Friday, June 1, 2007

In defense of microfinance

Does anyone know how to post something "behind the scenes" and then link to it? I predated this article so it wouldn't clog things up (it's a long post), but I'd really like to "hide" it somewhere and only link to it within another blog entry. If you have thoughts, let me know. Thanks :)

Hitting its Mark: Microfinance and the Alleviation of Poverty
by Peter Greer

In the face of overwhelming world poverty, microfinance shines as a proven way to improve the lives of many of the world’s poorest people. After more than 30 years and hundreds of millions of micro-loans, this intervention has been recognized as one of the most effective ways of addressing poverty of all time.

Of course, once any movement becomes popular, it attracts critics. Microfinance recently took a strong hit from a surprising source, the Stanford Social Innovations Review in its Summer 2007 edition ( The magazine published an article by Aneel Karnani, boldly titled “Microfinance Misses its Mark,” in which Karnani made several aggressive, yet largely unsubstantiated, claims. His criticisms of microfinance are not new, however, given the prominence of the usually excellent publication that printed them, they deserve thoughtful rebuttal.

Is microfinance drawing too much attention? Should we, as Mr. Karnani suggests, redirect resources away from microfinance and into labor-intensive factories? Or is microfinance a tool that has not been fully utilized? Must we choose one or the other? Or do we need both – and more – to hit the mark of reducing poverty?[1] For that matter, what is the “mark”? Let us try to answer these and other questions by addressing some of Mr. Karnani’s arguments and assumptions:

1. Microfinance has been over-hyped.

Guilty as charged. Some claims about microfinance have been over-the-top, inviting skepticism. Microfinance alone cannot solve poverty. It is one tool, not a panacea. Defeating poverty, especially spiritual poverty, will take far more than microfinance. Other interventions, including Mr. Karnani’s large, labor-intensive factories, certainly have their place in the development toolbox.

2. Microfinance misses its mark – it doesn’t lift people out of poverty.

Mr. Karnani provides no evidence for this assertion except for “macroeconomic data,” the use of which may be inappropriate and even irrelevant for this question (see below). In contrast, the impact of microfinance – changes in people’s lives – is well documented and readily evident to those who visit microfinance programs worldwide.

Many studies have shown increases and diversification in income and assets and decreases in vulnerability. A few examples are listed here:[2]

* BRI clients in Indonesia reported an average client income increase of 112%;
* Clients of several institutions in Ghana realized income increases of $36 (vs. $18 for non-clients);
* The incomes of two-thirds of CRECER clients (Bolivia) increased, and clients reported consumption smoothing. Eighty-six percent of clients reported increased savings; and
* Long-term (four years or more) BRAC clients in Bangladesh increased their household spending by 28% and assets by 112%. These clients also saw reduction in vulnerability through consumption smoothing and asset increases.

Could it be that Mr. Karnani is a victim of the hype propagated by over-enthusiastic cheerleaders of microfinance? This may be reflected in his use of wide-ranging terms for defining the “mark” for microfinance. He uses “alleviating poverty” but also “lifting people out of poverty,” “curing poverty,” and even “eradicating” poverty. It is one thing to define microfinance's mark as poverty alleviation but another altogether to say its aim is poverty eradication. Even though anecdotal evidence shows that it is possible to make big gains, studies tend to show that the norm is more modest - alleviation.

Would, say, a 50% increase in income of the very poor “lift them out” of poverty? Probably not.

Would it “cure” or “eradicate” poverty? Not likely.

However, would it “alleviate” poverty? In other words, would the lives of those people significantly improve? Most definitely.

A 50% increase in income, even if it would be relatively small in absolute terms and tiny to our Western eyes, would likely mean that people eat better, enjoy better health, improve their housing, and/or have greater confidence and hope for the future. It would also provide a catalytic boost toward additional improvement – perhaps even permanent graduation out of poverty. If this is the “mark,” not rapid, overnight “eradication of poverty,” then microfinance is indeed hitting it.

