A Quick Word About Microfinance

My friend Anthony and I have a blog where we occasionally discuss various political issues. He posted a question some weeks ago concerning microfinance, which you can read here. Here is my response:


Microfinance is lauded by some as a silver bullet which will rescue poor societies by allowing people to pull themselves up by their bootstraps, through providing financial services, training, and small loans to poor entrepreneurs. When microfinance is at its best, this is exactly what it does. It provides the means for people to provide for their families, save money, and improve their living situations. It avoids some of the problems of the traditional aid models, such as relying on corrupt governments, skewing local markets, and building dependence among the poor. Microfinance banks have typically targeted women, which has resulted in more freedom and empowerment for them; loans reduce the vulnerability of the poor during crises like sickness and drought. Repayment rates are typically high, and World Vision has reported increases in health and education, as families with loans are able to afford better living conditions and school fees.

But it comes with problems of its own. One obvious one is that microfinance, like any other tool, can be mishandled. It is not free from problems such as fraud, usury, and human error, just like other banks. Anthony mentions wealth disparity as a problem that might arise; to be frank, the real problem is nearly the opposite of this. The fact is that microfinance does little to help the poorest of the poor. They are usually trapped in subsistence activities, and if their loan does not help them grow their income beyond the interest rates, they will be worse off in the end. Most people in the developing world are not true entrepreneurs who have a visionary idea which can turn into profit and jobs for their community; 90% of these populations would be most benefited by a factory moving to their area and providing jobs. The International Labor Organization says that “nothing is more fundamental to poverty reduction than employment.”

So if a micro-entrepreneur is able to use a loan and develop a business where he can employ 100 people in his community, that will be far better than those 100 people getting their own loans to fund subsistence activities. The factory is able to access economies of scale and increase productivity; 100 women with their own sewing business simply crowd the market.

So to answer your question, in 10-20 years the criticism of microfinance will be that it wasn't able to deliver on the promise of curing poverty. It still is a good idea, and still helps millions of people around the world to provide for their families and defend against crises. But large-scale enterprises intensive in labor, public or private, will go much farther towards pulling societies out of poverty.