Roodman microfinance book. Chapter 9. DRAFT. Not for citation or quotation. 2/14/2011
Neither a borrower nor a lender be;
For loan oft loses both itself and friend.
And borrowing dulls the edge of husbandry.
This above all: to thine own self be true,
And it must follow, as the night the day,
Thou canst not then be false to any man. – Hamlet I.iii.79–84[1]
In the last seven chapters, we have examined microfinance from more angles than ever before in one place. We have shared the points of view of the user at the metaphorical teller window and the manager behind it. We have placed modern microfinance in the flow of history. We have surveyed its diversity. And we have taken seriously the strongest claims for its virtues, investigating each in turn: microfinance as reducer of poverty, enhancer of freedom, builder of industry. It is time to sum up, draw lessons, and ponder what lies ahead.
You know the popular image of microfinance: It was invented by that guy in India (or Bangladesh?) who won the Nobel Prize. It helps people start businesses and lift themselves out of poverty. Without claiming much originality, part I of this book put the lie to that image. But it also teased out a story that is more credible, more complex, and still impressive. Modern microfinance is not, as a cynic might have it, merely another foreign aid fad foisted upon the poor, doomed by its naiveté to fail. If it is a fad, then it must be the longest in the history of overseas charity. What explains its persistence is its remarkable success on the market test: poor people are willing to pay for reliable financial services. Thus microfinance is best seen as arising organically from several sources: the real needs of poor people for tools to manage tumultuous financial lives; a long historical process of experimentation with ways of delivering financial services; the creativity, vision, and commitment of the pioneers such as Muhammad Yunus; and the business imperatives of mass producing small-scale financial services.
In part II, I looked behind the mythology of microfinance. I tried, in the words of my colleague Ethan Kapstein, to be critical but not cynical, to investigate the evidentiary bases of the most serious defenses of microfinance with an eye to constructing a more realistic story. The lessons distill to:
· Credible evidence on microfinance’s success in development as poverty reduction is scarce. We have essentially two studies of microcredit and one of microsavings. The two of credit found no impact on indicators of household welfare such as income, spending, and school attendance over 15–18 months. That the celebrated sequence from credit to enterprise is more than a myth. The study of group credit in Hyderabad, India, spotted an increase in profits among the minority (31 percent) of households that already had a business, and more business starts among those best positioned by relative education and wealth to start one.[2] Meanwhile the randomized study of a savings account in Kenya found that this service too helped existing business owners, market vendors, invest in their businesses. And here, unlike with microcredit so far, the boost to entrepreneurship showed up as improvements in poverty indicators such as income and spending.
· The evidence on whether microcredit in particular spurs development as freedom is ambiguous. It stands to reason that poor people with volatile incomes need financial services more than the global rich, in order to put aside money in good days and seasons and spend it in bad; and that reliable loans, savings accounts, insurance, even money transfers, can help them do this. Financial services inherently enhance agency. But credit inevitably entraps some people through ill luck or judgment. Researchers who have spent weeks or years with borrowers have collected some happy stories of women of finding liberation by doing financial business in public spaces. Others have returned with disturbing stories—some mild, as of the women made to sit in meeting till all dues are paid, some more serious, as of the women whose roofs are taken by peers in order to pay off their debts. These contradictions are not hard to understand, for credit is both a source of possibilities and a bond. Overall, it is hard to feel sanguine that success stories are the whole story.
· The success on which microfinance can stake its strongest claim is in industry building. With time, the microfinance industry is growing larger, more efficient, generally more competitive, more diverse in its offerings financing. More institutions are becoming national intermediaries, taking deposits and lending domestically. In few realms can foreign aid and philanthropy point to such success in building industries. But this success still leaves scope for critique. The enthusiastic supply of credit for microcredit, predominantly from public investors, is distorting the industry: undermining the drive to take savings and spurring overeager lending, even bubbles. Enthusiasm for credit appears inherently destabilizing in competitive markets, where MFIs can grow fastest by poaching each other’s clients, leading people to take several loans at once, and where no credit bureau gives MFIs the full picture. Meanwhile, an important qualification relative to popular perception is that microfinance rarely turns clients into agents of economic transformation and growth. It does not fill the role Joseph Schumpeter saw for finance.
The hope that microfinance credibly offers lies in building institutions that give millions of poor people an increment of control over their lives, control they will use to put food on the table more regularly, invest in education, and, yes, start tiny businesses. Few lives will be completely transformed by microfinance; few will be lifted out of poverty. Yet because poor people are willing to pay for the services, microfinance institutions can serve many from a modest base of charitable funds. Recently, Rich Rosenberg recalled his oversight while at the U.S. Agency for International Development of “a few million dollars of donor subsidies in the mid-1990s” for Bolivia’s Prodem, which became the microfinance bank BancoSol and now serves [tens of thousands]. He reflected on the “value proposition” of microfinance, which he aptly diagramed this way:
Small one-time subsidies
leverage large multiples of unsubsidized funds
producing sustainable delivery year after year of highly valued services
that help hundreds of millions of people
keep their consumption stable, finance major expenses, and cope with shocks
despite incomes that are low, irregular, and unreliable.[3]
All varieties of microfinance—credit, savings, and the rest—ought to be seen as prescription-strength medicines. In appropriate doses for appropriate patients, they can do much good. In moderation, for example, credit can help people discipline themselves to put aside money for big but manageable purchases, including stock and capital for microenterprise. But pushed too hard, all financial services can be dangerous. People can get in over their heads with credit, watch their savings disappear in flimsy banks, be duped by fraudulent insurance companies, lose funds to dubious money transfer schemes. The enthusiasm right now is primarily for credit, so that is where the danger primarily lies.
