Why Microcredit Does Not Work

Microcredit does not significantly reduce poverty for four major reasons: First, the money from most microcredit loans is spent on consumption rather than invested in business ventures, and therefore cannot result in increased income for the poor. Second, most poor people are not entrepreneurs and lack the skills to succeed at running their own business. Third, the microenterprises funded using microcredit lack economies of scale and have low productivity. Thus, microcredit borrowers earn too little to rise out of poverty. Finally, if the interest rates on microcredit are too high, the borrower might even become poorer rather than wealthier.

Consumption Loans

According to the Grameen Bank website, microcredit is “offered for creating self-employment for income-generating activities and for housing for the poor, as opposed to consumption.” The empirical evidence, however, does not support this statement. Between 50 percent and 90 percent of microcredit borrowers use the loans for a nonbusiness purpose, such as repaying another loan, purchasing an appliance, or paying for some other consumption activity. The recent book Portfolios of the Poor offers a uniquely detailed picture of the financial lives of the poor.25 Based on a small sample, only about half the loans made by Grameen Bank have been used for business purposes. More interestingly, less than 15 percent of the borrowers accounted for the bulk of these business loans by taking on multiple loans. Thus, the vast majority of borrowers used microcredit to finance personal consumption. The Hyderabad study cited above found that more than half the loans were used to finance personal consumption, and the authors conclude that these borrowers “may eventually become poorer” because they are “borrowing against the future.”

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