Has the microfinance bubble really burst? Guest blog by Milford Bateman

Microfinance used to be untouchable – the developmental equivalent of motherhood, apple pie or Mother Teresa. milford batemanNow it is increasingly coming under fire. Today guest blogger Milford Bateman lays out the case for the prosecution. Responses by Malcolm Harper and Thankom Arun to follow. Or you could just listen to this Guardian podcast with Ha-Joon Chang, David Roodman and Ajaz Khan. “The development industry has recently been transfixed by the battle being fought by Dr Muhammad Yunus to remain in charge of the institution he founded in 1983, the Grameen Bank. Yunus was relieved of his position as head of Grameen Bank last month, though yet another appeal has been mooted. Given Yunus’s iconic status as Nobel Peace Prize-winning global anti-poverty campaigner, this story not surprisingly generated headlines around the world. But of far more long-term importance is the accompanying critical scrutiny of the previously unchallenged ‘success’ of microfinance itself. This is something new. Mainstream media everywhere these past few years have begun asking awkward questions about microfinance (more accurately ‘microcredit’), among them: How come microfinance-dominated Bangladesh remains in deep poverty compared to the rest of rapidly growing East Asia? Why is it that Jobra village in Bangladesh, where Muhammad Yunus effectively started the entire microfinance movement more than thirty years ago, is not only still mired in deep poverty and deprivation, but also has a new social problem in the shape of serious individual over-indebtedness? With so many countries having achieved microfinance ‘saturation’ this last decade or so (notably Bolivia, Bosnia, Mexico, Peru, Cambodia and others), why is it that in none of these countries can we see obvious substantive poverty reduction and ‘bottom-up’ development gains? And, more recently, how could the microfinance industry in the Indian state of Andhra Pradesh precipitate such an explosively damaging wave of individual over-indebtedness, social distress and economic disruption? I look at the evidence in a just-released Background Note published by the Overseas Development Institute (ODI) and conclude that microfinance is certainly not all that it is cracked up to be. The first place to start looking is among the very many impact evaluations undertaken by the microfinance industry and its supporters. Most of the early impact evaluations were undertaken or sponsored by the very same microfinance institutions and microfinance promotional institutions (notably the US-based Grameen Foundation, ACCION and Opportunity) that were trying to convince the world of the magic bullet virtues of microfinance. Since then, however, most independent and rigorous evaluations have been unable to show any concrete evidence that microfinance has had a meaningful positive impact. After decades of huge funding and policy attention, for economic policy-makers and poverty specialists everywhere this is naturally a very worrying outcome.  The first specific issue I raise in my Background Note is one that is typically over-looked, but which seriously undermines the original argument for microfinance, namely that it promotes poverty reduction and development through income-generating activities. In fact, major microfinance figures, notably FINCA’s John Hatch, have openly admitted that up to 90% of microfinance is actually used for consumption rather than income generation. If we then factor in the high interest rates that typically prevail in most microfinance programs (because of high transactions costs and, increasingly, because of profiteering by those owning and/or in control of a microfinance institution) it becomes clear why many now refer to microfinance as ‘loan sharking-lite’. In response, microfinance supporters have shifted their argument, stressing its ability to smooth consumption, (notably the authors of the book ‘Portfolios of the Poor’). But such arguments largely ignore the growing percentage of poor households’ weekly budget that is being allocated to a new budget category – ‘microloan interest payments’. microfinanceWe find more bad news when we look at that small amount of microfinance that, as per the original Grameen Bank model, actually does go into supporting income-generating activities through microenterprise development. Previously identifiable positive impacts are, in fact, swamped by two largely ignored factors operating at the local level. First, local economies in developing countries don’t just elastically expand in order to automatically accommodate the legions of new microfinance-induced arrivals and expansions. With no additional local demand, pre-existing microenterprises will suffer by losing their existing customers (and these individuals are often just as poor as those requiring microfinance).  What we are seeing here is the ‘fallacy of composition’ – the microfinance industry is wrongly assuming that the marginal benefit registered by one supported unit (by one microenterprise making, say, baskets) will remain true for the whole community of microenterprises (everyone making baskets).    