Moreover, in trying to determine the goals and success of microfinance, one must think long-term. FINCA, a leading microfinance network, reports that 93% of its clients have all their school-age children in school. John Hatch, FINCA’s founder, encourages us to look at the “intergenerational” changes that are occurring:

We may have been focusing for the past 20 years on the wrong assumption – that (our clients) will grow their businesses and the family will get better and better off and eventually step out of poverty.

I don’t think that’s an accurate perception of what is happening. The priority of the mother is not on growing the business, but growing the child’s education. Her strategy for supporting the child’s schooling is her strategy for escaping poverty.[3]

To be sure, not every microfinance client enjoys dramatic success. Some experience modest returns, and a small percentage even fail – a reality in capitalist economies with winners and losers. However, there is ample evidence of significant change in the lives of the very poor with whom HOPE International and other microfinance organizations work.

Some clients’ stories may not appear very dramatic to those in wealthy nations – and may not even show up as a blip on a country’s GNP. But for someone earning a dollar a day, adding a second dollar can make a huge difference. Pocket change to us, but the world to them.

While microfinance’s impact may not reach the stratospheric hype surrounding it (that microfinance alone can eradicate poverty everywhere), the vast majority of microfinance clients are benefiting in real and unprecedented ways from this service. To abandon one of the few clearly well-functioning tools in development for failing to reach its hype would be incredibly short-sighted and unfair to the millions who have yet to take advantage of the fruits of microfinance.

3. Macroeconomic data show that microfinance misses its mark.

In determining whether microfinance is succeeding, Mr. Karnani may be examining the wrong data. Mr. Karnani says, “…my analysis of the macroeconomic data suggests that although microcredit yields some non-economic benefits, it does not significantly alleviate poverty.” He then cites the growth of countries like China, Vietnam, and South Korea and compares them to the entire continent of Africa.

Again, could Mr. Karnani be a victim here of the hype – expecting too much from microfinance? He will be disappointed, as would any of us, if he expects microfinance to transform entire nations, especially as measured by GDP. While he does not specifically cite GDP figures, this is implied in the countries that he compares. Instead, when examining poverty, one should look at changes amongst poor and very poor individuals, families, and communities.

One should examine the distribution of income and wealth, not just aggregate figures for an entire country. Developing countries have extremely unequal income distribution. For example, according to the World Fact Book, 10% of Sierra Leoneans enjoy only 0.5% of the country’s income. The country’s top 10% earn 87 times more, or 43.6% of the GDP. In Brazil the figures are 0.7% and 31.3%, respectively. The disparities are even greater when measured as “wealth” (assets) as opposed to income.

Swaziland serves as a typical example of income disparities. The bottom 10% receive one percent of income and the top 10% share 50.2%. Assume that, through microfinance and other development efforts, the poorest 10% made significant increases in their household income. Such would result in almost no influence on the nation’s aggregate GDP. A 50% increase in income for the lowest 10% of income earners would mean a lot to these people but little to Mr. Karnani’s macroeconomic analysis.

Given this measure, ironically, if one really wanted to focus on increasing GDP and other macroeconomic indicators as a measurement of whether any development intervention is hitting its mark, the best way to do that would be to help the rich! Increasing the income of only the richest 10% of a country, if they represent 50% of its income (not to mention 70%-90% of its wealth), would make a major difference in GDP. Unfortunately, it probably would not fight poverty.

In addition, when considering a country’s economic growth and whether microfinance is making a difference, one ought to consider the percentage of a country’s population being served by microfinance. In India, for example, the microfinance industry is reaching no more than 1.5% of the population of 1.12 billion. Even an enormous income increase amongst these 17 million people would have little effect on the nation’s GNP – especially, again, when their incomes were so low to start with.

4. Some clients may be worse off from microfinance.

While this may be relatively rare, theoretically it could be true. As mentioned above, in business (including those involving large, labor intensive factories), not all succeed. All enterprises, from the largest to the smallest, are subject to competitive pressures.