The Effects of Causes
One lesson of part I is the one emphasized in its last chapter (chapter 5), that microfinance as we observe it is the outcome of an evolutionary process. This helps explain the emphases on credit, groups, and women. The evolutionary perspective also explains a trait little noted in chapter 5: the mythology that promoters have woven around the workaday business of disbursing and collecting loans. Almost no development project holds such strong and multidimensional appeal as microcredit. It appeals to the left with talk of empowering women and to the right by insisting on individual responsibility. As the cliché goes, it offers a hand, not a hand-out. And because the currency of microcredit is currency itself, not textbooks or trainers, investors feel that what they contribute—money—goes directly to the poor. To this extent, the intermediary disappears in the mind of the giver, creating a stronger sense of connection to the ultimate recipient. Peer-to-peer lending sites such as Kiva feature pictures and stories of borrowers to make the bond even stronger.
Just as it hardly matters from the evolutionary point of view whether joint liability was invented, discovered, or copied from earlier models in the 1970s, it hardly matters whether microfinance promoters believe the mythology, what Pankaj Jain and Mick Moore have called the “orthodox fallacy.” What matters is that investors—again, understood broadly to include all who provide finance for microfinance—have often rewarded those who tell certain stories, creating a selective environment that favors the microfinance groups best at telling them. This should not surprise. Partly in order to raise funds, all of us who believe in our work tell the best stories we can to illustrate our theories about how we help. Jain and Moore put it well:
We are not suggesting here that the leaders of the big [microfinance institutions (MFIs)] perpetrated some kind of fraud….The picture is far more complex than that and notions of blame or of individual responsibility are irrelevant to our objective of obtaining practical understanding of why and how [MFIs] have been so successful. Our limited evidence suggests that the orthodox fallacy blossomed and spread in large part because that is what people in aid agencies wanted to hear, thought they had heard, or asked [MFI] leaders to talk about and publicise. To the extent that [MFI] leaders did foster a particular image, this could be seen simply as targeted product promotion in a “market” of aid abundance…
…to justify the continuing flow of that money to their own particular organisations and to the microfinance sector as a whole, [MFI] leaders and spokespersons have gradually found themselves, through a combination of circumstances and pressures, purveying a misleading interpretation of the reasons for their success. They emphasise a few elements in a complex organisational system, and are silent on many key components.[4]
Ironically, microfinance succeeded in part by obscuring the businesslike nature of its success.
Though the mythologizing of microfinance is understandable, even inevitable, and though it has done a phenomenal job of promoting financial services for the poor, it has also harmed the movement. As studies emerge that contradict the high-flying myth, suggesting instead that microcredit is not a reliable weapon against poverty, public support may dive, like Icarus after he flew too close to the sun. Investors may turn against all of microfinance. And even if it escapes this fate, the mythology threatens to keep distorting the movement in favor of one service, microcredit, delivered in ways conceived at one time, about three decades ago. The mythology has spread the dangerous idea that investing in microcredit, putting the poor in debt on a large scale, is automatically good for the poor. In 2004, for example, the U.S. Congress acceded to lobbying from U.S. microfinance groups to require that half of all U.S. microfinance aid go to “very poor” people, despite the lack of much evidence that this was a practical and good idea.[5] This book is an attempt to develop a more honest story of microfinance, so that Icarus will neither fly too close to the sun nor brush the waves, so that the movement will realize its fullest potential to serve the poor. To start the construction of this new story, we need to synthesize the lessons on the impacts of microfinance from part II.
You can’t have it all
Economics is sometimes defined as the study of the optimal allocation of scarce resources. In truth, there is more to it than that (resources are rarely allocated optimally anyway) but the definition is apt in that dismal scientists often think in trade-offs. Rejiggering a factory to alter the allocation of labor and capital means more toasters but fewer microwaves. Part II labored to think and gather evidence about each kind of success, one at a time. But that evaluation is only input to judgment, which is necessary for wise action. Having built our evidence base by scoring microfinance against various standards, we now need to think across them, and here it is helpful think in terms of trade-offs.
Trade-offs await us on at least two levels: in comparing microfinance to other charitable projects, and in comparing styles of microfinance. On that first, broader level, the notion brings us to the grand questions of this book: Does microfinance deserve all that praise and funding? Or should microfinance investors channel their charity elsewhere? Microfinance is not unusual in the degree of our ignorance about its impacts. So our limited understanding of microfinance in particular is not a strong argument against it. I think that financial services for the poor do deserve a place in the world’s aid portfolio, for two reasons. First, microfinance has compiled impressive achievements in building institutions that enhance the freedom of millions. These achievements come with caveats, especially about the dangers of credit, but because microfinance is more than microcredit, and because microcredit is generally safe in moderation, the caveats are not fatal. Second, a principle of diversification applies in charitable investing just as it does in conventional investing: given the achievements and the inevitable uncertainties about the impacts of microfinance, school-building, road-building, or anything else, it is wise to invest in several strategies at once. Diversification reduces risk. That said, I will argue below that from the point of view of delivering appropriate financial services to the poor, microfinance’s slice of the portfolio has effectively grown too large, dominated as it is by credit for microcredit. Microfinance would do better on its own terms if there were less money for it. To this substantial extent, then, there is no trade-off between microfinance and other kinds of aid. Less money for microcredit and more for bednets would be a double win.