Second, negative impacts also arise from microenterprise failure. Just as in the developed economies, many microenterprises quickly fail after just a short period of operation. The importance of this event is not just that any possible poverty and development impetus is lost, but that it all too often plunges the poor clients into irretrievable poverty and deprivation through the loss of other assets. Importantly, as one book famously noted in its title ‘The Poor Always Pay Back’ (Dowla and Barua, 2006) – many poor clients feel honour-bound to repay their microloan, even though they now have no income flow with which to do so. That typically means that they have to liquidate a whole range of other assets, such as savings accounts, buildings and land, and divert remittance incomes flows into loan repayments. The microloan is eventually repaid, but the poor become poorer. As we have seen in Andhra Pradesh state in India, others simply continue taking out microloans from other microfinance institutions in order to repay their earlier microloans, leading to spiralling individual debts and an even greater personal/family crisis when they can repay no more.  Finally, the microfinance industry makes a fatal mistake in believing that sustainable poverty reduction and ‘bottom-up’ development actually lies within the gift of the informal microenterprise sector in the first place. Much of the impetus for this thinking has come from Peruvian economist Hernando de Soto (The Other Path; The Mystery of Capital), and more recently from the late CK Prahalad (The Fortune at the Bottom of the Pyramid). However, as with the earlier ideas promoted by Yunus, both de Soto and Prahalad appear to have misunderstood the nature of the growth and poverty reduction processes in the typical local economy. In Latin America, for instance, rising poverty and the expansion of the informal sector pretty much went hand in hand from the 1970s through to the early 2000s, a juxtaposition that clearly undermined De Soto’s very well received predictions made in the late 1980s that if microenterprises could massively proliferate (say, through liberalisation and getting rid of rules and regulations), then poverty would soon become a thing of the past. As Mike Davis notes, the displacement issue raised above meant that in Latin America average incomes in poor communities typically fell as more and more informal microenterprises were encouraged into competition with each other. The Inter-American Development Bank (IDB) provided high-level confirmation of this seriously debilitating trend in its 2010 flagship report ‘The Age of Productivity’, arguing that Latin America’s high levels of poverty arose because far too much of its scarce financial resources were channelled into microenterprises and self-employment, and so not into small and medium businesses that are far more productive. De Soto’s ideas on microenterprises would now appear to be dead in the water. Similarly, Karnani found that hardly any of Prahalad’s signature ideas (actually, case studies) held up in practise. Dambisa Moyo’s best-selling book ‘Dead Aid’ provides possibly the most vivid example of flawed logic linking microfinance, microenterprises and sustainable development. Referring to her native Zambia, Moyo argues (page 129) that the flow of microfinance in Zambia urgently needs to be increased in order to help out what she calls ‘the real entrepreneurs, the backbone of Zambia’s economic future’. What she actually means by this ‘backbone of Zambia’s economic future’, however, is made clear when she says you need to ’Think of a women selling tomatoes on a side street’. Her argument, in a nutshell, is that rapidly increasing the supply of female tomato sellers and similar petty activities will somehow underpin a sustainable development and poverty reduction trajectory. This is a staggering misunderstanding of what lies behind development and growth. Ha-Joon Chang in his most recent book ’23 Things they don’t tell you about Capitalism’, argues that the problem in developing countries is not a shortage of micro-entrepreneurs at all: Africa, for example, has proportionally far more entrepreneurs than the developed countries. The development problem here is actually that the vast majority of existing entrepreneurs are forced to operate outside of the institutional and organizational structures required to raise the productivity of their efforts and upgrade their businesses. The western economies in their past climb to economic power, as well as the East Asian ‘miracle’ economies more recently, were able to build collective structures and sophisticated organisational options (large business and industrial organisations, local supply chains, subcontracting networks, industrial clusters, etc). Without these mainly state interventions, including a ‘developmental state’ operating at all levels (national, regional, local/village), the massive proliferation of individual entrepreneurship in developing countries actually becomes part of the problem, according to Chang, and not the solution.  In short, then, a carefully balanced reading of the evidence shows the microfinance model to be a much less positive intervention than has been widely claimed. It might even constitute a new form of ‘poverty trap’. Recently, a number of alternative interventions using the same resources and targeted at the same people have quietly begun to take the place of microfinance. Indeed, the recent proliferation of these alternatives – from cash grants to micro-savings to public employment programs and to a renewed interest in the ‘missing middle’ of SMEs which must now be filled more pro-actively – indicates that the international development community has finally begun to appreciate the serious problems surrounding the microfinance model. Milford Bateman is a Research Fellow at the Overseas Development Institute and, since 2005, Visiting Professor of Economics at the University of Juraj Dobrila Pula, Croatia. He is the author of ‘Why Doesn’t Microfinance Work? The Destructive Rise of Local Neoliberalism’ And here’s Al Jazeera’s take on the Andhra Pradesh story ]]>