However, failure at the level of the very poor is relatively rare. The client success rate is tremendously high when compared to other economic development interventions.

Perhaps this is partly true because historically, before receiving help from microfinance institutions, many clients were already refined by fire – by borrowing from high-interest loan sharks at real rates of 10%-20% per month and more. Despite such rates, they were able to operate somewhat profitable businesses. It is no wonder, then, that when they finance their enterprises instead with microloans at rates of a fraction of the moneylenders’, they rarely fail.

No development intervention is perfect. A certain percentage of people will be worse off as a result of just about any effort, and historically, most attempts to “help the poor” have failed. However, one failure accompanied by 99 successes is hardly justification for throwing away the tool of microfinance. Even if such success is sometimes more modest and often takes longer than might have been thought 10 years ago, it is still significant.

5. Few have studied the impact of microfinance, and what they have found has been troubling.

Mr. Karnani’s information in this area is terribly dated, highly selective, and bafflingly limited. For example, to support one point he cites a study from 1996 – one of the very few that reached the conclusions he apparently sought. This is despite the existence of several much more recent studies reaching quite different conclusions.

Rigorous impact evaluations whose methodologies satisfy academics and similar parties require enormous amounts of time and hundreds of thousands of dollars. Thus, it would be impractical and even a questionable use of resources for every microfinance institution to do frequent, in-depth studies. Nevertheless, well over 100 such studies, many financed by objective third parties such as USAID’s “Assessing the Impact of Microfinance Services” (AIMS) Project, were completed from 1986 to 2005.

Space limitations and concern that readers may question this author’s own “selection bias” prevent the inclusion of a detailed list of results. Readers may draw their own conclusions from a literature review titled “Measuring the Impact of Microfinance: Taking Stock of What we Know,” by Nathanael Goldberg ( This landmark study, released in December 2005, surveys roughly 100 studies (excluding only those with serious methodological flaws) and includes hyperlinks to the original studies themselves. Those who commissioned the study desired “that we could finally have informed discussions about impact rooted in empirical data rather than ideology and emotion.”[4]

The report even addresses some of the issues raised by Mr. Karnani:

We know every client does not overcome poverty and that there are few overnight successes. Yet, we are confident that the trend is solidly in the right direction…

Some…findings may surprise many people. For example, two major studies strongly suggest that microfinance works best for the poorest rather than the less poor. Second, there is strong evidence that female clients are empowered… Third, society-wide benefits that go beyond clients’ families are apparently significant… Fourth, even in cases where women take but do not use the loan themselves, they and their families benefit more than if the loans had gone directly to their husbands.

Perhaps, as is suggested, ‘After reading this paper, even people who have not spent time in communities benefiting from microfinance will be confident that microfinance is an effective, and ever-improving, strategy for tackling the global poverty crisis.’[5]

Again, supporting evidence for these generalizations can be found in the original studies, of which there are upwards of 100.

6. Microfinance’s positive impact in women has been primarily that of “non-economic empowerment.”

The only way to understand this claim is to recognize that it is part of Mr. Karnani’s larger assertion that microfinance is not working in general – that it does not alleviate poverty. Hopefully, this article already sufficiently addresses that concern. If, as experience shows, clients are benefiting (albeit at times modestly and often over the long term), we must conclude that women are benefiting. After all, 80% of microfinance clients are women and experience has shown that on average they and their children benefit far more from microfinance than do men.

However, even if for the sake of argument one were to agree that the benefit to women has been largely limited to “empowerment,” that fails to signify that women’s empowerment is “non-economic” – and thus apparently of little value. Karnani is also too eager to dismiss the “non-economic” aspects of empowerment. When a woman who has little, if any, influence over household decision-making sees the kind of increase in her status shown by Sajah below (an Indian woman who used to beg on the street but now employs 70 people, including her formerly-abusive husband), this can benefit the family – in “non-economic” and economic ways.

