November 28, 2007

The Big Picture on Microfinance

by Michael Miller

Among those concerned about economic development for the marginalized, few things have inspired the imagination and generated such excitement as microfinance. Secular and religious organizations alike tout it as force to fight poverty and empower the poor, especially women. While microfinance can play a role in helping people become independent, free them from the vicious cycle of loan sharks, create a sense of empowerment, and help people get out of abject poverty, its long term role in poverty reduction is unclear. And there may be negative unintended consequences with this form of aid that undermines development rather than encourages it.

Microfinance was popularized by Muhammad Yunus, winner of the Nobel Peace Prize and founder of the Grameen Bank in Bangladesh. The bank provides small loans to those with little or no access to credit, and enables them to buy resources to produce goods they can sell on the market. The primary borrowers are women, and access to loans provides them independence and opportunity to go into business for themselves.

Despite good intentions and some positive impact, there are some serious concerns about microfinance that should not be ignored. Investing in microfinance is attractive, but as Arneel Karnani points out in the Stanford Social Innovation Review, microfinance places the emphasis on small subsistence activities which are much less effective than larger industries at helping the poor. Microfinance can also create a dependence on borrowing. Credit can be helpful, but it is not a solution for long term growth. Jobs in larger companies and factories are much more stable and lucrative. Businesses that create value are the best answer for sustainable growth, and for these to flourish focus needs to be placed on institutional reform and the creation of a just investment climate.

There are other concerns as well. The Grameen Bank not only gives out loans, it also attempts to change culture and promote development by encouraging new attitudes and behaviors among its clients. The bank encourages women to make "16 Decisions" to change their behavior and lifestyle. The “16 Decisions” include helpful practices like keeping their houses and the environment clean, building pit latrines and drinking from well water. Others, however, promote a collectivist mentality or attempt to promote cultural change such as abolishing dowries and discouraging childbirth—that is, generally promoting a Western secular view of the person. While the promotion of hygiene is beneficial, the Decisions’ collectivist social engineering elements can actually exacerbate an already existing scarcity mindset, undermine development and entrepreneurship, and harm women.

Let's examine the decision to have small families. First, whatever one’s personal beliefs about family and children may be, the idea of small families is clearly a Western, secular idea, and pressuring poor women in the developing world to accept it in exchange for loans smacks of cultural imperialism. There are economic consequences as well. The idea that small families are beneficial is based on a zero-sum game that sees people as consumers and not as producers. This is precisely not the type of attitude one wants to encourage if the goal is to promote development and entrepreneurship. The zero-sum fallacy undermines an entrepreneurial mentality because it teaches people that it is impossible to create new wealth. It inadvertently teaches that the only way to get wealth is to get it from somebody else. This encourages people to look to government distribution programs which end up punishing the real wealth creators thereby harming the poor even more. If microcredit is supposed to be the first rung on the ladder to economic independence then teaching a zero-sum mentality is not a step in the right direction.

The Grameen Bank prides itself on its role in empowering women, but perhaps the most insidious effects are the possible unintended consequences for women. In any culture that prizes boy children more than girls, the practical effect of promoting fewer children will be the abortion or abandonment of girls, who are seen as financial burdens. The unintended consequence of this plan to empower women can result in the exact opposite -- a silent war against them. This leads to a host of other cultural and social problems down the road. As Nicholas Eberstadt’s studies have shown, China provides a good example of this effect: The male-female ratio there is close to 125:100, way above the 105:100 norm.

While microfinance can play a role in development it is not a panacea for poverty, and the way it is practiced now can have serious unintended consequences that actually undermine development. If it is going to be successful it has to help people move away from borrowing and stop promoting collectivist notions and a zero sum mentality that only hinders development. Microfinance can be the first step on the ladder but macro-finance is needed too. For widespread and sustainable eradication of poverty, an attractive investment climate with secure property rights and rule of law are much more important in the long run. Microfinance is a stop-gap measure: development will have taken place when it is no longer needed.