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9 Responses to “Has the microfinance bubble really burst? Guest blog by Milford Bateman”
  1. Alice

    Thank you Milford, I’m a huge fan of your book. I’ve just returned from a year of research in Zambia’s Copperbelt. In the aftermath of the global economic crisis and job losses many people have turned to trading in the saturated informal sector, which permits tiny profits, enough to buy relish but not escape poverty. It’s a city of traders, with very little value addition. In this urban context microfinance neither seems to enable individuals to escape their vulnerability nor support development more broadly. Supporting SMEs sounds like a great idea, Zambia should really stop exporting raw cotton, tobacco, copper etc etc. But there’s a political motive for the government promotion of microfinance, it allows the government to be seen to be directly helping poor women and youths (the two programmes are called ‘women empowerment’ and ‘youth empowerment’). These two programmes are regularly lauded in the government press. While government might gain equal political capital if jobs are created through SMEs, there havent been any photo promotions of the government credit programme for SMEs (CEEC) in the government press – perhaps because these are widely regarded as only going to political cadres, not to the people themselves. So while microfinance may not work for the poor or national development, it does seem to have political capital (particularly amongst supporters of the ruling party in Zambia’s Eastern province).

  2. Alice

    Also, just drawing on my time of living with MPs at Zambia’s hotel for MPs and attending parliamentary sessions on ‘youth empowerment’… Even though MPs may have different ideas about development, there is very little resistance to microfinance in parliament, as most parliamentarians are trying to secure this (UNDP) money for their constituencies, and thereby be seen to be helping the people (and in some cases reward their cadres). Because even if microfinance is not the best way to use additional money it is perceived as better than no money. In this way, donor enthusiasm for microfinance may bolster the power of the ruling party and its incumbent MPs, which may affect upcoming national elections.

  3. Re “…it becomes clear why many now refer to microfinance as ‘loan sharking-lite’. In response, microfinance supporters have shifted their argument, stressing its ability to smooth consumption, (notably the authors of the book ‘Portfolios of the Poor’)”
    This is intellectual sleight-of-hand. Those who are familiar with Stuart Rutherford’s work will know he has held this view for a long time. Consistent with this view, he has been a long time advocate of the importance of providing better savings opportunities, and an innovator of services in this area.

