IE: Microfinance is less important than macro results: March 11, 2008

PRINTLINE – Big picture analysis

Why microfinance is less important than macro results

MAKING loans and fighting poverty are normally two of the least glamorous pursuits around, but put the two together and you have an economic innovation that has become not just popular but downright chic. The innovation -microfinance – involves making small loans to poor entrepreneurs, usually in developing countries… Unfortunately, it has also translated into a flood of hype. There’s no doubt that microfinance does a tremendous amount of good, yet there are also real limits to what it can accomplish.

This isn’t because microloans don’t work; it’s because of how they work. The idealised view of microfinance is that budding entrepreneurs use the loans to start and grow businesses – expanding operations, boosting inventory, and so on.

The reality is more complicated. Microloans are often used to smooth consumption’ – tiding a borrower over in times of crisis. They’re also, as Karol Boudreaux and Tyler Cowen point out in a re- cent paper, often used for non-business expenses, such as a child’s educa- tion… Microfinance evangelists sometimes make it sound as if, in an ideal world, everyone would own his own business. “All people are entrepre- neurs,” Muhammad Yunus has said. But in any successful economy most people aren’t entrepreneurs – they make a living by working for someone else. Just fourteen per cent of Americans, for instance, are running (or trying to run) their own business. That percentage is much higher in developing countries – in Peru, it’s almost forty per cent. That’s not because Peruvians are more entrepreneurial. It’s because they don’t have other op tions. What poor countries need most, then, is not more microbusinesses.

They need more small-to-medium-sized enterprises, the kind that are big ger than a fruit stand but smaller than a Fortune 1000 corporation… It’s easy for really big companies in poor countries to tap the markets for fund ing, and now, because of microfinance, it’s possible for really small enter prises to get money, too. But the companies in between find it hard. It’s a phe nomenon that has been dubbed the missing middle’.

Both socially and economically, microloans do a lot of good, working what Boudreaux and Cowen call Micromagic’. But the overselling of their promise has made us neglect the enterprises that could be real engines of macromagic. The cult of the entrepreneur that the microfinance boom has helped foster is understandably appealing. But thinking that everyone is, and should be, an entrepreneur leads us to underrate the virtues of larger businesses and of the income that a steady job can provide. To be sure, for some people the best route out of poverty will be a bank loan. But for most it’s going to be something much simpler: a regular paycheck.

Excerpted from James Surowiecki’s What microloans miss’ in the latest issue of The New Yorker

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