Vinoth Ramachandra

Micro-Credit Hype

Posted on: December 26, 2011

I return to Ha-Joon Chang’s debunking 23 Things They Don’t Tell You About Capitalism.  In one of his chapters, Chang argues that people in poor countries are generally more entrepreneurial than those in rich countries. Most citizens of rich countries work for a company, doing highly specialized jobs. As a result, they spend their working lives implementing somebody else’s entrepreneurial vision, and not their own. According to an OECD study, in most developing countries 30-50 per cent of the non-agricultural workforce is self-employed (the ratio tends to be even higher in agriculture). In some of the poorest countries the ratio of people working as one-person entrepreneurs can be way above that: 66.9 per cent in Ghana, 75.4 percent in Bangladesh and a staggering 88.7 per cent in Benin. In contrast, only 12.8 per cent of the non-agricultural workforce in developed countries is self-employed.

For developing-country entrepreneurs, however, things go wrong all the time: power cuts, delivery delays due to bureaucratic red-tape, bribery and transport breakdowns. Coping with all these obstacles, Chang observes, requires agile thinking and improvisation. An average American businessman would not last a week if he had to manage a small company in Maputo or Phnom Penh. Why then do these entrepreneurs remain poor?

Recognizing the entrepreneurial energy of the poor has led many secular and Christian NGOs to leap on the “micro-credit bandwagon” in the past couple of decades. The main idea behind micro-credit is that the poor lack the necessary capital to realize their entrepreneurial potential. Regular banks ignore them and local money sharks charge exorbitant interest on loans. Enter the micro-credit (or, more broadly, the microfinance) industry which gives  poor people, especially poor women, small loans at reasonable interest rates to set up a food stall, buy a mobile phone to rent calls, or buy a cow or chickens and sell their produce.

This was seen as the magic formula to end poverty. It proved immensely popular among American donor agencies who saw it as a way of making every poor person a capitalist, no longer depending on government handouts. Governments, in turn, could simply forget the poor and leave their welfare in the hands of foreign and local development agencies who would distribute microcredit loans far and wide. The popularity of micro-credit reached fever pitch in 2005, which the UN declared the International Year of Microcredit. The following year Muhammad Yunus and his Grameen Bank in Bangladesh, widely hailed as the pioneers of microcredit, received the Nobel Peace Prize.

Unfortunately, the cracks in the micro-credit industry began to appear before this. And they have widened. Several books have questioned the claims that microfinance has significantly improved the lives of its clients. The problems are too numerous to mention. But just consider the woman who initially makes good money by renting out a mobile phone in her village. As soon as more “telephone ladies” appear on the scene, the incomes fall dramatically. The answer to such overcrowding of the market is to start manufacturing the phones yourself or writing software to develop applications for the phones. But this is a major step up and the “telephone ladies” do not have the education or wherewithal to move into manufacturing or software design. The problem is that there is only a very limited range of simple businesses that the poor in developing countries can take on, given their limited skills, lack of education and access to technologies, and the limited amount of funds that they can  mobilize through microfinance.

What is worse, however, is that without subsidies from governments or international donors, microfinance institutions have had to charge near-usurious rates. It has been revealed that the Grameen Bank could initially charge reasonable rates of interest only because of the (hushed-up) subsidies it was getting from the Bangladesh government and foreign donors. When, in the late 1990s, it came under pressure to give up the government subsidies, the Grameen Bank was forced to re-launch itself (in 2001) and start charging interest rates of 40-50 per cent. In countries such as Mexico the interest rates can be high as 100 per cent. Since few businesses can make the necessary profits to repay the loans, most of the loans now made by microfinance institutions go towards “consumption smoothing”- people taking out loans to pay for their daughter’s wedding or to make up a temporary fall in income due to the illness of a working family member. In other words, the vast bulk of microcredit is not being used to fuel entrepreneurship by the poor, but to finance consumption.

What really made rich countries rich is their ability to channel individual entrepreneurial energy into collective, productive enterprises. Even exceptional individuals like Thomas Edison or Bill Gates could become what they have only because they lived in societies that had good collective institutions: laws that enabled them to build large and complex organizations; a scientific infrastructure that enabled them to acquire their knowledge and experiment with it; an educational system that supplied trained scientists, engineers, managers, and workers to run these companies; a financial system that enabled them to raise large amounts of capital when they wanted to expand; patents and copyright laws that protected their inventions; easily accessible local and overseas markets for their products, and so on.

