April 5, 2008
KINDER, GENTLER LOANSHARKING:
The Micromagic of Microcredit (Karol Boudreaux and Tyler Cowen, Wilson Quarterly)
Yes, microcredit is mostly a good thing. Very often it helps keep borrowers from even greater catastrophes, but only rarely does it enable them to climb out of poverty.The modern story of microcredit began 30 years ago, when Yunus—then an economics professor at Chittagong University in southeastern Bangladesh—set out to apply his theories to improving the lives of the poor in the nearby village of Jobra. He began in 1976 by lending $27 to a group of 42 villagers, who used the money to develop informal businesses, such as making soap or weaving baskets to sell at the local market. After the success of the first experiment, Yunus founded Grameen Bank. Today, the bank claims more than five million “members” and a loan repayment rate of 98 percent. It has lent out some $6.5 billion.
At the outset, Yunus set a goal that half of the borrowers would be women. He explained, “The banking system not only rejects poor people, it rejects women.... Not even one percent of their borrowers are women.” He soon discovered that women were good credit risks, and good at managing family finances. Today, more than 95 percent of Grameen Bank’s borrowers are women. The UN estimates that women make up 76 percent of microcredit customers around the world, varying from nearly 90 percent in Asia to less than a third in the Middle East.
While 70 percent of microcredit borrowers are in Asia, the institution has spread around the world; Latin America and sub-Saharan Africa account for 14 and 10 percent of the number of borrowers, respectively. Some of the biggest microfinance institutions include Grameen Bank, ACCION International, and Pro Mujer of Bolivia.
The average loan size varies, usually in proportion to the income level of the home country. In Rwanda, a typical loan might be $50 to $200; in Romania, it is more likely to be $2,500 to $5,000. Often there is no explicit collateral. Instead, the banks lend to small groups of about five people, relying on peer pressure for repayment. At mandatory weekly meetings, if one borrower cannot make her payment, the rest of the group must come up with the cash.
The achievements of microcredit, however, are not quite what they seem. There is, for example, a puzzling fact at the heart of the enterprise. Most microcredit banks charge interest rates of 50 to 100 percent on an annualized basis (loans, typically, must be paid off within weeks or months). That’s not as scandalous as it sounds—local moneylenders demand much higher rates. The puzzle is a matter of basic economics: How can people in new businesses growing at perhaps 20 percent annually afford to pay interest at rates as high as 100 percent?
The answer is that, for the most part, they can’t. By and large, the loans serve more modest ends—laudable, but not world changing.
Microcredit does not always lead to the creation of small businesses. Many microlenders refuse to lend money for start-ups; they insist that a business already be in place. This suggests that the business was sustainable to begin with, without a microloan. Sometimes lenders help businesses to grow, but often what they really finance is spending and consumption.
That is not to say that the poor are out shopping for jewelry and fancy clothes. In Hyderabad, India, as in many other places, we saw that loans are often used to pay for a child’s doctor visit. In the Tanzanian capital of Dar es Salaam, Joel Mwakitalu, who runs the Small Enterprise Foundation, a local microlender, told us that 60 percent of his loans are used to send kids to school; 40 percent are for investments. A study of microcredit in Indonesia found that 30 percent of the borrowed money was spent on some form of consumption.
Sometimes consumption and investment are one and the same, such as when parents send their children to school. Indian borrowers often buy mopeds and motorbikes—they are fun to ride but also a way of getting to work. Cell phones are used to call friends but also to run businesses.
For better or worse, microborrowing often entails a kind of bait and switch. The borrower claims that the money is for a business, but uses it for other purposes. In effect, the cash allows a poor entrepreneur to maintain her business without having to sacrifice the life or education of her child. In that sense, the money is for the business, but most of all it is for the child. Such lifesaving uses for the funds are obviously desirable, but it is also a sad reality that many microcredit loans help borrowers to survive or tread water more than they help them get ahead. This sounds unglamorous and even disappointing, but the alternative—such as no doctor’s visit for a child or no school for a year—is much worse.
Commentators often seem to assume that the experience of borrowing and lending is completely new for the poor. But moneylenders have offered money to the world’s poor for millennia, albeit at extortionate rates of interest. A typical moneylender is a single individual, well-known in his neighborhood or village, who borrows money from his wealthier connections and in turn lends those funds to individuals in need, typically people he knows personally. But that personal connection is rarely good for a break; a moneylender may charge 200 to 400 percent interest on an annualized basis. He will insist on collateral (a television, for instance), and resort to intimidation and sometimes violence if he is not repaid on time. The moneylender operates informally, off the books, and usually outside the law.
So compared to the alternative, microcredit is often a very good deal indeed.
Improving lives is no small achievement. Posted by Orrin Judd at April 5, 2008 7:35 AM