Why Microloans Are No Panacea

With Mohammad Yunus getting the 2006 Nobel Peace prize for his microlending idea, implementation (mainly in Bangladesh), and global promotion, the practice of microlending reached a high point. There have been some complains about microlending - the main complaint is the almost astronomical interest rates that this type of lending charges - 25-50%, or more, annualized. Some of it can be explained away as risk premium. But Yunus claims a repayment rate of 99-98%, mainly due to peer-pressure of the community. Based on the default rates claimed and possible risk, the interest rates still are very high.

Another main grouse against microlending is that it's not a substitute for good goverance, free economic policies, and social spending by government. James Surowiecki, writes in the New Yorker, that there may be something to this.

The fundamental flaw in microlending promoters is the assumption that all people are entrepreneurs - i.e., a poor women running a family can buy that cow, or chickens, or rotating mobile phone to increase or complement sustenance income and very soon the family would move into lower middle class. It works for many people. But most people are not entrepreneurs. Most people want a steady sustainable income. For that, small to medium size businesses (SMBs), many of which require no- or low-skill, have to be promoted with wise economic policies and good governance - low taxes, ease of setting up business, and having access to cheap credit. Microlending can do none of that.

Surowiecki uses a study by Karol Boudreaux and Tyler Cowen to write that for poor society to become well off, promoting small and medium businesses (SMBs) is the key.

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What poor countries need most, then, is not more microbusinesses. They need more small-to-medium-sized enterprises, the kind that are bigger than a fruit stand but smaller than a Fortune 1000 corporation. In high-income countries, these companies create more than sixty per cent of all jobs, but in the developing world they’re relatively rare, thanks to a lack of institutions able to provide them with the capital they need. It’s easy for really big companies in poor countries to tap the markets for funding, and now, because of microfinance, it’s possible for really small enterprises to get money, too. But the companies in between find it hard. It’s a phenomenon that has been dubbed the “missing middle.”[What Microloans Miss - New Yorker]

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A condensed version of the article at IE.

Although Surowiecki talks of angels and venture capitalists, the key to nurturing SMBs is bureaucratic reform such as easing business hurdles - reducing time and money needed to form SMBs and labour reforms that gives SMBs hiring flexibility. The key indicators for ease of doing business are in the annual "Doing Business" publication by World Bank. Unfortunately Bharat is always in the bottom quartile, along with most poor-income, high unemployment countries. The UPA government has done nothing to ease the burden of promoting SMBs in the past four years with all indicators decreasing or static for 2007 and 2008 (presumably for years 2006 and 2007), except for credit and cross trade profile. Over all Bharat is still categorized under "difficult."