Poor nations need help in building effective institutions and collective, entrepreneurial organizations, if they are to get out of mass poverty. There are severe limits to developing individual talents alone.

This raises a major question: Are NGOs, both secular and Christian, unwittingly helping governments evade their responsibilities for social justice?

10 Responses to "Micro-Credit Hype"

Some logical connectors seem missing. Micro-finance’s effects are surely painted in broad strokes and overstated, but this argument seems to do the same, debunking itself (at least in this short form). The final question leaves me wondering, Do you think NGO’s are homogeneously failing in the same way? I would love to come out of a post like this with positive and negative examples and/or at least one fresh, constructive idea (or practical step) to consider acting on.

Two questions:
1) Are there any micro-finance organizations that are doing a better job than others in keeping interest rates low and in addressing the big picture as they go?
2) Are there organizations that focus on this collective aspect to build infrastructure (or advocate with government leaders) as necessary to support economic development?

I ask because I get it. My job in the United States is to lead and develop non-profit trade associations to do that here. Part of that does involve non-profits advocating with government leaders for the necessary support. I want to know how I can better support the same in other countries.

There are two excellent points in this article:

“The problem is that there is only a very limited range of simple businesses that the poor in developing countries can take on, given their limited skills, lack of education and access to technologies, and the limited amount of funds that they can mobilize through microfinance”


“without subsidies from governments or international donors, microfinance institutions have had to charge near-usurious rates.”

I think this hits the nail on the head. Too often we look for simple quick fix solutions. But in reality the poor in the two thirds world need more. They need substantial investment in education, industry and infrastructure. Without these Micro finance will stagnate which is what we are seeing it do right now.

I agree with the article, it has helped governments to evade their responsibility to administer justice, and develop their nations.

I agree with most of the posts published Mr. Ramachandra, and I agree that the points above are well made. But I think the strokes are too broad, given that micro-finance does meet real needs, and it is not all diverted to consumption smoothing (a solid statistic would help here). There is nothing wrong with helping individual businessmen, if the loans are fair. And I would argue that NGO’s in general help governments evade their responsibilities, not just micro-finance organizations, but in either case not all are equally guilty, or guilty at all. Again, some examples would go a long way. You’ve responded to me before that you are writing to provoke and get people to read these books, but don’t the books have any hard evidence or examples that you could briefly describe? If not, then who are they for aside from graduate students and their teachers?

Absolutely agree with your conclusion…its hard to admit that well intentioned actions produce unjust results as well as good ones (at least in the short term)…it is hard to believe that we still fall into these myopic holes when just an bit of foresight could predict the problems ahead. That said…is there any evidence that micro-finance investment has led to an increase in civilian lobbying of governments to improve infrastructure? That could be a positive spin off…
Thanks for your reflections.

Good question, Carol. I, too, would like to know.

Andy, Chang’s book is popular, easy reading, very accessible. If you want “hard evidence’ you will find some of it there and more in the academic works from which he draws (details given in the endnotes).
I disagree with your comment about “NGOs in general”- that is a far more sweeping statement than anything I have made in my post! What “hard evidence” would you present for your case?

Partially true. The competition issue actually emerged because private equity started to chase micro-finance companies – a bigger problem of over debtedness began to emerge in India. It is now recognised that micro-credit has to be accompanied by other social development efforts – livelihood training, health insurance, infrastructure improvement, education etc. Nevertheless, this can only suplement efforts of government agencies and cannot be a substitute for government action.

There are some statistics on the success rates of micro-credit programs world wide – if i can remember correctly, it is close to only 2% of the programs that are successful, i.e. sustainable while benefiting the recipients. Chalmers center for economic development ( recommends churches to not get involved in micro-credit but promote small scale savings and credit associations (SCA) which does not involve the churches to handle money nor does it require massive overhead costs for loan processing that Grameen had to meet without govt. subsidies. SCA can function as training grounds for business planning, food and nutrition, and etc. while being a social accountability factor to those who borrow. The down side of SCA is they cannot afford to give large loans. I agree with C. Thomas comment that the development effort has to be holistic in nature so that people are empowered to speak for themselves with govt. agencies.

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“Six lenders chose to completely evade the law by rewriting their contracts. Getting a payday advance with no broker means that there will be no third party involved in the process.

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