  4. Milford Bateman

    I don’t see my point here as amounting to ‘intellectual sleight-of-hand’. I’m familiar with Stuart Rutherford’s work and, yes, he has long advocated savings (while also supporting microcredit and the Grameen Bank in its pre-savings phase). But he was the exception: the vast majority of individuals in at the start of the microfinance movement in the 1980s were converted to the cause by Yunus and others because they believed the hype and spin that microcredit would create income-generating activities, which would in turn lead on to massive numbers of sustainable jobs, raised incomes, meaningful empowerment, and so on and so forth. When by the late 1990s/early 2000s these supporters began to realise that microcredit was actualy having very little net impact in these directions, if not a very negative one, the only way to keep the entire microfinance edifice afloat (and in many cases, it has to be said, to keep their jazzy careers and high-profile jobs in advocacy and promotional bodies going) was to engage in a ‘goal rotation’ exercise, and quickly find another goal that they could reasonably claim to be passionate about pursuing and very near to achieving given more time and resources – this was ‘universal financial inclusion’ as CGAP likes to put it. In addition, these supporters sought to emphasise other financial instruments within the broader world of microfinance, like savings and insurance, in order to shift attention away from the original core, but now clearly failing, ‘pure’ microcredit concept.
    My point about ‘Portfolios of the Poor’ is that, to me anyway, the book downplayed the extent to which the poor in many countries are becoming dangerously addicted to using microcredit as a prop to consumption and, importantly, that they are increasingly paying out of their meagre incomes a growing portion to cover interest payments. This can’t be right for longer-term poverty reduction. In some countries, Bosnia for example, the poor are now being advised by new international donor-funded Debt Counselling bodies to now avoid coming into contact with microfinance institutions if at all possible, because they will inevitably end up seeing a valuable and growing portion of their income channelled into interest payments. How times change.
    I support savings-led financial programs and I think they do a lot of good. But my central research interest has always been the operations and real net development impact of the original microcredit idea pioneered by the Grameen Bank and others. Savings were not part of the original microfinance idea promoted by Yunus and others, as I noted in my response to Rick Davies above, but came much later. Which is why I dont really look at them much.

  5. Sudha

    first, thanks for your perspective.
    after reading the post, i have the following observations:
    1. you first note that microfinance is used for consumption (up to 90%), but then state how increased consumption drives profits down so more businesses fail, which drives microfinance clients into debt due to the increased supply – without a shift in demand. the logic here appears inconsistent.
    2. you also note that microfinance creates a new budget category called “microloan interest payments.” why is there no mention of moneylenders?
    3. lastly, i find the lack of mention of endogeneity or even a counterfactual telling, particularly with regards to correlations in the Latin America analysis you cite as evidence for the argument.
    i’m not a “miracle of microfinance” person, but i find that this kind of analysis, without caveat or exceptions, may only further confuse those unfamiliar with how microfinance truly operates on the ground.

