Microfinance has at times been labeled as one of the greater international development solutions of the 21st century. The idea underlying it is quite simple – people in developing countries, stuck at the bottom of the economic ladder, can change their life and become self-sustained with loans as small as several hundred dollars. On an aggregate country level, this generates growth by moving people out of extreme poverty.
Over the past few years, a number of microfinance banks and organizations have sprung up around the world, driven partly by the global attention generated by Muhammad Yunus and his Nobel Prize. These institutions are becoming an alternative to big banks, unwilling or unable to give loans to “the little guy” who often lacks collateral. I myself have seen Muhammad Yunus speak and he is quite engaging in making the case for microfinance.
Not discounting the usefulness of microloans, James Surowiecki questions their contribution to the development of countries in this New Yorker piece. Here is (a rather lengthy but) a good summary of the main idea:
The idealized 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 recent paper, often used for non-business expenses, such as a child’s education. It’s less common to find them used to fund major business expansions or to hire new employees.
In other words, as the argument goes, microloans for the most part fund operational activities of small entrepreneurs and don’t lead to much job creation through hiring new workers. And if development is much about creating jobs and generating wealth, microloans [despite doing a lot of good for individuals] do not lead to sweeping macro-level economic changes. What say you?
Published Date: July 23, 2008