Too Good to Be True: The Remarkable Resilience of Microfinance

Article excerpt

When the concept of underdevelopment took shape in the middle of the last century, the search for the holy grail of poverty reduction began in earnest. And while many answers to the daunting challenge have been offered, none of the ideas put forth has had greater appeal or more endurance than microfinance. Yet no other longstanding idea about poverty reduction rests on as little empirical evidence of success.

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This is not to say that microfinance cannot work as a business concept. There are a number of microfinance institutions (MFIs) which make money {at least two, one in Mexico and one in India have even taken the initial public filing route) and a fair amount of what is now called microfinance is done under the aegis of commercial or other types of banking institutions, such as credit unions, which have been around for a long time. These kinds of MFIs are not subsidized by development-oriented public or private grants or soft loans. As such, they can go about what they do whether or not their claims to a greater good rest on a solid foundation or are merely good public relations.

But even given today's loose array of entities that call themselves MFIs--ads in the Paris Metro for consumer loans to the middle class refer to their loans as "microfinance"--at a minimum over half the funds committed to microfinance today are subsidized. Why should this be so? The only good reason to subsidize microfinance is if it has a demonstrable impact on poverty reduction or some other measurable social benefit that is otherwise unachievable. But it does not.

Microfinance's anti-poverty promise and its growing popularity are less a mystery if one looks at microfinance "memetically"--that is, as an idea which has spread contagiously, propelled in part because so many of its proponents want its promise of poverty reduction to be true, and indeed, need it to be true. The appeal of microfinance is remarkably broad, flawlessly magical, and has the added benefit of brevity--microfinance's anti-poverty promise can be stated in a couple of simple sentences: lend money to poor people who will invest in tiny businesses, and with their profits pay back the money and gradually rise out of poverty. And as more and more of such services are available, these ''micro-enterprises" will contribute to (and even drive) economic growth. The idea reaches the heart and the head (see below), the ideological left and the right, and contains an almost universally irresistible narrative: the poor can be agents of their own destiny if only they have a chance to access formal financial services, which, especially and for almost all of the history of microfinance, takes the form of microcredit.

I have argued elsewhere that perhaps one of the reasons explaining the serious lack of rigorous research on micro-finance's impact on poverty is that the idea was so strongly cherished that no one wanted to risk hearing that it might not work. For years the field took refuge in saying that what counts is high repayment rates (a proxy for success), or that the difficulties (and cost) of rigorous research were too daunting and in the end not worth it.

But in 2009, for essentially the first time, research based on rigorous randomized controlled trials showed that microfinance has no sustained effect on poverty reduction, much less economic growth. The Massachusetts Institute of Technology (MIT) Poverty Action Lab study in India as well as a study using randomized controlled trials in the Philippines by academics Dean Karlan and Jonathan Zin-man both found that microcredit did not reduce poverty. In addition, a recent study of four high microfinance growth countries (Bosnia-Herzegovina, Nicaragua, Morocco, and Pakistan) showed rising default and delinquency problems as well as a pattern of the poor borrowing from multiple sources. Moreover, many microfinance practitioners who work directly with clients on-the-ground have long noticed that the poorer the borrower, the more likely the borrower's economic activity is for the purpose of survival with little likelihood that activity will become a genuine and thriving business. …