Should We Give Up on Microfinance?
The cover story in the summer issue of the Stanford Social Innovation Review hits like a bombshell: "Microfinance Misses It's Mark" (accessible here even if you don't subscribe to SSIR). Immediately the development-savvy reader is put on edge: isn't microfinance the one thing we can safely be proud of?
Yes and no, says author Aneel Karnani. He grants that microfinance produces well-documented social benefits, particularly for women. But, Karnani argues, it does not cure poverty. Stable jobs do. His illustration is simple and effective.
To understand why creating jobs, not offering microcredit, is the better solution to alleviating poverty, consider these two alternative scenarios: (1) A microfinancier lends $200 to each of 500 women so that each can buy a sewing machine and set up her own sewing microenterprise, or (2) a traditional financier lends $100,000 to one savvy entrepreneur and helps her set up a garment manufacturing business that employs 500 people. In the first case, the women must make enough money to pay off their usually high-interest loans while competing with each other in exactly the same market niche. Meanwhile the garment manufacturing business can exploit economies of scale and use modern manufacturing processes and organizational techniques to enrich not only its owners, but also its workers.
Karnani warns us about romanticizing the poor as entrepreneurs. Bedrock economic principles -- such as economies of scale -- still apply, and access to credit does not impart specialized skills to help differentiate a poor microentrepreneur or give her the financial wherewithal to take risks (i.e. invest in new technology or hire employees) beyond the provision of a subsistence-level income. So the poor compete directly in low-skill trades and lose out on economies of scale.
In other words, most microenterprises are small and many fail – contrary to the United Nations’ hype that microentrepreneurs will grow thriving businesses that lead to flourishing economies.This should not be too surprising. Most people do not have the skills, vision, creativity, and persistence to be entrepreneurial. Even in developed countries with high levels of education and access to financial services, about 90 percent of the labor force is employees, not entrepreneurs.
Even so, does Karnani's resulting charge -- "If societies are serious about helping the poorest of the poor, they should stop investing in microfinance and start supporting large, labor-intensive industries." -- make sense? I would argue that it does not.
The empowering virtue of the market is that when people have proper access and proper tools to gain entry, they find their own way. Karnani is absolutely correct that the vast majority of poor people are not cut out to be visionary entrepreneurs -- and neither are most Americans. Stable jobs provide economic security for most of us, rich and poor alike.
Access to such jobs is reason enough to lift the penalties widely imposed on big businesses for employing a large number of people or taking in revenues above a certain figure. These tax and quota policies take away the competitive advantage of economies of scale, locking big businesses out of their natural markets; these are the culprits denying steady jobs to the poor. Yes developing countries should seek out large, labor intensive industries, but doing this involves policy fixes that need hardly compete with microfinance.
To the contrary, microfinance does not and should not represent a pill for curing poverty that we force on unsuspecting poor people to make them get better. Karnani appropriately warns us against this. But then he makes the mistake of trying to pick a different winner, another idea that is "the key to ending poverty." Haven't development practitioners and economists been doing this for long enough?
I've got an idea: let's let the poor decide how they would like to proceed. Let's facilitate access to steady factory jobs if people want them, access to credit if they opt to start their own business and as many of the other resources that you and I enjoy in the developed world as we evaluate economic options for ourselves.
But let's not tell them which to choose. After all, we don't need an army of successful microentrepreneurs to make access to microfinance worthwhile: a handful of self-selecting visionaries can create a handful of companies that generate wealth for thousands of employees. Chances are that such visionaries exist in odd, poverty-stricken places: local entrepreneurs have the comparative advantage of local knowledge; that sort of "market research" is hard for established players to come by in new markets.
It's worth noting that Karnani doesn't just target microfinance. He intends the piece as a corrective in large part to governments that exult in empowering the poor through economic progress ("the poor have access to a booming microcredit industry don't they?") while allowing massive human needs to go unmet. Karnani singles India out particularly:
Sure, more Indians have cell phones. But what many remember about India is not all the people using cell phones. It’s all the people defecating in public because they do not have toilets. Even in Mumbai, the business capital of India, about 50 percent of the people defecate outside. The current celebration of private sector successes should be met, and perhaps chastened, with anger at the failure of the state to provide basic services.
Indeed, governments must do their part where there is market failure. Education, water and sanitation should be first priorities. Luckily, governments don't have to worry about how best to direct the poor out of poverty; only make sure they have options to find their own way. That should leave plenty of time to concentrate on the areas where government can help most.