  6. Observer

    This is an excellent, concise summary of some of the problems facing the sector. Thank you.
    The observation that a large proportion of micro-credit is used for consumption is worrying, and over-indebtedness is inevitable, well documented and placing stress on the entire sector. However, even if we focus on the productive use of micro-credit (the remaining 10% or so), much of this is channelled into inventory finance. Have a look at any peer-to-peer platform where loan purposes is stated and you will see the majority of business requirements are to buy stock. In addition to the crowding out effect discussed, there is an implicit assumption that information flows in markets where the poor operate are inefficient. The truth is the precise opposite. If a poor person offers a new product, or is able to buy an existing product in bulk due to a microloan and sell his or her product more cheaply, the other participants quickly catch-up and replicate the business, eroding any excess margins, as in any competitive market. Markets in developing countires are fiercely competitive. Worsening this situation is the fact that many MFIs prefer to lend to multiple vendors in a single market as this makes disbursement and collection easier, cheaper, and may therefore be more profitbale for the MFI (via reduced operating costs). If one or two vendors have access to capital, perhaps excess returns can be made, even in excess of the often onerous interest charge. But when dozens, or hundreds of people in a market are offered loans, how long will these returns last? This is elementary supply and demand.
    Another dimension that is rarely considered is the number of children that are working in these micro-enterprises. In the absence of formal research in this area, my cursory observation is that a large number of micro-enterprises employ their own children. In some (not all) of these cases, is this at the expense of education? In Latin America, for example, universal primary and secondary education is becoming a reality, and yet some (I repeat, not all) families may be depriving their own children of an education in favour of shelf-stacking. Research in this area is required, but interestingly very little discussion revolves around this topic. Even the self-regulatory organisations fail to address it. The SMART Campaign, and the often-cited Client Protection Principles, promote various aspects of protecting the rights of the poor, transparent interest rates etc. but are silent on the topic of child labour.
    My final concern is that of the role of the microfinance investment funds and peer-to-peer organisations such as Kiva. These act as the primary sources of funding for most MFIs, and the more obvious means for most people to invest in microfinance. Are they somehow complicit in what could appear to be a cover-up of the actual impact of microfinance? To what extent do they have tangible evidence to support their vocal claims of poverty eradication? They claim to adhere to client protection principles, but they have an obvious conflict of interest regarding MFIs that charge high interest rates and are correspondingly profitable. Whenever the latest MFI scandal erupts, note how little attention is applied to the providers of capital to the MFI. There appears to be no effective regulation of these entitites. The peer-to-peer organisations provide heart-warming stories about the borrower and what they intend to do with the funds, but rarely state the interest rate the poor will actually pay for the loans.
    The sad aspect of this emerging critique of microfinance is that under certain conditions it can work, and some MFIs are genuinely contributing to poverty reduction. The absence of any evidence of broad poverty reduction as a result of microfinance suggests this is a small sub-set of the sector, but do we risk throwing out the baby with the bathwater by brandishing the entire sector as ineffective? Although I agree with much of Bateman’s premise, perhaps it would be useful to focus our attention on the conditions under which microfinance can work? The self-regulatory bodies, often funded by microfinance insiders, are clearly inadecuate. Perhaps formal regulation is not the evil it is often claimed to be? Perhaps greater transparency on interest rates (see http://www.mftransparency.com) and the proportion of loans destined for consumption, and an explicit policy on child labour, would be good places to start? But I am increasingly agreeing with Bateman et al that SMEs may be a more productive use of scarce capital. But with such massive vested interests in microfinance, this is likely to be fiercely resisted, even in the face of such overwhelming evidence that microfinance is nowhere near as effective as it was once claimed.
    Mr. Bateman – do you believe there are ANY circumstances in which an MFI can benefit the poor?

  7. Milford Bateman

    A belated thanks for your kind comments. Your research sounds very interesting and I hope it finds its way into some high-profile publication very soon.
    I think you are a little confused here, or maybe I was unclear.
    1. Consumption – I raise the issue of most microcredit now going into consumption spending to emphasise that the original Yunus idea behind it – support for income-generating activities – is now no longer operative. But the issue of consumption and displacement are completely separate issues. I was arguing that most microenterprises by their very nature target local demand patterns. They tend to find very little demand, and so struggle and almost all simply end up displacing incumbent microenterprises, meaning ultimately no net gain in terms of local employment or income. Crowding more and more microenterprises into the same local economic space is simply not the way to reduce poverty, raise the level of local employment, or promote sustainable development.
    2. Not sure what you are getting at here. Loan sharks are bad, we all accept that. But simply to argue that microfinance is ‘a little better than loan sharking’ is not much of a social achievement if we can go much further than this as we seek to help the poor out of poverty. I’m reminded of the Godfather and Vito Corleone dispatching the old Don in his hallway and then providing to the community, among other things, loans at slightly lower interest rates than the old ‘nasty’ Don. People did not love him as much as he had hoped – he was still a loan shark!
    3. I had a limited amount of space in the blog to discuss issue of endogenous development. Or to outline lots of counter-examples. I made my points within the space I was allowed. Better to consult my book for such material. But one point – for so long the hugely biased nonsense produced by the main microfinance advocacy bodies was not countered by anyone, yet as soon as a critic attempts (often in a small amount of space) to make the case against microfinance, he or she is bombarded by the demand to fully present both sides of the argument. Sheesh!

  8. The true scandal of MF is that it was so obviously an availability cascade of the silliest sort- without any footing in Development Econ or any other discipline-and yet it was allowed to run and run.
    I suppose there might be a purely intellectual interest, amongst second rate data-crunchers, in the nitty gritty of Randomised Trials and so on- but why place the burden of detailed refutation, in this case, upon Prof. Bateman? He has better things to do- indeed writing this post, he is doing a far better thing then arguing the toss with the Randomised Trial tossers.