Bateman has taken the narrative of microfinance – that poor people pick themselves up by their bootstraps and march to middle class – and taken it as conventional wisdom.  But most serious critics of microfinance, like David Roodman, Dean Karlan, and Esther Duflo, who rely on randomly-controlled trials to determine the effectiveness of development programs, acknowledge that the narrative doesn’t always conform to reality and that microfinance, while not without flaws, does have a net positive impact.  The fish-seller is a good example of this impact.  Even if you simplify the argument, as Bateman does, to say that microfinance doesn’t produce macroeonomic change while SMEs do, it still doesn’t support the conclusion that microfinance “doesn’t work.”  That is, unless your definition of “work” is move all poor people out of poverty.  Richard Rosenberg, a researcher at CGAP and industry veteran, properly picks apart Bateman’s argument:

I’m generally delighted when anyone sticks pins in the inflated claims that have long been made for microfinance.  I’ve been around the business for a quarter-century and I’ve never seen any evidence that it promotes macroeconomic growth.  Pending the arrival of the new wave of randomized studies, I remain agnostic about the long-term effect of microfinance in raising the incomes of individual customers.

On the other hand, I’m confident that millions of MFI customers find the services very helpful in smoothing consumption, which sounds like a minor benefit only to people who have never had their consumption levels seriously disrupted.  Poor people clearly think that microcredit is helping them.  They pay high interest rates for it.  They repay loans, come back for more, and continue to repay faithfully over long periods, which is particularly revealing because the principal incentive to repay is the customer’s desire to keep access to a highly valued service.  That, plus the fact that you can get large quantities of microfinance out of very modest levels of initial subsidy if you do a competent job of placing those subsidies, adds up to a pretty good value proposition as far as I’m concerned.

Beyond the fact that customers like it and it doesn’t cost much, microfinance serves what already exists – people making ends meet by buying, selling, and making things.  If every microfinance institution ceased to exist, people would still be selling fish.  Only now, in order to buy the fish, they’d take a loan from a moneylender who gives $5 in the morning and comes back for $6 at night (300% interest annually).  Or, they’d take that same loan to buy food for dinner.  Taking it a step further, investing in SMEs is delayed gratification.  The U.S. knows how difficult it is to create jobs – if SMEs were the solution, we’d just be throwing money at every Pep Boy’s and Supercuts franchise that came in for a loan.  And not every SME would produce jobs for these people, and certainly not right away.  So microfinance and SME financing are complementary, not mutually exclusive.  You see this same concept at work in the way neoconservatives talk about American support for Israel (not to get off topic).  If you are opposed to what Israel does, you are an anti-Semitic Hamas sympathizer – there is no middle ground (which leaves people like me, wondering what to do).   In both debates, it is easier to view things in opposition to one another – black and white – rather than as integral components of something larger.

Bateman isn’t the only one to make this argument, but other critics are more nuanced and measured in their assessment.  James Surowiecki talked about the same concept a few years ago in an article called “What Microloans Miss.” The final paragraph sums up the argument:

Both socially and economically, microloans do a lot of good, working what Boudreaux and Cowen call “Micromagic.” But the overselling of their promise has made us neglect the enterprises that could be real engines of macromagic. The cult of the entrepreneur that the microfinance boom has helped foster is understandably appealing. But thinking that everyone is, and should be, an entrepreneur leads us to underrate the virtues of larger businesses and of the income that a steady job can provide. To be sure, for some people the best route out of poverty will be a bank loan. But for most it’s going to be something much simpler: a regular paycheck.

To me, Surowiecki demonstrates a better understanding of nuances of the problem.  Not all critics acknowledge or choose to deal with the complexities of poverty in their critiques, which doesn’t help anyone.

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