I Failure of the Libertarian Approach

Microcredit Misses Its Mark

Since Muhammad Yunus pioneered the concept of microcredit in 1976 and founded the Grameen Bank in Bangladesh, microcredit has become a major movement.1 The Nobel Peace Prize for 2006 was awarded to the Grameen Bank and its founder, and the Nobel Committee affirmed that microcredit must play “a major part” in eliminating poverty, noting that, “from modest beginnings three decades ago, Yunus has, first and foremost through Grameen Bank, developed microcredit into an ever more important instrument in the fight against poverty.” The United Nations designated 2005 as the International Year of Microcredit, and it states on its website, “Currently microentrepreneurs use loans as small as $100 to grow thriving business and, in turn, provide [for] their families, leading to strong and flourishing local economies.” Kofi Annan, then Secretary-General of the United Nations, declared that providing microloans to help poor people launch small businesses is a recognition that they “are the solution, not the problem. It is a way to build on their ideas, energy, and vision. It is a way to grow productive enterprises, and so allow communities to prosper.”2 C.K. Prahalad, in his popular book The Fortune at the Bottom of the Pyramid, argues that we should recognize the poor as “resilient and creative entrepreneurs,” and commends commercial banks, such as ICICI in India, for expanding into microcredit. What makes microfinance such an appealing idea is that it offers “hope to many poor people of improving their own situations through their own efforts,” says Stanley Fischer, former chief economist of the World Bank.3 Microcredit is touted as one of the newest silver bullets for alleviating poverty.

In this book, I use the terms microfinance and microcredit interchangeably. In the literature, microfinance sometimes also includes other financial services, such as microsavings and microinsurance. However, in practice, microcredit accounts for the bulk of the activities of most microfinance organizations, and thus that is my focus. Microcredit has captured the attention of the development community, the foreign aid industry, government policymakers, journalists, academics, and even the general public. Many books on the subject have been published, with optimistic titles like Banker to the Poor: Micro-Lending and the Battle Against World Poverty; The Miracles of Barefoot Capitalism; Pathways Out of Poverty; Hands Around the Globe; Back Alley Banking; Defying the Odds; Give Us Credit; The Price of a Dream; Small Loans, Big Dreams; Poverty Capital; and A Billion Bootstraps, to name just a few.

All this enthusiasm has attracted billions of dollars into the microcredit arena. Foreign aid organizations and the World Bank have devoted significant financial capital to microcredit. Wealthy philanthropists, such as financier George Soros, eBay co-founder Pierre Omidyar, and venture capitalist Vinod Khosla, have pledged hundreds of millions of dollars. Global commercial banks, such as Citigroup and Deutsche Bank, have established microfinance funds. When Banco Compartamos, a microcredit bank in Mexico, went public in 2007, it was valued at over $1.5 billion, and its initial public offering was 13 times oversubscribed. Even people with just a few dollars to spare are going to microcredit websites, such as Kiva.org, and with a click of the mouse, lending money to rice farmers in Ecuador and auto mechanics in Togo.

Grameen Bank alone disbursed over $5 billion in microloans over the last ten years, and it now has 7.7 million borrowers. In 2006, about 1,000 microcredit organizations and 300 commercial banks lent $1.3 billion to 17.5 million people in India, says Sanjay Sinha, managing director of the rating agency Micro-Credit Ratings International in India.4 According to the Microfinance Information Exchange, the 1,395 microfinance institutions (MFIs) that voluntarily reported data had lent $44 billion to 86 million borrowers in 2008.5 And the total loan amount had been growing at the rate of 34 percent annually for the previous five years. Worldwide, 3,552 microcredit institutions provided loans to 155 million clients, finds the State of the Microcredit Summit Campaign Report 2009.6 This implies that the total amount of microloans worldwide significantly exceeds $44 billion.

This fervor may suggest that microcredit significantly helps the poor. And many proponents make grand claims to this effect, including Yunus, who has said, “We aim to eradicate 50 per cent poverty by 2015 and eliminate it by 2030 . . . the first “museum of poverty eradication” will be established in Bangladesh.”7 Yunus claims that poverty rates in Bangladesh are declining by 2 percent a year thanks to the stellar role played by the Grameen Bank, and that 5 percent of the bank’s clients exit poverty annually. Somewhat less extravagantly, but still enthusiastically, the State of the Microcredit Summit Campaign Report 2006 declared that “microcredit is one of the most powerful tools to address global poverty.”

Given the intensity of interest in microcredit, the resources devoted to it, and the claims of success, it is reasonable to ask, How much do the poor really benefit from microcredit? There is surprisingly little evidence that microcredit actually reduces poverty. This, combined with doubts about the underlying logic of microcredit, has led to increasing skepticism about its impact. Besides myself, other prominent critics of microcredit include Thomas Dichter, Vijay Mahajan, Robert Pollin, and Milford

Bateman.8 The skeptics are becoming increasingly vocal. Recent books to question the success of microfinance include What’s Wrong with Microfinance; Why Doesn’t Microfinance Work?: The Destructive Rise of Local Neoliberalism; and Confronting Microfinance: Undermining Sustainable Development. On the whole, microcredit has, at best, a minimal impact on poverty reduction, and in some situations actually works to the detriment of the poor.

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