Karnani himself recognizes the benefits of social development when he says the following on p.39:

Poverty alleviation cannot be defined only in economic terms; it is also about addressing a much broader set of needs. Amartya Sen, the Nobel-prize-winning economist, eloquently argues that development can be seen as a ‘process of expanding the real freedoms that people enjoy.’ Social, cultural and political freedoms are desirable in and of themselves, and they also enable individual income growth.

He then goes on to argue that because of this broader view of development, governments should provide more and better social services. It is astounding that in doing this he is seemingly unaware of the irony of having previously dismissed women’s empowerment from microfinance as being “non-economic” and thus of little value.

7. The poor would be better off with labor-intensive factory jobs.

This article began by agreeing with Mr. Karnani’s concern over the way in which microfinance has been over-hyped, and it will conclude this list by agreeing partly with him here as well. Microfinance practitioners do not aim to downplay the importance of steady employment and the added-value of manufacturing and other productive endeavors. Stories even exist of poor people taking loans from microfinance institutions to use as bribes to get factory jobs.

This is despite criticism in the West of such “sweatshops” and even cases where one has to raise the issue of abuse and exploitation. In many cases these labor-intensive factories can be highly beneficial to the poor. It is fair to say that even if some studies find that 1 out of 10 of these factories is actually abusive and exploitative, there could still be good coming from the other nine that should not be discounted.

However, is building labor-intensive factories a realistic option for everywhere? Will the China model work in all countries and regions within those countries? Will the poor always be given that choice – a factory job or self-employment? Furthermore, how much would it take to employ the billions of people who do not have such work? Is our choice really one of “either-or”? – either factory jobs or microfinance?

7.1 Is this a realistic option?

In a word, no. It is great that the economic reforms and other factors in China have lifted millions out of poverty through promoting labor-intensive manufacturing jobs. But the China model is difficult to replicate. It takes more than capital to compete in manufacturing. Such success requires government stability, reasonable infrastructure and transportation links, good communications, hard-working and educated work forces, the absence of major corruption, and the rule of law, among other factors.

Will labor-intensive manufacturing work everywhere – and be competitive on the world market against China and similar countries? Will it work in Congo, Sierra Leone, Afghanistan, and Liberia? Microfinance works in these countries – it helps alleviate poverty. People in each of these countries are better off because of it, and many more could use its help. Mr. Karnani suggests that we abandon these gains and invest instead in ventures that are likely uncompetitive and destined to fail.

7.2 $100K for 500-employee factories vs. 500 sewing enterprises.

Where in the world can a 500-employee factory be created with only $100,000? In many countries, it is not even possible to acquire the land with that paltry sum of capital. An industrialist in China who has created and operated many factories has said that the amount needed would normally be dozens of times or more that. This industrialist says that even in low-cost China, a typical factory would employ about four people for every $100,000 of capital. In this case, to build a factory for 500 people would cost $12.5 million. How many microfinance jobs could be created with $12.5 million?

Furthermore, microfinance would produce more than 500 jobs with $100,000, using the figures in Mr. Karnani’s example. How? When the loans are staggered and well-managed, payments from initial loans can be used to make new loans – resulting in hundreds more clients being helped. Furthermore, when clients “graduate” and no longer need credit, the money can be used to help hundreds more. Putting these two factors together, over time, thousands, not just 500, could be equipped with $200 sewing enterprises with a $100,000 loan fund.

Thus, even where factories can be built and be competitive on world markets, the choice appears not to be 500 sewing enterprises vs. 500 factory jobs. Instead, for $100,000, thousands of sewing enterprises or a handful of factory jobs could result. That is even assuming that the sewing enterprises would need $200. Two examples of entrepreneurs who bought sewing machines for far less are cited below.

7.3 “Either/or” or “both/and”?

For these and other reasons, those striving to combat poverty should not limit themselves to one tool.

