Bigger Is Better

Microfinance proponents also ignore the crucial role of economies of scale. Abundant research confirms that there is a positive relationship between the size of a company and its productivity. Evidence from India, for example, shows that labor productivity increases significantly with the size of the manufacturing establishment (see table 2.1).30 This problem is particularly acute for microenterprises, most of which have no paid employees. A study of microenterprises in Kenya found that only 26 percent of these owners earned an income above the minimum wage.31

Microfinance is very closely identified with the promotion of enterprises overwhelmingly below a minimum efficient scale, which could lead to long-term problems in economic development.32 Microfinance produces an oversupply of inefficient microenterprises that undermines the development of more efficient small and medium enterprises (SMEs). For example, microenterprises forced into drastic cost-cutting strategies to survive routinely, but temporarily, take crucial market share away from local SMEs that might otherwise be able to reduce unit costs and register meaningful productivity growth. China, Vietnam, and South Korea have significantly reduced poverty in recent years with very little microfinance activity. On the other hand, Bangladesh, Bolivia, and Indonesia have been havens for microcredit, and have been far less successful at reducing poverty. Bangladesh “has, in fact, made some economic progress in recent years, most notably through the growth of an export-oriented garment industry. Although the few thousand firms in the industry are smaller and less efficient than their Chinese counterparts, they are larger and more productive than individual craftsmen, microfinanced or not.”33

The ready-made garment industry in Bangladesh has grown significantly in the last couple of decades and has become a prominent part of the economy. Clothing exports from Bangladesh reached $9.2 billion in 2007, accounting for 76 percent of the country’s foreign exchange; the industry employed 2.2 million people, 80 percent of whom were women.34 Although there has been controversy over the working conditions in garment factories, it is clear that the industry has contributed to foreign exchange earnings, employment creation, poverty alleviation, and the empowerment of women.35 It is midsized entrepreneurial

Table 2.1 Distribution of firms by size in India

Own-account

Small-size

firm

Medium-size

firm

Large firm, formal sector

Average of total workers in establishment

1.7

3.2

10.0

63.9

Employment as % of all manufacturing employment

55.9

12.4

14.4

17.3

Average of hired workers in establishment

0

1.8

7.8

60.9

Value added as % of all manufacturing value added

10.3

6.8

8.9

84.3

Labor productivity index (Formal = 100)

4.2

11.3

12.7

100

Source: Dipak Mazumdar. The Employment Problem in India and the Phenomenon of the Missing Middle. Working Paper, University of Toronto, 2010.

companies, not microenterprises, that have led to the growth of this industry. According to a World Bank study, firms with fewer than 100 employees are not considered to be competitive given the market conditions.36 Manufacturing firms with 200 to 500 workers are considered to be the most suitable size by the owners and account for the majority of the industry output.

Rather than lending two hundred dollars to 500 women so that each can buy a sewing machine and set up a microenterprise manufacturing garments, it is much better to lend $100,000 to a true entrepreneur with managerial capabilities and business acumen and help her establish a garment manufacturing business employing 500 people. This business could exploit economies of scale, deploy specialized assets, and use modern business processes to generate value for both its owners and employees.

Proponents of microcredit often respond to the above argument by asking why not invest in both microenterprises and larger enterprises. The answer is that we should prioritize and make the best use of scarce resources. The limited supply of capital can be better deployed in businesses larger than microenterprises. It is also possible that the hype surrounding microenterprises might distract governments in impoverished countries from undertaking the necessary reforms to foster true entrepreneurship and larger enterprises. “Governments in fragile states have only so much political capital and capacity. So it is crucial to proceed in a disciplined sequence.”37 Governments need to prioritize and focus on development approaches with a higher payoff.

 
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