Microcredit Doesn’t Work

The concept of microcredit — tiny microloans used to help establish or expand income-generating informal microenterprises — was for most of the last 30 years seen by the international development community to be the perfect self-help answer to poverty, unemployment and under-development.Thanks to the passion and practical work of Bangladeshi economist, Dr Muhammad Yunus, Bangladesh effectively became the global ‘test-bed’ for the microcredit concept. Great things were promised.

Muhammad Yunus famously announced that poverty would be eradicated in a generation, and the very notion of poverty itself would soon be ‘consigned to a museum’ to which our children would have to go on study tours to see what all the fuss was about. With such hugely seductive and supposedly successful forms of ‘capitalism by and for the poor’ on offer, the key international development institutions, and the US government and World Bank in particular, fell over themselves to finance the idea of microcredit. The global microcredit movement was up and running very fast indeed.

Unfortunately, after nearly 30 years of global experience in the field, it is now quite clear that Dr Yunus has turned out to be spectacularly wrong. A growing number of independent analysts and institutions, and even long-standing supporters of microcredit, now accept that this is indeed the case. (http://www.booksforchange.info/Pop-Why%20Doesnt%20Microfinance.html)

Consider the latest ‘microfinance meltdown’ that recently took place in neighbouring India, in the state of Andhra Pradesh. Extensive deregulation, combined with the manifest greed and aggressive ‘get rich quick’ attitudes of the key individuals running the main microcredit institutions, unleashed a Wall Street/sub-prime-style trajectory that in less than a decade drove the microfinance industry into the wall. Some individuals, like Vikram Akula, became spectacularly rich thanks to their attachment to the microcredit industry; but for the poor, especially those now massively over-indebted, it has largely been a case of ‘all pain, and no gain’. (http://indian-microfinance-future.com/)

So why is it that the microcredit industry, from the Grameen Bank onwards, has not generated a positive long-run local economic development impact? History pretty conclusively shows that successful local economic development is actually most likely built upon an expanding base of scaled-up growth-oriented small and medium enterprises (SMEs) that, among other things, can adopt and develop important technologies, innovations and organisational routines, and which together can productively interact with other enterprises and organisations through vertical subcontracting and horizontal networking and clustering arrangements. (http://www.amazon.com/Things-They-Dont-About-Capitalism/dp/1608191664)

However, those communities in developing countries that pursued and then achieved the ‘holy grail’ of the microcredit movement – every poor individual can very easily access a microloan if they want one – have encountered a quite different history. Rather than experiencing local economic success, they were condemned instead to a wasteful and unproductive process of microenterprise entry and exit, an increasingly embedded informalisation dynamic, hyper-competition and self-exploitation (especially involving women in poverty) leading to progressively lower volumes, margins, wages and incomes in the microenterprise sector, rising personal over-indebtedness, and a dangerously mushrooming culture of violence within the growing community of micro-entrepreneurs all made increasingly desperate for clients in order to survive. Put simply, it is in underpinning these mutually destructive local development trajectories that (more) microcredit actually frustrates the attempt to construct a successful local economy over the longer term.

For perhaps the saddest reflection of this adverse microcredit-driven process at work in Asia, we need look no further than to Bangladesh itself, and especially to the iconic village of Jobra near Chittagong. Jobra is, of course, the location for Muhammad Yunus’ pioneering Grameen Bank, and so the effective starting point for the global microcredit movement. But in spite of an unparalleled availability of microcredit since the late 1970s, Jobra and its neighbouring villages very much remain mired in deep poverty, unemployment and underdevelopment. The tiny informal microenterprises that have been helped into operation simply cannot expand or innovate, nor can they productively interact to form a local economy with the potential to sustainably grow. Instead, the informal microenterprises established are all far too tiny and too weak, and faced with far too much competition from other microenterprises operated by others equally poor, to do anything other than barely survive.

Most informal microenterprises simply collapse after a few months or years. Importantly, failure often means the hapless micro-entrepreneur loses his/her savings, household equipment, land and other assets in the process of failing (or being forced to repay a microloan with no income). An unwise step into microenterprise activities thus all too often strips a poor family of its accumulated financial, physical and social assets, leaving them in a situation of irretrievable and dire poverty. Moreover, a new social problem haunts Jobra and its surrounding villages thanks to the ubiquity of microcredit – growing levels of personal over-indebtedness.

It is also a long-running tragedy that SMEs in Bangladesh have largely failed to get any support from the local financial system. Locally mobilised funds are increasingly channelled into informal and largely unproductive local microenterprises and self-employment. More recently, and even worse, these funds are going into consumption spending as well, an end use that has even less impact on the local economy than informal business activities and has also resulted in the recent over-indebtedness phenomenon in Bangladesh. The inexorable expansion of microcredit and informal microenterprises in Bangladesh, just as we recently confirmed in the Western Balkans, (http://www.kpbooks.com/Books/BookDetail.aspx?productID=236319) inevitably absorbs the financial resources and policymaker attention that might otherwise have been directed towards supporting the crucial SME sector.

Importantly, effective confirmation that microcredit has had no visible positive impact this last 30 years came last month, in the form of a UK government funded systematic review of microfinance – ‘What is the Evidence of the Impact of Microfinance on the Well-being of Poor People?’ This document provides the most comprehensive refutation to date of the many heady claims made on behalf of the microcredit model by its international development community supporters, and by Muhammad Yunus. The conclusion reached by the review team is an explosive one – ‘(the) current enthusiasm (for microfinance) is built on (..) foundations of sand’ (page 75). After 30 years since the microcredit movement was founded, the review team essentially found NO concrete evidence to confirm that microcredit has had an overall positive impact.

(Microcredit is a mirage, says UK study, http://bdnews24.com/details.php?id=203518&cid=2)

So, while perhaps well-meaning, it is now perfectly clear that Muhammad Yunus and his band of international development community supporters got it all wrong. The sour reality is that sustainable local economic development trajectories have everywhere been undermined thanks to the expansion of microcredit. In place of failed Yunus-style microcredit and informal microenterprise myths, we now urgently need to rediscover and revalidate the role of the SME sector.

To do this we need to underpin the various forms of community-owned and controlled financial institutions that we know from recent history can best support SMEs, notably financial cooperatives, credit unions, building societies, social venture capital funds and local/regional development banks. Making these changes will inevitably prove to be a difficult task everywhere, and it will require much more soul-searching, foot-dragging, reluctant career-changes, and additional financial resources too.

But the alternative of dogmatically continuing forward with the failed Grameen Bank-style microcredit model is surely now, more than ever, no longer a realistic option.

Dr Milford Bateman is a freelance consultant, Professor of Economics and the author of ‘Why Doesn’t Microfinance Work? The Destructive Rise of Local Neoliberalism.  

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