The world, and the world of poverty, is so diverse that a “one-size-fits-all” approach seems misguided at best. As the industrialist in China said, “We need BOTH microfinance and manufacturing – PLUS a lot more.”

Despite the attention that microfinance has received, it still reaches only a fraction of the number of people who could benefit from it. Major improvements in people’s lives are resulting from what Mr. Karnani and others might dismiss as minor changes. Mr. Karnani argues that too much attention has been showered on this tool; in reality, there has not been enough, since hundreds of millions more people could benefit. It is time to roll up our sleeves and follow the industrialist’s advice – to help many of these people with microfinance, manufacturing, and more.

As President of HOPE International, an organization that operates and supports microfinance operations in a dozen countries and is dedicated to providing permanent solutions to poverty, this author has repeatedly seen microfinance make a substantial difference in people’s lives. Articles like Mr. Karnani’s have the devastating potential to persuade some that microfinance is receiving too many resources and doing too little, when in reality this wonderful tool is underutilized.

Is microfinance a “ten” on a scale of one to ten? No, it is not. It’s an eight. It is very effective but not perfect. The problem is that microfinance has been so hyped that some expect a ten – or even a fifteen – and are ready to abandon it if it does not live up to these exaggerated, unrealistic expectations. Readers should appreciate microfinance for what it can do and evaluate it in terms of the ones and twos that have comprised so much of the rest of development efforts over the decades.

Those who have gone to “the field” and talked with people who are benefiting from microfinance feel excited about the results and further potential of this intervention. Given that fact, this article concludes by taking the reader on a journey to the field through the stories of some of the countless men and women who are benefiting from microfinance.
From $7/mo to $75/mo: A client in Pune, India earned $7/month working seven days a week as a dishwasher before accessing a loan. When a HOPE representative recently visited her and her family of four, the interior of their tin can house was sweltering, forcing him to periodically step outside for fresh air. She described how, since receiving a $125 loan to purchase a sewing machine, her income has risen to $75/month. She now sews on contract for local stores, turning their raw materials into key fobs, shorts, and other articles. While her absolute income may still be low enough to conclude that she has not been “lifted out of poverty,” she and her family are thrilled with their 10-fold increase in income.

From vendor to manufacturer: In Zaporozhye, Ukraine, Taras Fessik provides an illustration of how typical entrepreneurs get their start – not with a $100,000 loan for a factory, but much more modestly. Taras began with a loan of $500 to sell socks and hosiery in a kiosk. With additional loans, he grew his business and within 10 years became part-owner of a factory employing 50 people, manufacturing some of the very items he once sold.
From struggling, to blessing hundreds: A few years ago, Milán Tapia lived hand-to-mouth in the Dominican Republic. Like one-third of her compatriots, Milán earned less than $1/day. Then, Milán received a loan of just over $100, which she used to buy a sewing machine. With additional loans, she bought more equipment and materials to manufacture and sell women’s clothing. She also met Christ and dedicated her life to serving Him. In time, Milán felt called to pass on her blessing to others. She developed a vision for educating, feeding, and loving the children of her community, especially those most disadvantaged. More than 200 children now come each day to receive this care from Milán and others at “Tu Hogar Cristiano” (Your Christian Home).

From abused beggar to respected businesswoman: In the city of Guntur, India, Sajah Sabama lived in a hut and begged on the streets for pennies a day. She was looked down upon, even by her abusive husband, who would sometimes burn her fingers in scalding oil when she arrived home later than expected. With an $85 loan, Sajah developed an ingenious way to earn a living and create employment for many others. She bought trinkets and offered them to children in exchange for the hair collected from their mothers’ brushes. She sold the hair to a pharmaceutical company, which extracts the oil for medicinal purposes. Her business grew rapidly, and she now employs 70 women. She and her family live in a comfortable home, and her children are healthy and attending school. Her husband no longer abuses Sajah; he even works for her now, running errands on a motorcycle for her business. She reports that people respect her now, “even my husband.”

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