Learning from Microfinance’s Woes
March 1, 2012 Editor 0
A few weeks ago, I attended a lecture about microfinance, and got sucker-punched. Expecting to hear a litany of pros and cons about the business, and an exploration of good and bad models, I was instead greeted with a knockout punch: Microfinance doesn’t work, at least not in the way we think it does.
The pugilist-presenter was David Roodman, a fellow at the Center for Global Development and the author of a new book, Due Diligence: An Impertinent Inquiry into Microfinance. Billed as the “most complete investigation ever into the consequences of microfinance,” Roodman’s findings aren’t pretty.
Development agencies have promoted microfinance — the provision of small financial loans to poor people — because it is supposed to help poor people move out of poverty. After a comprehensive review of existing studies, with particular focus on recent randomized control trials, Roodman says that just isn’t true. “On current evidence, the best estimate of the average impact of microcredit on the poverty of clients is zero,” he argues.
Roodman does find, though, that the while microcredit isn’t a successful approach to poverty reduction, “it’s not the financial equivalent of cigarettes.” Wow. That’s comforting.
Another reason for justifying microcredit is that it offers poor people, particularly women, greater control over their financial lives. Roodman says the evidence is mixed on that count too. Some women may have been empowered, but others have been forced to repay loans when it wasn’t best for them. Cross-collateralization groups become burdensome, not emancipating, and at their worst, they lead to situations where people rob from each other to pay off their debts.
The third benefit is that microfinance represents a new industry that generates jobs and services. Roodman does say that the evidence is generally positive here. Microfinance institutions do “compete and innovate, cater to poor people, create jobs, and enrich the national economic fabric.” According to Roodman, the cumulative amount of subsidized capital in microfinance by 2009 was $15.7 billion, and that has helped create a new industry. That’s nice.
However, those billions could have helped create jobs in other industries, some of which — such as health, water, and sanitation — may have had a bigger impact on poverty than microfinance has had. To make a judgment, a comparative cost-benefit analysis would be necessary. And we couldn’t throw in the benefit of poverty-reduction as a mitigating factor since that doesn’t seem to be happening.
I left the discussion feeling defeated and fearful.
For starters, if Roodman is right, I’m a liar, or at least, a misinformed advocate of microfinance. For years, I’ve been saying that microfinance has lifted millions of families out of poverty, but we need a thriving small and growing business sector in order to lift countries out of poverty. You can’t build sustainable national economic prosperity based on tiny firms. It seems like the first part of that isn’t true.
My other response was fear. The organization I work for, Aspen Network of Development Entrepreneurs (ANDE), is dedicated to building a “movement like microfinance, but aimed at the next level up” — another line I may have to stop using. Businesses that have the greatest potential to create impact are the ones seeking $200,000 or $2 million in investment, not $200 or $2,000.
Organizations join ANDE because they share the common mission of increasing the prosperity of poor people in emerging markets, believing that supporting entrepreneurship and market-based solutions is part of a sustainable approach to poverty reduction. ANDE has identified the “missing middle” — the space between investments in small businesses and those in other businesses in emerging markets, such as private equity for larger companies — and its members help fill the gap with capital, training, and resources.
But that’s a hypothesis; there isn’t sufficient evidence to back the assertion that small and growing businesses are a key part of poverty reduction. That’s why I was scared… I was standing there thinking “I don’t want to be sitting in a room like this 10 years from now, hearing how my industry, my movement, my life’s work had ‘an average impact on poverty of zero.'”
I’m relieved that ANDE launched a research initiative in late 2011 that aims at answering the question of whether support for small-and-growing businesses creates prosperity for poor people. Working with academics and practitioners, it is conducting rigorous impact assessments of support programs, and developing data sets at the household level to track poverty reduction over time. This is a relatively nascent field, so it will be necessary to explore it rigorously.
I’m sure that we’ll find that it has a positive impact on poverty reduction, but then again, I was certain that microfinance had a positive impact as well. At a minimum, we won’t be blindsided again.
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