Roodman microfinance book. Chapter 9. DRAFT. Not for citation or quotation.10/12/2018

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 examinedmicrofinance 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 forreliable financial services. Thus microfinance is best seen asarising 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 freedomis 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 bydoing 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 offtheir 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 offeringsfinancing. 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 enthusiasticsupply of credit for microcredit, predominantly from public investors, is distorting the industry: undermining the drive to take savings andspurring overeager lending, even bubbles. Enthusiasm for credit appears inherently destabilizing in competitive markets, where MFIs can grow fastestby poaching each other’s clients, leading people to take several loans at once, and where no credit bureau givesMFIs the full picture. Meanwhile, animportant qualification relative to popular perceptionis 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 thatgive 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]. Hereflected 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 aptin that dismal scientistsoften think in trade-offs. Rejiggering a factory to alter theallocation of labor and capitalmeans more toasters but fewer microwaves. Part IIlabored 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 awaitus on at least two levels: in comparing microfinance to other charitable projects, andin 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 poordo deserve a place in the world’s aid portfolio, for two reasons.First, microfinance has compiled impressive achievements in building institutions that enhancethe 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 caveatsare 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 thepoint 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.

But within microfinance, trade-offs are harder to avoid. In the late 1990s specialists hotly debated the importance of serving the poorest, even if that required subsidies (including through wholesale finance at submarket rates), relative to the importance of weaning MFIs off subsidies so that they could grow to serve more people. Economist Jonathan Morduch called the split between the “poverty” and “sustainability” advocates the “microfinance schism.” Within this breach, however, a line of thought grew that questioned the inevitability of the trade-off: business-like sustainability, the argument went,need not cost much in depth of outreach” to the poorest. Bangladesh was Exhibit A. True to his training, Morduch doubted that the choices could be dodged so easily.[6] With coauthors, for example, he demonstrated that increasing a microcredit interest rate 1 percent (not 1 percentage point) in Dhaka, the capital of Bangladesh, reduced borrowing by slightly more than 1 percent on average. The implication: even in Bangladesh, cutting interest subsidies at an MFI might make it more self-sufficient,but wouldalso put formal financial services beyond the reach of somepoor people.[7] With other coauthors, Morduch examined data on MFIs around the world, looking for relationships between profitabilityand the shares of clientele that were poor or female. While hardly uniform, the overall correlationswere negative. “[I]nvestors seeking pure profits,” they concluded,“would have little interest in most of the institutions we see that are now serving poorer customers.”[8]

Theevidence gathered in this book also hintsat trade-offs, especially between development as freedom and development asinstitution building. Recall the end of chapter 7: “There is a margin at which convenience for the institution and the needs of the client conflict.” MFIs can do credit more easily than savings or insurance, yet it is credit that by nature curtails freedom more. Layering non-financial services on top of financial ones may enhance women’s agency but also takes subsidies. Higher interest rates may boostthe profitability of MFIs and the dynamism of the industry—and flirt with “usury.”Likewise, the trade-off between developmentaspovertyreductionand developmentasindustry building is so direct as to almost escape mention: higher prices make clients poorer.

If it is easy to point out choices, it is harder to make them. The consequences of subsidizing microfinance vary over place and time in ways we cannot gauge any more than we can predict the precise consequences of a one-percent interest rate cut on a hundred different borrowing families. Even if we knew exact consequences, ethical imponderables would raise their heads.How are we to weigh the benefits of cheaper services for a smaller group against those of more expensive services for a larger one?

In the face of such unknowns and imponderables, I suggest two principles of judgment. First,that microfinance (or anything else) is mostly likely to achieve its potential when it follows its natural constructive tendencies. If your daughter werea piano prodigy,you would probably try to nurture her talent even at the expense some growth along other dimensions. Note the “constructive”: you would probably not nurture her tendencyto sociopathy. By this principle, microfinance is likely to do the most good when it plays to its strengths. Going by the review above, the microfinance project’s real talent is for turning modest amounts of aid into substantial businesses and industries that provide reliable services.Among charitable projects, it is in this respect truly prodigious. To echo the previous chapter:“There is no Grameen Bank of vaccination.One does not hear of organizations sprouting like sunflowers in the world of clean water supply, hiring thousands and serving millions, turning a profit and wooing investors.”In contrast, client-for-client, microfinance does not stand head and shoulders above other forms of aid in reaching the poorest, let alone lifting them out of poverty. The evidence suggests the contrary in fact, that microcredit is more likely to reduce poverty among those who already have businesses or who, because they are better off to start with, can start a business more easily. With respect to Morduch’s “schism,” I therefore favor those who seek to do microfinance in a self-financing, businesslike way in order to maximize reach.